Twin Disc Inc (TWIN) 2013 Q2 法說會逐字稿

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Twin Disc, Inc. second quarter fiscal 2013 financial results conference call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be opened up for questions. (Operator instructions). This conference is being recorded today, January 22, 2013. I would now like to turn the conference over to Stan Berger. Please go ahead.

Thank you, Ian. 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 2013 second-quarter and first-half 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 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 Mianecki 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 Christopher Eperjesy, the Company's Vice President of Finance, Chief Financial Officer and Treasurer. At this time, I'll turn the call over to Michael Batten. Mike?

Thanks, Stan, and good day, everyone. Welcome to our fiscal 2013 second quarter conference call.

I will begin with a brief summary statement and then John, Chris and I will be ready to take your questions. Our second-quarter results reflect continuing weakness from the oil and gas industry, offset somewhat by improving conditions in the global commercial marine markets. Our near-term outlook remains challenging as we've worked through the bottom of the energy cycle, although we anticipate that demand will resume for our fiscal year 2014.

Looking at the results for the quarter, the sales for the second fiscal quarter of 2013 were $72 million, down from a record $83 million for the same period a year ago. Sales for the first six months were $141 million compared to $164 million this prior year. The decrease in sales was primarily the result of lower demand from customers in the pressure pumping sector of the North American oil and gas market. Offsetting those weaknesses in this market was higher demand from customers in the North American and Asian commercial marine market. Sales to customers in serving the global mega-yacht market remained at historical lows for the quarter, while demand remained steady for equipment used in airport, rescue, and fire fighting and military markets.

Our gross margin for the second fiscal quarter was 30.8% compared to 35.6% in the same period last fiscal year and 28.2% in the fiscal 2013 first quarter. The anticipated decline in gross margin was the result of lower sales volumes and less profitable mix of business. Year to date gross margin was 29.6% compared to 36.7% for the first half of fiscal year 2012.

Our marketing, engineering, and administrative expenses for the second quarter of fiscal 2013 were 23.2% of sales compared to 24.2% of sales for the same period a year ago. ME&A expenses decreased $3.3 million in the quarter, due primarily to reduced stock-based compensation and annual bonus expenses compared to the previous year. On a year-to-date basis, ME&A expenses decreased $2.6 million from the same six months the prior year, primarily as a result of reduced stock-based compensation and bonus expenses offset somewhat by increased R&D activities, wage inflation and additional headcount.

The effective tax rate for the first half of fiscal 2013 is 38.3%, which is slightly higher than the prior-year rate of 35.6%. The current-year rate is somewhat inflated due to non-deductibility of the losses in certain foreign jurisdictions during the first half due to an ongoing valuation allowance determination. The favorable impact of the recently extended R&D tax credit, estimated to be approximately $500,000, will be recorded in the third fiscal quarter.

Net earnings attributable to Twin Disc for the fiscal 2013 second quarter were $3.4 million or $0.29 per diluted share compared to $5.8 million or $0.50 per diluted share for the fiscal 2012 second quarter. Year-to-date net earnings attributable to Twin Disc were $4.6 million or $0.40 per diluted share compared to $15.5 million or $1.34 per diluted share for the fiscal 2012 first half.

EBITDA for the second quarter was $8.2 million compared to $12.3 million for the same period a year ago. For the first six months, EBITDA was $13.5 million compared to $30.1 million last year.

Our balance sheet and liquidity continued to improve during the second quarter despite elevated inventory levels required to support growth markets. We generated $12.1 million in cash from operations in the quarter to increase our overall cash position to $20.6 million.

During the quarter, the Company and a European subsidiary entered into a $15 million multi-currency revolving credit agreement with Wells Fargo Bank that will provide our global operations with greater borrowing flexibility.

Also during the second quarter, we repurchased 185,000 shares of our common stock at an average price of $16.59 per share for a total cost of $3.1 million. We have 315,000 shares remaining under our current authorization.

Capital expenditures through the first six months totaled $3.5 million and we anticipate $10 million in capital expenditures for the fiscal year.

Turning now to our outlook, as we stated last quarter, our fiscal 2013 results will be challenged by a decline in market activity in North America for our pressure pumping transmissions. Despite the lack of demand from this market, we were able to keep the second quarter gross margin above 30% and maintain our overall profitability. This is a testament to our end market and geographic diversity and flexible manufacturing operations.

