Twin Disc Inc (TWIN) 2014 Q2 法說會逐字稿

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Twin Disc Incorporated second quarter FY14 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 for questions.

(Operator Instructions)

I'd now like to turn the conference over to Mr. Stan Berger. Please go ahead, sir.

Thank you, Camille. 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 FY14 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 statements -- I'm sorry -- 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 John Batten, Twin Disc's Chief Executive Officer, 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 John Batten. John?

Thank you, Stan, and good afternoon, everyone. Welcome to our FY14 second quarter conference call. As usual, we will begin with a short summary statement, and then Chris and I will be happy to take your questions.

Looking at our second quarter results, sales for the 2014 fiscal second quarter were $63.2 million, down 12.5% from $72.3 million for the same period a year ago. The decline in sales was primarily driven by lower demand in the North American and European market. Continued record levels of sales into Asia partially offset these declines, as demand for our pressure pumping transmissions in China and commercial marine transmissions throughout Asia remained at historically high levels in the quarter. Looking at our broader markets, global sales for our industrial products and marine products were down slightly in the quarter versus last year, but sequentially flat when compared to the first quarter. Shipments for both marine and industrial were lower to both North America and Europe than a year ago.

While part of the fall off in industrial can be explained by our shipping from both Racine and India during the start-up of our plant near Chennai, there was a noticeable drop in demand in North America for the first half of the fiscal year. Recent order trends may suggest that this may start to turn in the next quarter or two. While our marine shipments are lower than year ago levels, demand remains at high levels for the offshore oil and gas market, especially in the US Gulf Coast and Southeast Asian market. Recent improvement in new orders for our large commercial marine transmission is a good sign that these markets look healthy going forward.

Gross margins for the quarter were 29.3%, compared to 30.8% a year ago and 31.1% the previous quarter. The slight decline in gross margins was primarily driven by lower sales compared to the previous year, but partially offset by a slightly better mix of products. Year-to-date, gross margins are 30.2% versus 29.6% a year ago.

Second quarter spending and marketing, engineering and administrative, or ME&A, expenses rose slightly, by $415,000 versus the same period last fiscal year, from $16.7 million, or 23.2% of sales, to $17.2 million, or 27.2% of sales. The higher ME&A spending for the quarter relates to resource additions in Asia, as we continue to grow in the region, and increased spending with respect to patent and trademark protection, partially offset by reductions in ME&A spending at our North American and European operating facility. Year-to-date ME&A spending is down $688,000 when compared to year ago levels, or 25.2% of sales versus 23.7% of sales.

As we have mentioned in the last few calls, we continue to rationalize our resources and overhead in our European and North American operations. Even with the opening of the plant near Chennai and the adds to the sales and service organization in Asia, our net employment is down versus FY12 and FY13 year-end, as we are constantly evaluating each subsidiary's spending in overhead.

Looking at the bottom line, FY14 second quarter net earnings were $518,000, or $0.05 per diluted share, compared to $3.4 million, or $0.29 per diluted share for the same period a year ago. EBITDA for the first quarter was $4 million, versus $8.2 million a year ago and $6.6 million last quarter. Year-to-date, our EBITDA is at $10.6 million, compared to $13.5 million for the same period a year ago.

Turning to the balance sheet, we ended the second quarter with net cash of $6 million, due to positive changes in our working capital, including generating $7.7 million of free cash flow in the second quarter and $16.6 year-to-date -- $16.6 million year-to-date. Inventory has remained essentially flat, at $103 million for the last few quarters. The impact of foreign currency translation was to increase net inventory by $1.5 million versus June 30, 2013. Adjusting for the impacts of FX, inventory was down roughly $1.7 million, primarily at our domestic manufacturing operation.

The $2 million decline in our six-month backlog from $58 million to $56 million continues to reflect extremely soft North American oil and gas CapEx budgets, general weakness in all European markets, and a reduced order board for our legacy military transmission. Offsetting these slower markets were the incoming orders from Southeast Asia and the Gulf Coast for our commercial marine transmission and a continued demand for 8500 and 7500 oil field transmissions in China. The 2014 second fiscal quarter continued to be influenced by the same dynamics that have affected our business during the past several quarters.

We continue to see strong demand from our global, commercial marine customers and international oil and gas markets, which is more than offset by continuing weak activity from the European global mega yacht and North American oil and gas markets. While we feel very good about our backlog prospects with the Asian oil and gas and the global offshore oil and gas markets, we are hopeful that the potential opening of the gas fields in Mexico and general increase in demand and price of natural gas here in the US will spur a recovery in CapEx spending for the domestic pressure pumping fleet.

