Twin Disc Inc (TWIN) 2008 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Twin Disc 2009 second quarter financial results conference call. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded today, January 22, 2008. I would now like to turn the conference over to [Andrew Berger]. Please go ahead, sir.

On behalf of the management of Twin Disc we are extremely pleased that you have taken the time to participate in our call. Thank you for joining us to discuss the Company's fiscal 2008 second 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. Some additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements is 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 [Pauline Collins] at 262-638-4000, and she will send a copy to you.

Hosting the call today are Michael Batten, Twin Disc's Chairman, President and Chief Executive Officer; and Christopher Eperjesy, the Company's Vice President of Finance, Chief Financial Officer and Treasurer.

At this time I will turn the call over to Michael Batten.

Good afternoon everyone and welcome to our second quarter conference call. I will start with a brief statement, and then both Chris Eperjesy and I will be available to answer questions.

Sales for the quarter improved 10.3% to $81.9 million from $74.2 million in the same period last year. Sales for the first six months rose 11.1% to $155.5 million from $140 million reported in the first half of fiscal 2007. Favorable foreign currency translation represented $5.1 million of the $7.7 million increase in sales for the first quarter, while the same factor represented $7.5 million of the $15.5 million increase in sales for the first half.

The remainder of the increase in sales for both the quarter and six months was mainly the results of strong sales of marine and propulsion products to the commercial marine and mega yacht market, as well as continued demand for land-based transmission products for Airport Rescue and Fire Fighting and military markets.

Gross margins in the fiscal 2008 quarter decreased 2.0 percentage points from 32.9% to 30.9% compared to the same quarter a year ago. Year-to-date gross margins declined modestly from 31.9% to 31.6% compared to the similar period last year.

Second quarter profitability was negatively impacted by reduced sales of higher margin products, higher sales of lower margin products, and higher material costs, partially offset by higher pricing, expanded outsourcing, and lower pension expense.

The fiscal 2007 second quarter and first six months included the impact of unfavorable purchase accounting adjustments to inventory in the amount of $489,000 and $1,223,000 before tax, respectively.

Further, second quarter results were impacted by higher marketing, engineering and administrative expenses, which was -- as a percentage of the sales rose to 21.2% from 19.6% for the same three months a year ago.

The higher ME&A expenses were due to approximately $1 million increase in stock-based compensation, primarily a result of the increase in the price of the Company's stock, the impact of foreign currency translation from overseas operations and expenditures related to a new global ERP system. Year-to-date ME&A expenses rose more modestly to 20.6% from 20.1% a year ago.

As a result, net earnings for the fiscal 2008 second quarter declined to $4.2 million or $0.37 per diluted share compared to $5.7 million or $0.48 per diluted share for the equivalent three months a year ago. Year-to-date earnings of $9.3 million were equal to the same period last year, although earnings per diluted share improved to $0.81 compared to $0.79 as a result of the repurchase of shares in the first fiscal quarter.

For the second three months EBITDA totaled $9.6 million, down from $12 million reported in the same period a year ago. For the first six months EBITDA was $20.4 million compared to $20.1 million for the first half last year. As indicated in our press release, while demand for many of our products remains at a historical high, we have begun to experience a shift in our sales mix. Most notably, we have begun to see a slowdown in demand for our oil and gas transmissions. In addition, our industrial markets continue to experience a cyclical softening. However, despite a slowdown in these sectors, our commercial and mega yacht segments of the marine market and our Airport Rescue and Fire Fighting and military markets continue to grow.

Looking ahead, we continue to expect that fiscal 2008 will be another good year for Twin Disc. Our backlog of orders to be shipped over the next six months stands at $121 million, up 8% from $112 million reported a year ago, and up 10% from $110 million at the fiscal 2007 year end.

That concludes the prepared remarks for today, and Chris and I are prepared to take questions at this point. So, Josh, I will hand it back to you to start that Q&A period.

(OPERATOR INSTRUCTIONS). [Shawn Daley, THM Holdings].