Our six-month backlog at December 28, 2012 was $68 million compared to $82 million at the end of the first quarter and $149 million a year ago. As discussed, the decline in backlog reflects continued weakness in demand from the oil and gas industry. While the near-term outlook from that market is going to be more challenging than originally expected, we continue to anticipate a recovery in 7500 and 8500 pressure pumping transmission sales in fiscal 2014, which will be augmented by growing demand from customers in the commercial, marine, industrial, legacy military and ARFF markets. We are optimistic that we are well positioned to capitalize on the longer-term trends in all of our end markets.

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

(Operator instructions) Josh Chan, RW Baird.

I was just wondering about your view that the North American oil and gas outlook might improve in fiscal 2014. I was wondering if there is anything that you are hearing specifically that gives you that confidence in terms of the timing.

Yes. I guess that the first thing that we are hearing is just initial discussions for projects and tentative orders and knowing when these projects and orders would be. The first orders would fall into our fiscal 2014. So we are starting to see some activity, some initial requests for timing. So that's what is giving us hope that the recovery is going to start in 2014.

We are also -- I have been very pleasantly surprised to hear that some of our equipment that has been sitting in North America in finished rigs has begun to ship to Argentina and Australia. So it looks like, even though the market has been pretty slow as far as new rig construction, that some of that idle inventory is being used up and sent abroad.

Okay, that's definitely a positive. When you talk about orders, timing being in fiscal 2014, so does that mean that the translation into revenue probably occurs in the second half of fiscal 2014? Is that the more likely outcome?

It may start sooner than that, but it's certainly not going to have a big impact on the rest of fiscal 2013.

Okay, okay.

So yes, I would anticipate that as we get farther into fiscal 2014, oil and gas North America will be stronger.

Okay, great. And you alluded a little bit to international markets. Could you talk about international oil and gas and how that tended in the quarter for you?

I would say almost all of the oil and gas in the second quarter was overseas, and predominantly China. So that's part of the problem that we ran into with the inventory. The inventory at our manufacturing subs actually came down during the quarter, but there's a long transit time to get to Singapore and then into China. So a lot of the inventory basically is on the water right now, headed first to Singapore and then into China.

Okay. And typically, your business overall -- is it a bit stronger in the second half versus the first half? Do you think that's still a reasonable outlook this year, given the movement in the backlog?

I think that is going to be harder this year. I think, if you look at where our backlog has settled -- and we think it is pretty much at the bottom -- it kind of was bouncing around the bottom within the quarter -- anytime the backlog bottoms out, the next quarter or two are going to be challenging. So I think -- we are still optimistic that we could have a comparable second half as the first half. But it's going to be challenging, Josh, just given where the backlog is right now. And we know that any type of oil and gas drop in orders now really wouldn't be into fiscal 2014. So we are running out of time to fill in the second half.

Okay, that makes sense. And I guess the 30% gross margin that you guys achieved this quarter was certainly impressive. So assuming volume stays the same as you alluded to, is the 30% sustainable, or is there anything unusual there?

I think you are going to see margins in the third quarter more in the mid-20s to high 20s, something in that area, high 20s. But it will be very tough for us in the third quarter to hold the 30% gross margin.

Okay, great, thank you for your time.

Andrea Sharkey, Gabelli.

So a lot of my questions were just asked, but maybe just a little bit more on the inventory, the pressure pumping transmissions. I think last quarter, you guys said there was about 3 to 6 months in excess inventory in all the different channels. Is that about the same, or is that coming down a little bit now?

I think it's different. I think -- when I said 3 to 6 months, probably I meant North America. China is consuming as they need it. Andrea, I'm hopeful that it's a little bit less now because I think some of the idle inventory has worked its way into production, into operation in North America. And what we have heard is that the rigs that are going to Argentina and Australia are from the North American fleet. So, hopefully, that that's working down the unused inventory.

So it may be -- if it was 3 to 6 months last quarter, maybe you are looking at 2 to 4, average of about 3, now. But it's -- definitely, the situation is getting better.

Okay, great, that's helpful. And then you were saying that -- you think your backlog has now bottomed. I guess what gives you confidence that it is not getting any worse? Is it just that the North American orders and demand and what is in your backlog now is pretty much nonexistent, or just that maintenance run rate, and so there's really not much more that it can drop? Is that what is making you think that?

I guess what is giving us confidence is that the backlog actually bottomed out during the quarter. And we saw it come up within the quarter, and just the overall optimism in each one of our end markets about what's going to happen. And most of our customers deal in calendar 2013; they are pretty optimistic on a good calendar 2013.

So I expect to see that the backlog will not have gotten any worse. It may not get much better in the third quarter, but it should -- we have hit the bottom and it should start to come up.

The one component that has been hardest hit is North American oil and gas, and that is pretty much down very significantly. So that can't get much worse. So I can only see that improving as we go forward.