We are all aware of the increased efficiencies being realized by the frac services companies, but I am optimistic that in the next few quarters, orders will be placed for new spread. Middle- to long-term, we are well positioned to take advantage of the global opportunities ahead of us. Our leading positions in the markets we serve, our innovative product development and geographic diversity reflect a sound strategic plan for the future. That concludes our prepared remarks, and now Chris and I will be happy to take your questions. Camille, please open the line for questions.

Thank you, sir.

(Operator Instructions)

Our first question is from the line of Josh Chan with Robert W. Baird. Please go ahead.

Good afternoon, John and Chris.

Hello, Josh. How are you?

Hello. Good. Could I ask for more color on the sales decrease, the 13%? I was under the impression that North American oil and gas is no longer a comparison issue, and it sounds like industrial and marine were down slightly, as described. So I guess just wondering where the weakness was that led to that number?

Go ahead, Chris.

Josh, you touched on it. Part of it was -- North American oil and gas was very low last year, but it actually did go down a little bit versus that comparison last year, offset, as John was describing, by what's going on in Asia. But then commercial marine in North America has been particularly in the Gulf Coast in the second quarter, industrial, and then I think John also talked about legacy marine -- or sorry, legacy military. So it was a combination of all of those.

And in the industrial markets, Josh, we do have some of our larger air clutches that go into the oil fields, but our industrial products, and those were down versus year ago levels. And I would just say outside of offshore oil and gas, some of the crew boats and supply boats, there was just a general slight dip, I would say, in our marine sales versus a year ago. But I'm happy to say that the incoming orders, particularly in the fourth quarter, kind of reversed that trend.

Fourth calendar quarter.

Yes, fourth calendar quarter, correct.

Okay. I guess maybe good segue to talk about different types of orders in different markets. Could you elaborate a little bit more on what you're seeing in terms of the improvement in the industrial side, and then also what provides you the confidence that you're going to see the North American oil and gas orders in the next couple of quarters?

I'll start with the industrial. We had our best month of incoming orders were late in the second -- late in the quarter. And all of our products in industrial are within a three-month window. So everything is booking and shipping rather quickly.

I'm optimistic, because, in the last few days, I've seen some positive commentary from some of the larger OEMs that see improving business. So that generally translates to both our after market and industrial business. And my confidence in the North American oil and gas, I think if there is going to be some more activity in quoting on spreads going -- North American producers looking for South America or potentially Mexico. And I know that they have been operating the fleets pretty regularly. And my sense is as we get to late in the summer, maybe the third calendar quarter, that we should see some replacement activity going on.

Okay. That makes sense. And in the press release, you talked about the second-half results of the fiscal year being similar to the first half. I guess historically the second half has fairly consistently been stronger than the first half, until the last two years. And apparently this year it might be similar, as well. So I guess how do you think about your business from a seasonal perspective, first half versus second half? And I guess, what has changed relative to--

Well, I would say I think that there is potential for upside in the second half. Anything that we can potentially -- and we have, we can book and ship some oil and gas transmissions that won't, that they could book in January and could be out the door by March. So we see some opportunistic orders coming in, particularly for Asia in oil and gas. And if more of those come in, it certainly brightens the outlook for the second half of the year. I also -- if natural gas stays up a little bit in price, that's also positive impact.

Certainly reading some of the conference call scripts in the last couple days, I see more optimism than I maybe did last quarter. So we certainly have the capacity to have a second half that is better than the first half. We just need some of the orders and the projects that are in the pipeline to be brought up, and we can certainly respond.

Okay. Great. Thank you for your time, and best of wishes for the second half.

Thanks, Josh.

Our next question is from the line of Walter Liptak with Global Hunter Securities. Please go ahead.

Hello. Thanks. Wanted to ask just another follow-on on the comments you're making about the orders picking up for oil and gas in the next couple of quarters. And I just want to make sure I understand a little bit more. Is this specific to some basins where you're seeing demand for pressure pumping, or is it related to certain projects that are going on? I wonder if you could provide a little bit more color that way?

Sure. I would say that one of the things that's giving us the most optimism is maybe some orders for the Eagle Ford south of the US-Mexico border. That would be a very near-term plus. We have received orders from North American suppliers that supply down to Argentina. And I know of some domestic builders quoting for some projects in the Mid East. Specific to the North American shale field, I don't know if there's any one play that for us that's going to bring the orders first over another one. I wouldn't know with confidence right now which one -- where they'd be going. But certainly we have some upside potential, even in Asia, for the second half of the year.

Okay. But leaving out Asia for a second, it sounds like it's been weak for some time, and it sounds like the order, maybe the backlog was down, but at some point it sounds like we may be seeing the beginnings of what might be a turn. Is that how you want us to view the market?

