Twin Disc Inc (TWIN) 2013 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Twin Disc third-quarter fiscal 2013 financial results conference call. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. Instructions will be provided at that time. (Operator Instructions).

I will now turn the conference over to Stan Berger. Please go ahead, sir.

Thank you, Angel. 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 third-quarter and nine-month 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 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 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 Michael Batten. Mike?

Thank you, Stan, and good day, everyone. Welcome to our fiscal 2013 third-quarter conference call. I will begin with a brief summary statement. And then John, Chris. and I will be ready to take your questions. As previously forecast, our third-quarter results reflect continuing weakness from the oil and gas industry in North America, and general market demand in Europe. These soft markets have been offset somewhat by improving conditions for pressure pumping applications in Asia, and continuing demand in the global commercial marine market.

Our near-term outlook remains challenging, as we work through the bottom of the energy cycle, although we anticipate that demand will resume for fiscal 2014. Sales for the third fiscal quarter of 2013 were $68 million, down from a record $95 million for the same period a year ago. Sales for the first nine months were $209 million compared to a record $260 million in the 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 weakness in this market was higher demand for pressure pumping transmissions from China, as well as continuing demand from customers in the North American and Asia commercial marine market. Sales to customers serving the global mega yacht market remained at historic lows for the quarter, while demand remains steady for equipment used in airport, rescue, and firefighting, and the legacy military market.

As previously forecast, gross margin for the third fiscal quarter was lower, at 25.9% compared to 34.6% in the same three-month last fiscal year; and 30.8% in the fiscal 2013 fiscal second quarter. The anticipated decline in gross margin was the result of lower sales volumes and a less profitable mix of business. Year-to-date gross margin was 28.4% compared to 36.0% for the first nine months of fiscal 2012.

ME&A expenses -- marketing, engineering and administrative expenses -- for the third quarter of fiscal 2013 were 25.5% of sales, compared to 18.6% of sales for the same period a year ago. ME&A expenses decreased $341,000 in the quarter compared to last year. Year-to-date ME&A expenses were 24.3% of sales, compared to 20.7% for the first nine months of fiscal 2012. ME&A expenses decreased $3 million for the nine months versus the same period last fiscal year. The net declines in ME&A expenses reflected increased stock compensation, reduced incentive bonus accruals, tighter expense controls, and reduced R&D activities, wage inflation, and headcount addition.

The Company reported a net loss attributable to Twin Disc for the fiscal 2013 third quarter of $750,000, or $0.07 per diluted share, compared to net earnings of $10 million, or $0.86 per diluted share for the record fiscal 2012 third quarter. Year-to-date, net earnings attributable to Twin Disc were $3.8 million, or $0.34 per diluted share, compared to $25.5 million, or $2.20 per diluted share for the fiscal 2012 nine-month period.

EBITDA for the third quarter was $2.9 million, compared to $17.9 million for the same period a year ago. For the first nine months, EBITDA was $16.4 million, compared to $48 million recorded last year. While we continue to invest in inventory to support the growth in demand, we are seeing from customers in Asia, for our pressure pumping and commercial marine products, we are also working on reducing inventories to reflect overall demand and anticipate levels to decrease sequentially.

Our balance sheet and liquidity remains strong, and sufficient to fund corporate initiatives. Capital expenditures through the first nine months totaled $5.1 million, and we anticipate investing slightly less than $10 million in capital expenditures for the year.

Turning to our outlook, as we indicated last quarter, our fiscal 2013 results continue to be challenged by a decline in market activity in North America for our pressure pumping transmissions, as well as soft market conditions in Europe. Fortunately, our product market and our geographic diversity are helping to limit the impact on our results. Our six-month backlog as of March 29, 2013, was $65 million, compared to $68 million at the end of the second quarter, and $131 million a year ago. The backlog is in the process of bottoming and reflects the difficult situation encountered in the trough of the cycle, where some markets continue to sputter while others begin to gain traction for a recovery.