I know you don't generally give forward-looking guidance, but your stock is having the worst day in its history, down 25.6%. How do you feel about '08?

Actually, I am encouraged by the prospect for the second half of the year. As I have indicated in our general outlook in the press release and my remarks, right now, we are seeing obviously, as reported, some slowing down of activity in oil and gas and in industrial, but our volume did increase despite that year-over-year and quarter-over-quarter. We see that continuing for the balance of the year.

So our marine markets represented by propulsion products and marine transmissions going into commercial applications, and our transmissions going into military and ARFF applications are still growing, and we're comfortable about our outlook for the balance of the year.

How much do you have left on the repurchase, and is it accretive at this level?

I'm sorry, I didn't understand it --.

How many shares are left on your repurchase authorization and --?

I see. 140,000 shares are available under the repurchase authorization that we have.

Do you expect to go to the Board to increase that?

At this point in time we will work with the 140,000, and to the extent that we need to go to the Board, or want to, we have that capability.

(OPERATOR INSTRUCTIONS). [T.J. Carter, Altpoint Capital].

I had a question. Could you guys try to give us some more color on the oil and gas transmission weakness that you're seeing? Is that in any particular region or is that across the board?

The oil and gas market during the second quarter did see some softening, and it was largely here in North America that we saw it, both Canada and in West Texas. Some rescheduling or, actually in some cases, some cancellations of transmissions. We do see that activity does continue -- not everybody was involved in that activity. We have customers that are hanging on to their schedules, and we are planning to ship more in the second half.

The activity seems to have moved to Russia and to China, where we are active in selling transmissions directly. In that regard, we do supply our good North American customers, but we are also involved in supplying, for example, and have shipments going out this quarter to a new Chinese customer that we have acquired for application on their home-built or Chinese-built rigs.

We are also active supporting the population that has gone into Russia, and see opportunities in that market area as they prepare to spend a lot of money to develop their oil and gas markets as well. So come, yes, we hit a bump in the road in the second quarter. But that does mean that we still have order board and backlog for oil and gas transmissions going forward.

My next question. You guys have I guess outsourcing initiatives to help improve the margins. Could you give a little bit more color on the progress there, and how much more you guys could do going forward?

Regarding our global outsourcing effort, we're actually doing two things. One is, we say global, but part of it is resourcing both here in the U.S. and in Europe where we can get a total cost that is lower. But we are also putting a heavy emphasis on our expansion into India and China for sourcing activity. We have two offices in China. We have one office in India staffed with people who are engineers, manufacturing engineers, quality and purchasing people, as well as we are staffing up in the design engineering, as well in the office in India.

The activity is more in the -- about the third inning, so to speak, in a baseball game. We have got our feet on the ground. We're actually sourcing parts from these locations. We've got plenty of room to grow in this area to improve our margins and/or offset -- granted, we did see some material increases occurring, but our outsourcing is working on that.

My final question. Could you update us on your acquisition pipeline, and maybe how you acquisition versus share buyback, given where your stock is now?

A good question. The acquisition pipeline has candidates in it at various stages of the process. I'm not going to be definitive or project when we might do something, but we are actively in discussions and something could materialize or not materialize. You know how that works. But we are active in the acquisition front.

As it relates to stock buyback, at this point in time if we were to have an acquisition come our way, I think I would prefer to put the cash into an acquisition because of the long-term growth in revenues and earnings possibilities that an acquisition would offer.

But that doesn't mean that along the way that we might not have some repurchase activity going forward. It isn't going to be an either or situation. I think what we're going to see is possibly some of both.

(OPERATOR INSTRUCTIONS). [Shawn Fang], NorthPointe Capital.

Two questions. Number one, could you comment on the luxury build mega yacht market? Number two, could you tell us what is the competition for the backlog as far as what percentage is from oil/gas, what percentage is from the boat, etc.?

The mega yacht market continues to do very well for us. Activity continues to be strong. The yards are optimistic about their outlook for the balance of this year and into next. So there's a lot of activity and we're very encouraged by it.