Yes. And I'm trying not to operate in a vacuum. I've been reading some of the larger oil field service companies and how they're looking, particularly at dry gas, where I think they would probably put the investment first with some higher horsepower transmission. But my guess, having read some of the recent transcripts, is that it's still two quarters out. And they are really focusing on efficiencies and making sure that they can do everything they can with the existing fleet that they have.

Okay. And then just switching over to the 7500 and 8500 in China, and I wondered, we spent a lot of time last conference call talking about those and the progress. I wonder if we could just get an update on how that market is progressing and what the trajectory looks like.

Well, I still think that they are systematically adding the annual horsepower in the quarter of a million range. Tends towards the higher horsepower. We have a good order board for 8500. We have an order board now for 7500. So it's project by project. It is -- thankfully, it hasn't been kind of a boom or bust, but steady progression. Certainly, depending upon the quarter, our shipments may differ, go up, go down. But the overall trend has been very good and increasing.

Okay. And then if I can switch gears just to a couple of the negatives, like the military, I don't have that in my model what the percentage of revenue is. So I'm just trying to understand how big of a head wind was that in the quarter? I don't know if you can quantify it.

I would say it's not a very big percentage on the revenue side. These transmissions are fairly complex, so when the volume goes down, it hurts on the absorption and affects the gross margin. And the questions I've got is, is this part of sequester? It's really not. It's just that this fleet has been used heavily in Iraq and Afghanistan. And I think the realization now that everyone is coming home, they just don't need as much as they did before. So it's not going to go to zero, but I see the volume in this series of vehicles coming down on the order of 50% going forward.

In recent years, Walt, this business has been 5% or less.

Okay. And then the last one, just on Europe. Obviously, Europe's been weak for a while. But I wonder what product categories are weak, on the pleasure vessel, the luxury vessels? We've been hearing a little bit better tone out of Europe. Is there a pick up that might be coming on there eventually?

I would say what's -- I'll start with the market that's been relatively stable, and that's the industrial market that we serve out of our plant in Italy. But all of the marine markets have been extremely weak, the pleasure craft being number one, since really 2009, and never really recovered. What goes up and down depending upon the quarter are some of the European yards that are supplying international offshore oil vessels or patrol boats to the Mid East.

But really in the first half of the fiscal year, first and second quarter, really none of those projects have originated in Europe. So sales into Europe from our European subs, particularly in the marine market, and they don't really have a transmission market, so really the marine market is what suffered in the European markets in the first half of the year.

Okay. Thank you very much, guys.

Thanks, Walt.

Our next question is from the line of Jon Braatz with Kansas City Capital. Please go ahead.

Good afternoon, gentlemen.

Hello, Jon.

A couple questions. Returning to China. Obviously, China's been in the news recently, things slowing down, apparently, over there. Anything that you see over there in what you're seeing in order rates and so on that would suggest that maybe things might be moderating a little bit, or is energy getting more than its fair share of investment in China?

Jon, my gut says that it's the latter, not the former. Maybe there's not the upside that there was two or three quarters ago. And we see the same thing, the overall economy moderating. But they do see -- when I was there at the oil and gas shows, and our guys are there every day -- is there is a definite plan for domestic energy production, and natural gas and oil and pressure pumping is part of the mix.

Where we have seen, maybe where it has affected us are some of the orders for the Indonesian coal tugs, because we do see some of the imports of coal into China coming down a little bit. So that's the one area I would say where we've seen, I guess if you'd say a drop-off or some weakness, is tugs being built in Indonesia for coal transportation.

Is there any -- you probably won't answer this, but maybe you can give me a general statement -- any sense you can give me on the size of your Asian China revenues versus the domestic pressure pumping revenues? Any quantification that might be helpful?

No, we don't really disclose that, Jon. But obviously last year, China became a 10%-er for us for the first time, so you have that (Inaudible). They were over -- well, right around $30 million last year. And Asia, we have talked about, is just under a third of our overall business in FY13. We disclosed that in our Investor Relations presentation. So Asia is the second largest market after the US for us now. Or China, I should say.

Is that principally pressure pumping?

No, it's equal parts pressure pumping and commercial marine.

Okay. You also mentioned that in terms of Gulf Coast activity, I guess you're selling systems to -- transmission systems to the boating industry in the Gulf Coast area and you're seeing that pick up. What can you tell me a little bit more about what kind of boats and how much of a pick-up you're seeing in that area?

