Twin Disc Inc (TWIN) 2011 Q2 法說會逐字稿

Good day, ladies and gentlemen. Thank you for standing by.

Welcome to the Twin Disc second quarter financial 2011 results conference call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be opened for questions. (Operator Instructions). This conference is being recorded today, Monday, January 24, 2011.

I would now like to turn the conference over to Stan Berger. Please go ahead.

Thank you, Alicia.

On behalf of the management of Twin Disc, we are 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 2011 second quarter and first half 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 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 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 Annette [Mianake] at 262-638-4000 and she will send a copy to you.

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

At this time, I will turn the call over to Mike Batten. Mike?

Thank you, Stan and good day, everyone. Welcome to our second quarter 2011 conference call. Today I will start with a brief statement, and then John, Chris and I will be available to take your questions.

We assume that you have already read our press release. Twin Disc posted financial results for the quarter that continue to improve sequentially, as well as year-over-year. Diluted earnings per share for the quarter rose $0.35 per diluted share, compared to a loss of $0.04 per diluted share for the same period a year ago. Our backlog rose to the highest level in the past two years, and we expect continued improvement in the second half of the fiscal year.

Sales for the second fiscal quarter of fiscal 2011 were $75 million, compared to $55 million for the same three months in fiscal 2010. For the first six months of the current year, sales totaled $137 million, compared to $102 million for the first half of fiscal 2010. The growth in demand resulted from strong sales of our pressure pumping transmissions through the oil and gas market. The market for unconventional drilling remains robust. Orders for our 8500 series transmission systems have returned to peak levels. Stable demand was experienced in our ARFF, land- and marine-based military and commercial marine markets. We continue to see challenges in the pleasure craft marine market.

Gross margin for the second quarter of the current year was 31.6%, compared to 26.8% for the same quarter a year earlier, and 32.6% for the first quarter of fiscal 2011. The significant improvement in margin compared to a year ago was due to increased sales volumes, improved manufacturing efficiencies and absorption, as well as more profitable mix of business. The sequential decline in margin from the first quarter of 2011 resulted from a shift in product and market mix from the previous three months. Year-to-date gross margin was 32.1%, compared to 24% for the first fiscal half of 2010.

Marketing engineering and administrative, or ME&A, expenses for the current quarter were 24.8% compared to 27% for the second quarter of fiscal 2010. Of the $3.7 million increase in ME&A expenses between the two comparable quarters, approximately $2.2 million, or 58%, was the result of increased stock-based compensation driven by the increase in the Company's stock price in the current second quarter, as well as domestic bonus expense. Year-to-date ME&A expenses as a percent of sales were 24.5%, compared to 27.1% for the first half of last year. Of the $5.7 million increase in expenses between the two years, $4.2 million, or 73%, related to stock-based compensation and domestic bonus expense. The net remaining increase in ME&A expense both for the quarter and the half was driven primarily by higher salary and benefits, increased travel and projected related expenses -- project related expenses and a continuing emphasis on our product development program.

The effective tax rate for the first half of fiscal 2011 was 23.6%, which is significantly lower than the prior year rate of 37.6%. The rates for the comparable second quarters were 11.5% and 31-point -- 37.1%. The current rate -- year's rate includes a $794,000 benefit resulting from the increase in the estimated tax rate from 34% to 35%. The current year also includes the favorable impact of the reinstatement of an R&D credit that was passed into law during the second quarter of fiscal 2011.

Net earnings for the second quarter of fiscal 2011 were $4 million, or $0.35 per diluted share, compared to a net loss of $490,000 or $0.04 per diluted share for the three months a year ago. Year-to-date net earnings totaled $6.7 million, or $0.59 per diluted share, compared to a net loss of $2.9 million, or $0.26, per diluted share for the first half of fiscal 2010.

Our balance sheet remains strong. We've generated $4.4 million in cash during the current quarter. Total debt net of cash was $6.4 million at the end of the three months, compared to $12 million at the end of fiscal 2010, and $9.7 million at the end of the first quarter. Working capital increased to $103 million in the quarter, reflecting a 20% increase in inventories to support the growth of the oil field business. In addition, we expect capital expenditures to be about $15 million for the current fiscal year, as we continue to reinvest in new machine tools and programs to fund our anticipated growth.