While the near-term outlook for oil and gas will remain challenging for the North American market, demand from China is encouraging. Commercial marine activity in North America, the Pacific Basin, and Brazil continues to improve. Our legacy military and ARFF demand is holding steady. However, Europe and pleasure craft marine continue suffer from low demand.

While the near-term outlook will continue to be somewhat challenging, we anticipate a recovery in the 7500 and 8500 pressure pumping transmission sales in fiscal 2014. That 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. And now John, Chris, and I will be happy to take your questions.

Angel, would you please open the line for questions?

(Operator Instructions). Peter Lisnic, Robert W. Baird.

Good morning, gentlemen. First question just on gross margin. If we look at the year-over-year decline, or sequential, or however you want to do it -- just wondering if you could give us a feel or a flavor for how much of that decline was mix versus volume? I think year-over-year, you're down almost 900 basis points, so just a little bit of color on mix versus volume.

This is Chris, Pete. It's going to be equal parts of both. Both will have a significant impact. The volume decline -- I would say they were probably roughly equal.

Okay, all right. And should we expect the mix to be a weight as we go into the fourth quarter, end of fiscal 2014? Or are we troughed out on the mix impact?

I think we have troughed out on the mix impact. You should see -- I think in the release and in Mike's comments, we talk a little bit about what's going on in Asia for oil and gas. So you may start to see the benefit of that in the fourth quarter. So I think the answer is, we have troughed out on margin.

Okay, all right. And then when you talk about the 7500 and 8500 recovery in fiscal 2014 in the last bit of prepared comments, can you give us a sense of how much of that potential recovery that you're talking about [are staying] could be a function of replacement demand, i.e., things wearing out and needing to be replaced, versus what I would describe as new fleet or new rigs?

Pete, it's John. I would say any demand in the first half of our fiscal 2014; so the second half of calendar 2013, will be more replacement. And I don't anticipate new rig demand until calendar 2014. But, having said that, we have seen improved orders for China for those transmissions, which are new builds for China. So, North America replacement, I think, will be the kind of the next six months. I don't see any new, solid, rig activity -- frac rig construction -- until calendar 2014.

Okay, so North America, replacement; China, new fleet; is kind of the way to --

Yes, correct.

-- summarize that. Okay. And then, can you give us a little flavor for Europe, exactly where the end market weakness there is exactly?

Pete, it's John again. With the exception of some of the industrial markets, the small construction equipment, I would say most of our markets in Europe are very weak. And it's across the board. Most of the commercial marine activity that we are seeing is North America, South America, and Asia. Certainly a lot of our market here in Europe, historically, has been pleasure craft and fishing vessels and government vessels. And a lot of that activity has slowed down to a complete trickle. So Europe as a whole, with the exception of some of our industrial markets, is not doing very well.

Okay. All right. I'll get back in line. Thanks for the color.

Brian Palmer, Global Hunter.

Good morning. I had a couple of quick follow-ups. Got a lot of good stuff out of the way just now with those questions. But I was curious to what extent, when you talk about replacement, what extent of your work was aftermarket repair business in the North American oil and gas business, versus the new, worn-out replacement transmissions?

This is John. I believe, as a percentage, it hasn't really changed this fiscal year. So about 25% of what we have done this year in North American oil and gas has been repair/replacement. And that was all in, primarily, the first four months of the fiscal year. So we have not seen a lot of aftermarket activity and rebuild in the last four months. We know our rigs, they are working; we just haven't had a whole lot of issues.

Okay.

Brian, this is Mike, and that's a good news/bad news situation.

Yes, you're building them too well (laughter).

Well, we like to hear that. And that, I think, is the key takeaway here, is that our product is lasting longer than what the oilfield, historically, it is used to seeing. So that's good news for our reputation and for follow-on new business. But we aren't seeing the same rate of aftermarket parts supplies as maybe some others would see in a similar market.

Yes. Perfect, perfect. And I guess the thesis is -- a couple of the big guys came out in the last couple of days and said they are seeing some more stuff on 24-hour operations, so it should accelerate somewhat in the next two months. Have you started to see more indications of interest or discussions? Have those started to pick up a little bit here, or is it still too early for that?