Okay, great. That's helpful. And I don't know if this is maybe not important, but I have been seeing a lot of companies that are saying they are switching their pressure pumping trucks and their rigs to run on natural gas instead of diesel. Does that have any impact on your oil and gas transmissions, or your transmissions can just go on the trucks regardless?

That has more impact on -- I don't want to say 100% doesn't have much impact on our transmission, but that is more of an impact on the engine. And we certainly can run behind an engine that is running on natural gas.

Okay, great, and then maybe just one more on a different end market. I think I read something that you guys are producing a next-generation transmission for the airport, rescue, and fire fighting end market. I was just wondering if you can give us some details on that, what that is, how that is going in terms of customer adoption and (multiple speakers) you see that as potential revenue growth and --

As far as revenue, that wouldn't hit until probably the end of fiscal 2014 into 2015. And that is -- this market, which started off as a niche market, is even becoming more of a niche market because this is truly an off-road specialty vehicle. But it is being held to on-highway emission standards. And so it is a lot more challenging application on the engine, and a lot of engine manufacturers have dropped on-highway in this power range. So it is a much more challenging application for a transmission because they have to meet certain acceleration requirements. And so a lot of transmissions that are being used today we'll not be able to use just because of the torque levels of the new engine.

So as we are coming out with the new transmissions, our 4000 series, we are going to have a pretty good place in the market with this because there are going to be not many other competitive products that can handle this.

Okay, great, thanks a lot.

Jon Braatz, Kansas City Capital.

Did I understand correctly that you said there were no sales to the -- transmission sales to the North American oil and gas marketing the quarter?

No. No; there were some. But it was heavily weighted towards China.

Right, right, okay.

Yes, there were a few, but a complete flip of what we had been seeing as far as China being a small percentage and North America being the majority. It completely flipped in the quarter.

Okay, I'm trying to get a better idea of the size of change that we have seen here. During the peak period a couple quarters ago or a year ago, I think you had referenced that oil and gas was maybe about 30% of revenue, something of that magnitude. Can you give us an idea of where that has fallen to?

We are down -- year-to-date, we are down more than half in oil and gas.

So about 15%?

Yes, more or less, that would be the order of magnitude, yes.

Okay, okay. So obviously, the North American segment was even greater, and that's offset by the increases in China?

Yes.

Okay.

Now, just -- and the second half of the year -- the second half of fiscal 2012 was equally as strong. And we are not going to have as strong a second half in oil and gas this fiscal year.

Okay, when you look out towards 2013 -- excuse me, 2014 and maybe beyond, the oil and gas market in North America probably won't be as heady as it once was. But when you look at what some of your customers are telling you, how much do you think that could ratchet back? Is there an environment where we can get back to that 30% level just because of the strength of China and some resumption of growth in the United States? What kind of recovery do you think -- could you envision at this point?

I'm going to answer it a couple ways. I think we can get back to our peak.

Okay.

It's going to be with the addition of the 7500 coming on and sustained levels in Asia, meaning that I don't see the peak in North America necessarily coming back to its previous peak. I see us having a bigger market share with the 7500, and then ongoing growing business outside of the US. I don't -- the last -- in retrospect, looking back at the last bubble in North America, it is clear that everybody overbuilt. And maybe a lesson was learned and that won't happen next time. But I think we can get back to close to those peaks with the two different components of the 7500 and Asia.

With a more balanced environment -- and maybe pricing won't be as strong, I'm not sure -- but with a more balanced environment, do you think you can return to the same margin level?

Yes, yes.

Okay, thank you.

Brian Uhlmer, Global Hunter.

I have quick questions. What was the manufacturing and distribution revenue breakdown this quarter?

You know, Brian, I apologize. I don't have those at my fingertips. We are still finalizing our segment disclosures for the Q. So I apologize; I don't have those exact figures.

No worries. But if I assume relatively flat --

Distribution had a relatively strong quarter, for a lot of the reasons John was talking about with Asia and Singapore.

Okay, got it, which implies that orders were up sequentially Q1 to Q2? Is that correct?

No, I don't think that would be correct, because we reduced our backlog by about $14 million.

Okay, and of your orders in Q2, if I'm doing this right, around the $40 million, $50 million range, what percentage of that do you believe was oil and gas? Can you break down the various segments between oil and gas, ARFF and the mega-yacht, your segments a little bit in more detail?

No, as I think we have talked about in the past, we don't generally break down revenue by those end markets. I just -- I will leave it where John said, that in the quarter, certainly year-over-year, that market is down more than 50%, oil and gas market. And we have seen some pretty significant growth in the commercial marine market, but we don't disclose further than that.