Our backlog of orders to be shipped in the next six months was $119 million at the end of the second quarter, compared to $100 million at the end of the first quarter, and $70 million one year ago. We are clearly benefiting from the resurgence of oil and gas exploration and development. Orders and shipments of the 8500 series transmission are at record levels and the development of the 7500 series transmission system is ongoing. 7500 series units have been delivered to customers for field testing, and we anticipate this process to be completed over the next few months, with initial production units shipping in the fourth quarter of fiscal 2011. We are optimistic about our business prospects as we enter the seasonally strong second half of the fiscal year, and our product and geographic diversity continues to serve us well.

That concludes my prepared remarks, and now John, Chris and I will be happy to take your questions. Alicia, please open the line for questions.

Thank you, sir. (Operator Instructions). Peter Lisnic with Robert W Baird. Please go ahead.

First question, on the gross margin, the adverse mix from first quarter to second quarter; is there any way of giving us a little color commentary on what that was, and maybe what the impact exactly was on the mix line?

Sure. John, do you want to handle that?

Yes. Pete, it's two parts. It's product market and geography related. Oil and gas has pretty strong margins, as you know, but we saw, as a percentage of sales, an increase of some marine business and primarily coming out of Europe. And the European facilities are still not operating at full potential, so as their business level in terms of dollars or euros increases, it actually has, as a percentage of the wholesale, kind of a downward pull on the gross margin. Short-term it's not a good thing on the gross margin, but for us in the long-term it's definitely headed in the right direction to get them back up and operating at full potential.

Okay, and then if you continue that, or I guess if you look to the second half, should we assume gross margins, there's that dampening effect from Europe and picking up production there, or should we see a re-acceleration in the gross margin or the incremental gross margin in the second half?

I would see the gross margins improving in the second half.

Okay. All right. And then when you look at the mix in backlog, can you maybe give us a sense as to how that's evolved over the past quarter or two? Are we seeing a significant piece of that becoming oil and gas like we have? Is it more significant than in the past, or maybe some quantification on what exactly is in backlog?

Yes, for oil and gas, it's definitely still at a record backlog, but I guess I'm happy to say that after-market, industrial, and some of the commercial marine backlog has also improved. It's just not oil and gas.

Okay. So it's across the board improvement?

Yes.

Okay. And then if we're, what, two quarters away from 7500 maybe being out there and being sold outside of [field] production, is it safe to say that you have 7500 in the six-month backlog number now or no?

We have very few that would be in the six-month backlog, but I see that changing over the next month or two. Assuming we finish the field tests in this quarter, we will be shipping in the fourth quarter. How many, I can't say for sure, but we're definitely -- I have inventory coming in, so we are getting ready to produce and to ship.

Okay, great. And then last question, Chris I guess, with the growth in backlog and sales, can you give us a feeling for what the second half working capital requirements might be, further significant inventory and receivables billed, or how should we think about the back half working capital?

I think you're seeing a lot of that already, so I don't know that we're expecting a significant increase in working capital. Certainly you've seen the increase in inventory, which is in anticipation of what John just described, in terms of the oil and gas markets. So I don't think we're expecting a significant increase in working capital.

Okay. Perfect. Thanks for your time, and nice quarter.

Thanks.

Thanks, Pete.

Thanks, Pete.

Greg Garner with Singular Research. Please go ahead. Mr. Garner, your line is open.

First of all, thank you for taking my question, and very nice quarter, gentlemen. Regarding the 8500, if it's selling at peak levels right here, how does that -- how might that change your view on the market size for the 7500? Are there potential demand from the 7500, is that moving up to a higher level of drilling activity or of pressure pumping demand? I'm just wondering if the dynamic is changing here for the size of these two end markets.

John, do you want to take that?