It still too early. But I think there has been some utilization of inventory on the floor, so that is good. And I'm sure that's been going into replacing other rigs in the field. But I just don't see -- I guess I should clarify. I don't see new orders on us for new units until calendar 2014. I think some of the big guys are going to be putting new rigs out in the field. But it's going to be inventory of completed rigs that they have sitting idle; or engines, transmissions, and inventory they have, and they will assemble and put out in the field.

Right, okay.

To clarify what I said before -- I don't see new orders on us, shipments, until calendar 2014.

Calendar 2014?

Yes. For shipment, yes.

For shipment, okay.

Orders could be coming in between now and then.

Perfect. Now, can we talk a little bit about China? Are you selling these transmissions to existing customers from North America? Or is it a new customer base over there of local Chinese companies that (multiple speakers)?

They are local Chinese companies. We're selling to the SJ Petros in China. We're also selling to some of the Chinese companies that have offices here in the US, and then they are shipping product back over to China. So, the sale is happening in two ways. But they are all Chinese rig manufacturers, operating for the Chinese oil companies, the state oil companies.

Okay, and based on what you are seeing in the field, I don't think that your product really -- that there is a proclivity for reverse engineering and manufacturing by a local Chinese party.

No.

Is that how you feel as well?

Brian, of course I'm tapping on wood here. But our volume is so low that I just don't think it would be worth the effort. The economies of scale aren't there to reverse engineer.

Perfect. Thank you very much. I'll turn it over.

Andrea Sharkey, Gabelli & Company.

Hi, good morning. So, I just was curious what the CapEx spending -- you spent about $5 million already this year. You said you're going to spend a little bit less than $10 million for the full year. But you only have one quarter left. So just curious what the big spend in Q4 is going to be for. And then maybe if you have any preliminary thoughts about spending for fiscal 2014?

Andrea, this is Chris. I guess the caveat on fourth-quarter spending, obviously, is whether we're able to get the equipment in before the end of the quarter. So to answer your question, it could be closer to the $7.5 million, $8 million range if we don't get everything in. So that's the answer to the first question. If we get everything in, it could be closer to the $10 million.

Regarding next year, I think it will be more back in that $15 million-plus range, is what we have in our plans for next year. But, as we always do, we'll react to the kind of environment we're in at the time.

Okay. And when you say what you get in the quarter, what is that going to? Are you expanding capacity in a particular product line? Or is it just replacement equipment in newer facilities? What is that (multiple speakers) waiting for?

Andrea, it's John. It's some of both. It's new equipment to replace older equipment for [cobbing] and stuff on our industrial and marine product line. So a lot of it is fundamentally when the machines come in and when we get them up and running.

Okay, great. That's helpful. And then, I was just curious -- what happened -- the backlog appears to be bottoming. But it did come back a little bit -- come down a little bit sequentially. And I think, in the last-quarter call, you guys thought that it had already bottomed because it had started to come back up. Was there another down in March? And how is April trending in terms of orders, and what you think your backlog is going to look like?

Andrea, it's John. I'm the one that said that, so I'll take the question now. The backlog seesawed through the second quarter. And I had thought that we had potentially hit the bottom. But it seesawed again in the third quarter, and came up this March. The best months of orders have been February, March and April. And, overall, our backlog had held very study. It was just the six months that fell. And that was a combination of I didn't foresee some of the shipments from our -- our facilities shipped a little bit more than I had forecast. The European backlog came down a little bit more than I thought. But the backlog for North American and Asian customers did come up quite nicely. So I feel pretty good, where we are today.

Great. That's good news. I'll turn it back. Thank you.

Rand Gesing, Neuberger Berman.

Hey, guys. I guess I wanted to talk about -- you're trying to reduce some inventories. I'm assuming that's in pressure pumping, or maybe not. But just what are the areas where you're trying -- you have inventories where you are bit high?