Okay. Can you give us a little update on Caterpillar, on the JV, and if you started to receive -- where we are in that process and when we are going to start seeing orders and revenue flow through from that?

First off, Brian, just to clarify, it's not a JV; it's (multiple speakers) a traditional -- it's a supplier arrangement. We have completed a handful of Cat 360 vessels which our application team has signed off on. So we have got about 3 to 6 Cat dealers that are out now actively selling and can sell the joystick system. So we will start to see orders in the second half of the year and into fiscal 2014.

The other project, which is deploying our QuickShift and joystick technology into their product -- we are still probably a year and a half away from when we would see revenue from that. They are probably a year and a half, 18 to 24 months from production. So we would not see that impact really until late fiscal 2015. But we will start to see some impact later part of this year and fiscal 2014 for the joystick component.

Okay, that's very helpful, thanks. And final one -- just when we talk about your margins, I think they have outperformed my expectations by several hundred basis points this quarter. So when we look at that, how much of that breakdown would you think was operating leverage, how much was mix? And what were the various constituents that led to that outperformance versus your expectations and our expectations?

Sure. I guess maybe part of it was we have the fewest number of -- not few, but we have a lot of shutdowns in the first quarter. So you're going to see -- and we had more or less the same type of mix of business from the first and second quarter, but we had more working days and more shipping days. So the relative strength within the quarter, not versus last year or the year-ago quarter, oil and gas was still -- there were still some good shipments during the quarter. So that helped.

What is going to hurt in the third quarter is we do have fewer shipping days and we just have a lot lower mix of oil and gas in the third quarter. So that's why we are saying that holding 30% for the third quarter is going to be difficult. And from what your expectation was of the second quarter, I am guessing the third quarter is going to be more in line with what you were expecting in the second quarter.

Okay, perfect, perfect, thanks. And my final quick question is you were talking about Argentina and Australia. Just clarifying that those were units that were already built that were sitting in North America --

That's correct.

-- and were shipped over there?

That's correct.

Do you have any idea on the count, on the number of units? Are we talking 10, 20, 30, ballpark?

I don't. I think we are talking about, it's for both places, more than 10, fewer than 50. I think we are probably looking at maybe 2 to 3 spreads for each country. And I think what we're waiting for is for them to get them up and operational, and then more spreads would follow.

And was that a variety of customers, or just one (multiple speakers)?

It has been two customers.

Two? Yes, I've got it. Thank you, I really appreciate that.

Tim Fronda, Sidoti & Company.

Good morning, just a couple of follow-up questions. With the slowdown in the oil and gas market, what would you say would set you apart from competitors and may make you better able to handle the current weakness there?

I think what has been coming out of this which is really good is the feedback we are getting on our life, particularly the 8500, because those are the most units out there, and that the 8500 is far surpassing expectations on time between overhaul. And so I'm very hopeful that we are building up more loyalty as we head into the next ramp-up.

So it has been slow for everybody, but it's nice when you visit with customers and you hear positive things about your transmissions in the field.

Okay. Can you explain a little bit more just the actions you're taking now in anticipation of a recovery in fiscal 2014?

Sure. When you go back to fiscal 2010, heading into 2010, as a much different outlook, a lot more uncertainty. So we were getting rid of any inventory that we could, including oil and gas. That is not the case this time. We are well-positioned, both with raw materials, some finished bearings, clutch plates, and agreements with our suppliers that we feel that we will be able to react much quicker than we even did the last one run-up, when it comes. So we are ready -- we are much better prepared this time than we were last time for the next run-up.

Great, thanks for your time.

Rand Gesing, Neuberger Berman.

As it relates to oil and gas, what are you guys seeing in terms of international orders that are incoming? Is it still mainly China, or what other geographies?

Yes. Well, I would say China, because China seems to be the farthest along, as far as building the rigs in-country with either American and German engines or American transmissions and pumps. So they are building their own rigs. So we are getting orders from China, and we are delivering to rig manufacturers in China. What seems to be the case, and just following on Australia and Argentina, is that they are, at least for now, buying rigs that are being produced by North American producers.

So will Argentina and Australia start to build their own frac rigs? I could see Australia getting into frac rig production sooner than Argentina. So for the next year or two, I foresee any demand going to Argentina or Australia being produced by north -- in North America. Does that help, Rand?

So, would your assumption be that that equipment would be equipment that was already built for North America?

Yes.

-- instead of having any new build activity?

I think they would use up existing inventory in North America and then continue to buy from those same suppliers. That's what I see right now, but that could change. And Australia has such an advanced marine industry as far as boatbuilding, they could easily build the frac rig if they wanted to. It would not be a stretch at all. It's just, do they want to do that or do they -- the Australian dollar is so strong right now that they are probably getting a pretty good deal importing from the US.