Greg, that is a good question. I think it's changed a lot. It's changed somewhat over the last six months for us. The 8500 is definitely being used in some lower-horsepower applications that it wasn't before, just because the demand for overall pressure pumping is so great. You would think that would eat into the demand of the 7500, but these rigs are now engineered, and I do believe that some rig builders are looking at the 7500 as additional capacity in pressure pumping in general, at the horsepower it's targeted at and maybe even below.Because regardless of whoever is producing the pump, the transmissions or the engines, there's still a shortage of supply into the pressure pumping market currently. So I think when the 7500 goes into production, I guess the way to answer your question is, we don't think it's going to take that much away from the current 8500 business because no one wants to slow down a rig that's been engineered and designed and in production. So, I hope that answers the question.

Okay. And if this is a new horsepower range market for Twin Disc, who would you be taking share away from?

Well, currently the dominant player in this range is Allison. Caterpillar also has a transmission in this horsepower range. But I would say everybody in the market is scrambling to keep up with the demand.

And would you be able to release any info on how many field tests are going on right now, or how many have completed or -- ?

We currently have three, and we should be adding another two in the next four to eight weeks to be more thorough but to hopefully move the process along at a quicker pace.

And the increase in CapEx, I presume that has to do with the production of the 7500, primarily? Is it proper to look at it that way?

Well, it has to do with the 7500, but no, it's more an increase in just internal machining on our core competencies, whether it's the complex housings or gears. So, of that, some of it will definitely be used on the 7500, but it's not solely for the 7500.

Okay. And then finally, a question about the commercial marine. That is the area on the marine side that's showing some increases. Is that right? Versus the pleasure craft is not really ticking up yet? Is that -- ?

Yes, the pleasure craft is improving, but it's still at -- with respect to 2008, still at low levels when you look back two years. Commercial marine did not have that kind of falloff; has had some quarters that may be up and down in shipment and order levels, but overall we're more optimistic now than we were even six months ago on commercial marine. Primarily, again, driven by Asia, North America, and some business in South America, as well.

And the joystick is primarily for the pleasure craft; is that right?

Well, the first applications were targeted at pleasure crafts, but it can be applied at this point on vessels, twin engine -- any twin engine vessel with our quick shift transmissions, we can apply the joystick system to. So, it's a fairly complex product to design and to release and do the application work, so there are some pleasure craft builders that we're working with, but we're looking to move into some of the commercial markets like patrol boats, pilot boats that could also benefit from the technology.

Okay, and final question on the pleasure craft, is there any sign that might be changing, or is there any leading indicator that there's more inquiries from the boat manufacturers of any kind, or is that still looking weak?

Well, in some of the yards in the US, in Australia, some yards that produce in the Far East, and even in the UK and some in Italy, there is an increase in employment level and production. If you're looking for a macro-indicator, as the stock market typically does well in the US and Europe, and oil does well, you would hope that would drive increased demand in the mega-yacht market. It has in the past. Whether it happens this time remains to be seen.

Okay. All right. Thank you very much.

(Operator Instructions). Jon Braatz with Kansas City Capital. Please go ahead.

Couple questions. Can you speak a little bit about your production capacity, you're bringing on some new equipment, and I assume that's going to enhance production rates. Can you talk a little bit about how you see second half production rates relative to the, maybe, first half?

Well, we definitely see the second half being higher than the first half in production, both in hours and dollars. And it should be a fairly good jump.

Okay. And I assume that's essentially oil and gas, what we're talking about; right?

Well, it's oil and gas, obviously the pressure pumping units and after-market, but also industrial and after-market in general for commercial marine and the industrial products.

Okay. Can you talk a little bit about pricing and lead times for the oil and gas products?

Sure. We just had -- for most products here in the US, we had an October 1, in North America an October 1 price increase. We're looking at surcharge levels right now, and we're looking at what would need to be done maybe in the next coming up year, as far as any pricing actions. Lead times are probably right now for oil and gas kind of in the 8- to 10-month range right now for pressure pumping units.

Okay. What was the October price increase?

Depending upon the product, it ranged from 1% to 6%.

Okay. Would you think the expected surcharges would be similar to that, going forward?

Well, yes, if the end of the second quarter surcharges started to creep up a little bit. Definitely -- the 1% to 6% depending upon the product is not -- wouldn't be out of the range again, for this year.

Okay. As I look back historically at your ME&A costs as a percent of revenue, back in 2008, 2007, it was around 20%. Today we're sitting at 24%. Is there any structural reason that we might not be able to get back to those levels?