With respect to our backlog, we don't break out the numbers by market, but the composition of backlog in our transmission business has been healthy. It is a combination of both oil and gas and military and ARFF transmissions. The marine backlog both for mega yacht and commercial applications, that would be offshore oil related, both here domestically as well as overseas, is very strong.

Joe Norton, Singular Research.

I'm just trying to get a sense -- maybe you can say what you think, but I'm just trying to get a sense of what do you think -- why the disconnect or why are we seeing continued strength or such good strength on the marine side and such a slowdown on the industrial and the oil and gas? Is that just a matter of where you are geographically, or what do you think is accounting for that difference?

In part they are entirely different marketplaces, I'm sure you understand in just raising the question. The industrial markets by and large that we serve are domestic, though we do have global exposure with our Italian company as well. They are facing some of the slowdown that the U.S. economy has been experiencing along with some of the other markets, housing and automotive.

The marine market that we serve is unique. Most of the press that one would read about the pleasure craft market here in the United States deals with the lower horsepower segment of boating, and that of course is depressed, and reflects some of the same issues of high fuel prices and interest rates -- at least up until today -- in that marketplace for buyers without a great deal of discretionary income.

Now when you talk about the mega yacht market, you're talking a completely different story in terms of geography and income -- disposable income availability. These yachts are multi-million dollar yachts, and recession here in the United States or even elsewhere is not going to play as much a factor, if any at all, in the purchase of these yachts.

The other thing in terms of geography that is interesting is that many of these yachts are being purchased by people coming out of, I would say, the nonindustrialized countries that are making huge amounts of money from whatever they're doing. For example, there is a huge influx of wealthy Russians that are in effect taking a great deal of the product that is being built in Italy or along the Mediterranean yacht market. So that kind of wealth isolation and new money coming from Russia, China, in addition to the Middle East and others, continues to drive the yachting market. Does that respond to your question?

Yes, that is helpful. Historically have you seen -- is it normal that you would see the slowdown in the industrial business first, and then marine is just lagging, or do you really just not think that there is any correlation between these two?

The markets that respond to interest rates, such as the industrial and the lower horsepower pleasure craft, do tend to be more leading cycle product market segments than some of our other productlines and marketplaces. So historically, yes, the industrial markets have tended to be a leading indicator. However, the factors that continue to support us are in many -- in some cases I should say exogenous to the normal rule. That is the wealth factor we just talked about and the high-end boat segment that doesn't necessarily mean that it has to follow any cycle at all.

The military markets have been very good for us. That outlook continues to be healthy from our perspective. And then of course, the oil and gas, while we hit a bump in the road in the second quarter, as mentioned previously, the longer-term outlook for oil and gas is unlike what we have seen before. And I has been through the boom and the bust of the '70s and '80s. Even though there is, as I say, a bump in the road, the underlying demand cycle for oil and gas, given the demand from China and India -- the long-term demand suggests to us at Twin Disc that this cycle is going to have some -- perhaps some cycling, but that it isn't going to be a boom and bust kind of cycling. It is going to be more of a moderation and then continued acceleration as these countries are industrializing and using more and more oil as the U.S., Europe and Japan are using.

Just to follow on the oil and gas business, you made a comment about the geographic -- I don't know, but the moving geographics of that business. Are you guys well penetrated in those markets or are you saying that this opportunity for you to go where that business is moving?

We are already in China. We are getting more active in Russia, so we understand that we have to be there. We are doing two things. One is that our good customers are taking our product over into these markets, and those need to be supported in terms of repair, if need be, or additional trucks or fracturing rigs for the demand extension in that market -- in those marketplaces.

We also see the opportunity -- the Chinese for example have come to us, we have gone to them to develop their own fracturing rig business. And they see that while they can produce the truck, they don't have the pumps and the transmissions and the engines or the horsepower required to do the tracking. They come to us and others to provide that part of the truck, but they will develop and assemble the undercarriage and the cab and so on for the basic trucks. We are actively developing local players in both markets.