Well, I guess the inventories where we are high are not necessarily oil and gas. We'd like to reduce it by shipping more and getting the orders. But we really can't do much with that until we get new orders. Where we are reducing are in some of our more standard product lines; some of our marine transmissions, industrial, where we had had supplier issues last fiscal year and into this fiscal year, where we had a little too bit too much safety stock.

We're working that through. We don't necessarily want to push out our oil and gas. We haven't been adding to it. You'll notice that our inventory has come down in the last quarter. But we want to be ready for the next surge in North American oil and gas. And we are in a very good position this time around.

Yes, I was just trying to get a feel for the extent that you're underutilizing capacity, and the impact that's had on the last quarter and the next couple. Maybe it's a modest reduction of inventories, and so the capacity isn't being underutilized versus current demand by that much.

Right. And maybe just to add on to the inventory question -- so, right now, Asia is the market that continues to be growing at record levels. So some of that inventory is either in production, on a boat, or arriving there -- that will ship in the fourth quarter and beyond. So that's part of the natural reduction of inventory. Regarding your question, the third quarter, just looking at the volume year-over-year, it clearly was down significantly versus last year. So there is some impact on the absorption, if that's what you are referring to.

Yes.

(Multiple speakers) start to ramp up, and orders come in -- you're right, there will be some (technical difficulty).

Okay. Okay. But you view this as still continuing in Q4? And then as we move into the new fiscal year, that this will be less of an issue?

Yes, yes.

Okay. The free cash flow for the first three quarters -- $6 million or something like that. Will you guys, in the fourth quarter, with taking inventory out of it, will you grow that level of free cash flow? Or how should we think about the fourth quarter in terms of how free cash flow might look?

That's our expectation, Randy, yes.

Okay. And then, if I understand Europe, it sounds like it's been a weak market for you but it's still ticking down in terms of level of activity.

Yes, and I should clarify -- thanks for bringing that up again. Our European factories just don't ship to Europe. So what's keeping them going is their export market back here to North America, South America, and to Asia. And we just have to keep focusing on export for them and not relying on their traditional home market, because it's going to be a long recovery for the European market.

Right. So do you have to, at some point, start thinking about restructuring there, which is difficult to do?

You're always thinking about that, Rand.

Yes, okay. All right, thanks for the time.

Ben Mackovak, Cavalier Capital.

Hi, guys. Thanks for taking my call. So should we expect a sequential increase in the backlog next quarter?

Ben, that is the $1 million question. It's really -- if I look at the incoming order rates, I would say yes. But, traditionally, the fourth quarter is also the strongest shipping month. So it's going to be a factor of how much comes in and can be shipped in the fourth quarter. But I think it's not going to get significantly worse, or any worse. But we ship quite a bit in the fourth quarter. It's historically our best quarter. But I see the demand in Asia and North America improving; it's more about function of -- how much are the factories going to ship?

Okay, great.

It's hard to predict.

Of course, of course. I appreciate the color. Can you comment on any potential new customers out there, and just how the pipeline looks for that?

Yes, I would say, for new customers, really the success story has been the Chinese rig manufacturers that are servicing SJ Petro, Sinopec, and the state oil companies of China. And then we're always working on -- those are kind of like the home runs and the grand slams -- but our sales guys have been hitting some singles in the US, getting new industrial customers. And that's really where we're focusing.

In China, it's been getting the 7500 and the 8500 in, getting them accepted at the beginning of the market. It's a very good question, because that's how we are challenging our sales guys now, is finding the new customers. Because a lot of the customers, particularly the ones in Europe, we've seen the market shrink -- and through consolidations. But we've also seen some of the customers disappear. And so we're having to find more customers everywhere.

Okay. Great. Thanks a lot.

And, gentlemen, there are no further questions at this time. Please continue.

Well, thank you again for joining our conference call today. We appreciate your continued interest in Twin Disc, and hope that we have answered all of your questions. If not, please feel free to call Chris and John or me. We look forward to speaking with you again in July, following the close of our fourth quarter.

Angel, you can -- turn it back to you now.

Okay. Ladies and gentlemen, this does conclude the conference call for today. Thank you for your participation, and please disconnect your lines.