And then secondly, as it relates to the second quarter, were there any catch-up accruals in the second quarter regarding bonuses or stock compensation expenses or anything like that, that may not be there in the third and fourth quarters?

Chris, do you want to take that?

Yes, let me take that. I guess to answer the first question, the 24% is on a lower volume level; so I guess to answer the first one, there's no reason why we couldn't get back to that 20% range.

Your second question, as we noted in the press release, there weren't any catch-ups with respect to the bonus expense. The bonus plan was frozen last year, so there was no bonus expense. I disclosed in both the first and second quarter what the impact was, which was just under $1 million for both quarters; so that takes care of bonus expense.

With respect to stock-based comp, there was a catch-up in both the second and the first quarter. The first-quarter catch-up related to awards for a future year coming, I'll say, in the money. So we had five quarters of catch-up. The second quarter, the stock price moved from, I think, roughly $13 to just under $30 from basically the end of September until the end of December. So that obviously had an impact on stock-based comp.

To give you a relative idea, at the stock price at the end of the second quarter, which was just under $30, going forward without any other adjustments, that would translate to a normalized just over $800,000 for stock-based comp expense. So that gives you kind of the rough magnitude of what the catch-up was in the second quarter.

Okay.So going forward -- not that we want this to happen, but if the stock stayed flat, there would be no additional stock-based comp in the second half?

There would be no additional catch-ups.

Yes, no additional catch-up.

Correct.

Okay.

If the stock price for some reason were to go the other way, obviously, then there would be a good-guy adjustment.

Right, absolutely. Okay.

Jon, can I just add one thing?

Yes.

We're not looking, going forward, even as volumes return, we're not looking to go on an ME&A hiring spree or anything like that.

Right.

A lot of it was some one-time things happening in the quarter.

Thinking back to 2006, 2007, are the ME&A expenses, more specific I suppose marketing expenses, a little bit higher on the oil and gas business than the other pieces of the business?

No, the answer is no.

Okay.

On a dollar level, I don't know, but not significantly, if they are.

Okay. OperatorRand Gesing with Neuberger Berman. Please go ahead.

I was wondering, can you give us any help in terms of understanding the market opportunity for you guys from the 7500? I haven't really heard you be -- try to size that in any which way, or give us any color around how we might try to size it.

John, do you want to take that?

Sure. Rand, it's a moving amount for us because the market has been in such flux. But we had estimated that the 7500-horsepower range, that we look at as kind of 2250 to 2500 being roughly five times maybe more than that, than what the 8500 is. I have to admit, there's been -- everyone has been so busy getting pressure pumping units out. Whether that has remained the same, or a lot of the 3000-horsepower engines and transmissions, or even the 3000-horsepower transmissions which we know are being used on lower horsepower engines, how that's all shaking out; we don't know right now because everyone's so busy producing and shipping.

But we still believe that the 7500 in that horsepower range, even going down to 1800-horsepower up to 2250 and a little bit, is a bigger market globally than the higher horsepower market is. So we remain very optimistic that there is a big market for Twin Disc for the 7500, that is not being capitalized on with the 8500. Everybody, all frac builders, engine OEMs, are scrambling to get units out, and there hasn't been a lot of market share data being compiled.

My understanding is that your product is one of the -- is maybe the only one hitting the market that is specifically designed for this application. Is that right or -- ?

It's the only transmission that has been -- from the very first pen to paper, ink to paper, designed specifically for pressure pumping.

Okay.

All other transmissions had a life doing something else first before they were put into oil and gas.

Right. Do you envision that we'll get a little better clarity on this in the next six months, as to the size of the market?

Absolutely. Once we are delivering production units and getting in there as they've designed rigs to take them, and we get into production flow, we'll get a much better sense of how it's all been shaking out the last 12 months, and how fundamentally the sizes of each market have borne out.

Okay. All right. I guess we'll stay tuned. Thanks.

(Operator Instructions). Peter Lisnic with Robert W Baird. Please go ahead.

Yes, just a couple of quick ones. Just on the $15 million of CapEx, can you maybe talk about what that means in terms of productive capacity, does it significantly add to what you have in place? And then, are there any one-time tooling costs or set-up costs that we should think about in the second half of the year, as you get that capacity up and running?