Then finally, I don't think I saw this in the press release, but you usually in your Q tell us domestic versus international sales. Can you just give me those figures?

We generally disclose at the time of the Q, so we haven't disclosed it yet. But I don't know that there is a significant shift off of what you have seen in the 10-K from last year.

Just anecdotally, are the growth rates -- are you seeing a slowing in growth rates in both of these regions or is -- just trying to get a sense of how the international markets are doing relative to the U.S.?

The international markets are relatively doing better off of their own bases than the U.S. And the reason for that being is that most of our industrial business is U.S.-based and that is softening. The oil and gas has largely been a U.S. sold activity. The units may be going offshore, but it is our customers who doing that, so we would record it as a U.S. sale and activity. So those are the two areas that have seen some softening.

The marketplaces, the product and markets that are growing are generally the mega yacht, the commercial marine, and the military and ARFF markets, and with -- the military is a combined offshore and domestic business, as is the ARFF. We're penetrating Europe very well, as well as the Far East with our ARFF transmissions.

Good. That helps a lot. Thanks very much.

[Wei Lee, Whitebox Advisors].

I have got two questions here. Sorry, I jumped on the call a little bit late, so if you comment on this, I apologize. My first question is on the slowdown in demand for oil and gas transmission in the U.S. We are seeing oil right now like basically at a historic high, and there is certainly a little bit of disconnect there. So are you saying there is an oversupply of rigs out there right now or --?

What is happening is that the North American -- just to start with a little bit broader view, the North American market is seeing a bump in the road in that the market has reached a point where cost of equipment have accelerated and there is more competition occurring at the price level -- at the rental level of these rigs. So the margin for the investor to invest and get a return has been narrowing. That is the factor that is being dealt with here.

However, the markets in China and Russia continue to grow. And some of the North American companies, frac companies, have been moving equipment -- unutilized equipment -- over into these overseas markets to take advantage of the opportunities in those territories.

We still see that some of our domestic customers are still ordering and buying oil and gas. It is not like demand has dried up 100%. But we have seen moderation occurring in the form of either, in some cases, cancellations, in other cases pushing out the order board. But overall the market continues to exist, both on a domestic and an overseas basis.

Great. What is the mix right now between U.S. and overseas revenue?

That -- we discussed it. It is not too different. We don't publish it until the Q, and that won't be for --.

At least a couple more weeks. In the 10-K the mix was roughly a little less than 60/40. So a little less than 60% domestic, and a little more than 40% international.

I wouldn't expect that to change significantly.

With the U.S. dollar going still down against major currencies right now, would that be a net benefit for you guys going forward?

In terms of translation, it is a negative. In terms of stimulus for U.S. product overseas, it is a positive. We've got a foot in -- one foot in each canoe, so to speak. We are conflicted there. But on a net basis, the financial statements are positive for a weaker dollar.

Joe Norton, Singular Research.

Sorry, I forgot to ask one other question, if you don't mind.

Sure, go ahead.

On the gross margins, is the 30 -- I guess it was closer to 31% -- is that the barometer we're looking at now, or is anything you guys can do to get that back to prior year levels in the second half?

We're working real hard on that. That is an area that has got our attention as well to find ways to do that. Now we anticipate shipping more higher margin products in the second half, but we are also experiencing issues of material cost increases. Steel prices have gone up. Surcharges are at very high levels relative to where they were even just a few months or a year ago. So we are doing everything we can to expand our outsourcing efforts to offset what is happening there and have a net addition to margin. We're also accelerating pricing activity to make sure that we are covering the increases that we are experiencing. So we're working very hard on that to get those margins back up.

Jeffrey Matthews, RAM Partners.

I apologize for the redundant question, but I am new to the story, and I just want to make sure I understand the nature of the order cancellations in the U.S. The type of company that is canceling an order is what type of company? And they are canceling because costs have run up too high, or they're cutting their budgets in response to cost increases? I'm not quite sure I understand the link.