Right. I was just trying to get a sense for you guys actually having the manufacturing heat back up from those markets versus just soaking up excess capacity that's already out there. But it sounds like for the next year or so, we are going to still be soaking --

I think -- well, I think it will be -- the first part of 2013, they will be helping to use up the existing inventory in North America.

Yes, okay. Any of the other markets? It sounds like from your earlier comments that things are still pretty solid. I just was wondering, are there any other markets, key markets that are somehow gone a little more cautionary, yellow, in your mind? It didn't sound like that from the commentary, but I just wanted to ask the question.

No. There's nothing -- I guess the markets -- the two that are moving are oil and gas, North America, obviously slowing way down. But in the flipside, we've seen nice growth for commercial marine markets, particularly in North America and Asia. The rest of the markets are kind of just -- they are not coming -- in any one month, they could be going down a little bit, coming back up, but no real exciting movements either way. It has been North American oil and gas coming way down. But on the flipside, commercial marine going way up.

Okay, all right. In the quarter, we had nice operating cash flow. What are your expectations for the second half? Should we see that in each of the next quarters?

Yes, I would see a little bit more cash generated from a reduction in inventory. As we finally move out the product that has shipped to Asia, we will see some good cash generation there.

Just to repeat what John said, I would expect a continuation of the same.

And just to answer an earlier question, because I now have the figures, the manufacturing was down roughly 15% in that segment. Distribution was up roughly 15% year-over-year. And now manufacturing is much larger; that's why you see a net reduction. So some of what we will see, as John is talking about with respect to inventory, will be as a result of what is going on in the distribution operations, in particular in Asia.

Okay, that's it for me, thanks, guys.

[Jay Foley], Private Investor.

Staying here in North America just for a second, is Twin Disc withdrawing from the old mechanical power takeoffs or (inaudible) clutch market? I ask that, because when I'm at trade shows, I see very few new equipment using Twin Disc PTOs.

No, we are not withdrawing with it. Part of the segment that you see are the product that has been produced in China, very price sensitive. We are seeing this kind of -- the market is fracturing a little bit, very price sensitive on the mechanical PTOs, but then there's also a trend towards higher-technology products, whether it's hydraulically-controlled dry clutches type PTO or hydraulic PTO, meaning a wet clutch like you would see in our marine transmission. More and more of our business has been migrating to the higher technology components of the industrial market.

But having said that, we continue to work with outsourcing and trying to find more cost-competitive suppliers so that we can make our baseline technology, the simple mechanical-clutch PTO, more competitive.

Thank you.

(Operator instructions) Tony Gikas, Allerion Asset Management.

Just a couple of little follow-ups on the inventory -- could you just give us a little more detail about -- just characterize the inventory, what parts of the business are you supporting there? And then, should we see the inventory come in, in the next 3 to 6 months, and trend more in line with sales? And then the last question -- in the second half, you had -- should we expect to see those ME&A expenses continue to be in a prudent zone, if you will?

This is Chris; I will take the inventory question. I guess I will take both. On the inventory, as John was talking about, a lot of the inventories that you have seen increase, particularly in the quarter and year to date, is going to be inventory that is going through our Asian operation, which from a sales standpoint is at -- it was at record levels last year and the year before, and it again is at new record levels. So a lot of that, as John was describing, is a sitting on a boat or working its way through that channel. So the answer is yes; you will definitely, over the next six months, start to see that come down.

Some of the inventory that is sitting here in North America, as John was also describing, it's somewhat intentional, and that, when that North American oil and gas market comes back, we feel like we are better positioned to address that recovery as it ramps up.

On the ME&A front, I think the answer is yes. Certainly, we will expect to see it in line. But however, you are not going to see the significant adjustment in stock-based compensation expense in the third and fourth quarter, which benefited this quarter. We will continue to invest in things, particularly in Asia, as John was describing. So you are not going to see a significant ramp-up, but you are also not going to see the significant reversals of stock-based compensation expense and things like that as well.

Okay, thanks, good luck, guys.

Thank you, and we have no further questions at this time.

Okay, thank you. We end, and we would like to thank everyone who participated in the conference for joining today. We appreciate your continuing interest in our Company and we hope that we have answered all of your questions. If not, please feel free to call Chris or John or me. We look forward to speaking with you again in April at the close of our third quarter.

And with that, Ian, I will turn it back to you for closing the call.

Thank you, sir. Ladies and gentlemen, this concludes the Twin Disc, Inc. second quarter fiscal 2013 financial results conference call. Thank you for your participation. You may now disconnect.