Well, the answer to the second question is no, there aren't going to be any specific charges or costs for that. The capacity that we're looking at on the CapEx for this year and what we're looking at for next year is really designed for us to get to doubling our production capability for oil and gas; and it has a carry-over to commercial marine in some of our ARFF markets. Because a lot of what we do with our large housings relies on our capacity to machine the housings for those transmissions. So for us to grow, and grow in size in those markets, we needed to increase our capacity.

And it is actually reducing our footprint in Racine. We've consolidated the two plants into one plant, our larger plant, but we'll be increasing overall capacity with the new machine tool asset. So I guess to give you -- we have to grow our ability to produce for oil and gas in commercial marine, and these CapEx expenditures are designed specifically to do that.

And it effectively doubles your capacity to serve oil and gas, is that -- ?

That is where we're headed, once we have some of these key pieces in place, yes.

And would there be incremental dollars that you need to add to that in 2012 to get to that doubling run rate, or is this the bulk of the expenditures?

Well, we'll be replacing older machines, some older pieces of equipment with newer ones that tend to be more efficient, each one we add is more efficient than the previous one. But really the ones that are coming up are more to replace older equipment that have been doing some of the key processes for us in the past.

Okay.

Shawn Boyd with Westcliff Capital Markets. Please go ahead.

Thanks, and congrats on the quarter, gentlemen.

Thank you.

Thank you.

Just a couple clarifications here. On the ME&A expense, if I heard the commentary earlier correctly, at existing stock prices we could expect about $800,000 a quarter in stock-based comp.

Correct.

Okay. And did you say what the bonus expense would be?

I don't anticipate any significant changes to what's been accrued in the first two quarters.

Okay.

It could be slightly up or down, depending on the results.

Okay. So at the end of the day, we end up around -- in the $17.5 million, $18 million in quarterly ME&A expense. Is there anything else that we need to think about that takes that structurally higher?

There's nothing that I'm aware of that would take it structurally higher. There may have been some one-time items, just in terms of the timing of some expenditures that hit the second quarter that may not be in the third or fourth quarter that could make the numbers you gave be lower, but I think directionally you're not far off.

Okay. And then hence we get back to that 20% of sales fairly quickly if we continue to ramp revenues. Tax rate going forward, did you guys address that earlier?

We did not but our number really hasn't changed from where it was in the past. There were some adjustments in the second quarter that made that number obviously be smaller, and that's the two adjustments that Mike talked about in terms of the deferred tax asset adjustment, as well as the R&D tax credit. In a typical normal quarter, depending on geographic mix, because obviously the tax rates are different in the different geographic markets we compete, but generally 35% to 37% I think is a reasonable number.

Okay. And last question, on the 7500, as this goes into production, do we have separate manufacturing dedicated to that? Or would those orders fall in line behind 8500 orders with that 8- to 10-month lead time right now? How should we think about that?

The lead times for the first production units would be shorter because we have a lot of the inventory and the forgings and the castings already in-house. But it would probably be -- once you're in a production run rate, the lead times would be very similar to the 8500. They would be at four months together and 10 months together, they would probably move the same. But we have a lot of the raw material in-house already for them, so we'll be quick to react and get it into production.

Okay. And on the increase in the CapEx potentially doubling your production capacity on oil and gas, so that would take us to -- can you just give us what level would that be, what kind of quarterly revenue level would that be?

I don't give specifics, but you could --

We generally don't give that type of guidance, but obviously, based on what John had said in terms of the increased production capability, and depending on the volume and success of the 7500, obviously it's going to be an increase.

Okay. Good enough for now. Thank you.

Thanks, Shawn.

I'm currently showing no further questions. I will turn it back over to Mike Batten for any closing remarks.

Thank you, Alicia. And again, everyone, we thank you all for joining the conference call today. We appreciate your continuing interest in Twin Disc, and hope that we've answered all of your questions. If you have any follow-on questions, please feel free to call Chris, John or me. We look forward to speaking with you again in April following the close of our third quarter.

Alicia, we'll turn it back to you now to close the call.

Ladies and gentlemen, this does conclude our conference call. You may now disconnect. Thank you for your participation.