We're talking about oil and gas and we're talking about specifically the fracturing rig market. What we do is we sell our transmissions to fracturing rig builders. They in turn sell them to operating people who rent or lease their vehicles to oil companies to do the fracturing. There is a day rate associated with that activity, that leasing day rate activity.

What is happening in the industry, the feedback that we're getting is that part of the slowdown is due to the fact that the cost of the rigs themselves, along with the other costs associated with doing the fracturing, have risen over the last several quarters to squeeze the margins of those people who are renting out the vehicles for fracturing. Given that situation, they are saying we're not going to invest in new vehicles because we are not getting our rates of return.

Got it. That is --.

That is the issue. There is another factor, and that is that with more vehicles out there, there is more competition on the day rate. But those are things that are happening in the marketplace.

(OPERATOR INSTRUCTIONS). [Scott Archer, Oaks and Ponds, LLC].

In your -- on our website in the description of the Company, it makes the statement that the Company has become a major player, if not a market leader, in each of its market segments, and has added new technologies. Given the businesses that you are in, I thought that is surprising. Like Jeff Matthews, I am relatively new to the story. But I am surprised at your overall revenue base wouldn't be a lot bigger, given you are international in all the big markets that you serve. Could you comment on that?

I think that in the markets that we're serving, which is largely the marine-based markets behind diesel engines and the transmission markets, again behind diesel engines but in vehicles that are high horsepower and specialty vehicles, and then industrial products, which are largely clutches or disconnect products for again off-highway heavy-duty industrial applications, while the names like transmissions and marine might suggest much larger markets, we have fairly significant shares of market in each of the activities that we're in.

So we aren't in huge global markets, at least as we define them. We're looking at our served segment. We participate in marine, for example, in pleasure craft, in commercial and in military, and we have excellent shares of market in all three of those areas of the marine market.

In the transmission market we are the Pluto, we say, of the universe because so many transmissions are built around the world, but our segment is 300 horsepower up to 3,000 horsepower. That reduces the size of the market available to us. And we have very good representation in that off-highway 300 plus horsepower market. Then in the industrial markets, again, it is how you cut the cookie, but the industrial products that we sell are largely heavy-duty disconnect products. And we have a major share of market here in the U.S. and an excellent share overseas. I hope that answers your question, but that is how we look at it.

Yes, it does. As you define and clarify your segments a little bit more, do you have an overall market size target in terms of dollars, if you would have all those markets you feel really yours together, how big that market is and what your penetration to date is?

We tend to look for markets that may not be billions of dollars, but rather more in the 100 to low hundreds of millions of dollars, because we think that our potential competitions are the Allisons or the ZF Friedrichshafens of the world, or people they have got much more critical mass than we do. While we tend to be the standard of the market in marine and industrial in the segments that we serve, we also recognize that for us to succeed we have to be able to be more nimble and design flexible to compete in the market areas that we serve. So that is our approach, is to be more niche oriented or smaller market oriented then larger market oriented.

But you have never really sat down and added all those up and say, well, here is the size of the potential market in terms of dollars that we're looking at?

We look at that, yes, we do.

But you don't disclose the number?

That's correct.

I see. Is there anything new on the competitive scene, either domestically or overseas?

What is new on the competitive scene --.

Or should I say any new threats in terms of market share competition?

There is one thing that is occurring in the marine area, which is presently in the lower horsepower segment, and this is -- they are called pods. One is being introduced by Volvo and the other is being introduced by Mercury. Volvo is called the IPS System, and the Mercury is a Zeus System. But they are in -- they are setting out in the sub 500 segment of the market. We're watching that closely and looking at what our competitive response is to be there.

(OPERATOR INSTRUCTIONS). At this time, gentlemen, there are no further questions. Please continue with any closing remarks.

We would like to thank you all for joining us today. Appreciate your interest in Twin Disc, and we are eager to continue the job that we're doing and look forward to discussing our results at the end of next quarter. Thank you.

Ladies and gentlemen, this concludes the Twin Disc 2008 second quarter financial results conference call. AT&T would like to thank you for your participation. Have a pleasant day. You may now disconnect.