Well, I would say, certainly the orders picked up. I think a lot of it has to do with timing. General activity, it's primarily crew boats, supply boats for the oil and gas industry. So going out from Morgan City, New Orleans out to the offshore rigs. Those typically take 4 to 5 -- well, for crew boats and supply boats, 4 to 5 of our large transmission supply boats, two of our larger transmissions. That activity has been very high for calendar 2013, looks like it should be more or less the same in 2014. So it really is the timing of the orders. That's been extremely strong.

Same types of vessels built in southeast Asia for southeast Asia offshore oil and gas rigs. The Gulf Coast has also been very strong recently and repowering a lot of fleet pf push boats and tugboats along the river, and so that's been a very big component, again, all going through. So when we say the Gulf Coast, we're tending towards the hub of the marine activities, New Orleans and Louisiana, in general. So that has been particularly strong. Same in Southeast Asia for us. I mentioned the coal tugs. For the last few years, those have been very successful, again, building tugs and push boats for moving the coal from Indonesia back up towards China. So those markets have been strong, and recent orders are suggesting that that's going to again be strong throughout calendar 2014.

We've been reading a lot about a lot of oil moving up and down the river, Mississippi, in barges. Would you have a role to play in barge construction, if you want to call it that?

Not barge construction, barge movement.

Barge movement, that's what I mean.

Yes, absolutely. Each one of the vessels moving one of those barges would probably have two of our transmissions on it.

Okay. But you didn't really mention that. Are you not seeing that?

That has remained steady. No, I neglected -- yes, that has been a very strong market.

Okay. All right. Thank you very much.

You're welcome.

Our next question is from the line of Peter van Roden with Spitfire Capital. Please go ahead.

Hello, guys.

Hello, Peter.

Can you spend a couple of minutes talking about the size of the pressure pumping opportunity in the replacement demand versus guys ordering new spreads?

Sure. I would say -- and I mentioned this one of the last calls. When we were in the height of the boom, several operators said that they wanted to replace up to 30% of their fleet annually. And I think it's safe to say for everyone in the industry, we never reached that.

I would hope once they work through the inventory, the excess inventory, and are more normalized that somewhere between 5% to 10%, maybe more, could be expected to be replacement every year. It's just when do we get to that normalized level.

Got it. And generally, how many hours do you have to put on a rig just to have to put a brand new transmission in?

They're measuring kind of two hours. It's the engine operating hours and then the hours on pumping. And certainly, we want to see well above 3,000 hours in operating, as far as pumping. Engine hours, that typically has been, I think, a higher number of hours, but I think they're narrowing the spread. So when the engines are running, I think, I believe the hours, the pumping hours, are closer to the overall engine hours. So engine hours, probably, I would say 6,000 hours.

Okay. That's helpful. And then moving back up to more a macro or Company-wide stance, how would you describe, as you work through your different end markets, where you think we are in the cycle for each one of them? And I don't know if it's appropriate to give a utilization rate? I guess I'm looking to you guys to sort of help me understand the right measure there.

Sure, that's a -- well I would say we just came off a discussion on marine commercial, Gulf Coast, work boat, offshore oil, I would say that is the one market globally that's doing well. So I think there's still continued growth there. I would say industrial, our broader industrial markets are probably near the bottom, and I think there's growth ahead of it.

Certainly North American oil and gas for CapEx for building frac rigs is at the bottom. And I would hope for people supplying the new frac rig construction, there's know where to go but up. And I still think in Asian oil and gas, it's still in the growth phase. So Europe, I would say every market has an opportunity to grow. Certainly for us, that is by far, as far as the geography, the broadest, weakest market.

Okay. That's all I had. Thanks for taking my questions, guys.

Thank you.

Thanks, Peter.

(Operator Instructions)

Our next question is from the line of Robert Vermillion with F/64 Capital. Please go ahead.

Hello. Good afternoon.

Hello, Robert.

Couple questions. One was could you provide the break down of gross revenue between manufacturing and distribution segments?

We do in the Q. We didn't disclose it in the press release. It will be filed next -- I believe, it's next Wednesday.

Okay. Got it. And then I believe in your prepared remarks, you made a reference to trademark or patent protection spending on the corporate side. Could you provide more detail there?

Sure. We have -- you're probably not going to be surprised, it has to do with a company in China. One, we have just more patents in general that we're bringing out new technology and we're filing patent on it. So that has increased our legal expense. But one issue we have with a trademark, a company in China trying to use Twin Disc and our red oval, basically for their use. So that was, I would say, the delta year over year was legal expenses, both here in the US and in Hong Kong, to stop that activity.

So that's a competitive transmission product that they're trying to pass off as yours?

No, more just trying to use -- a trading house using our name and trying to sell our products, other competitors' products, more of a spare parts.

And mostly unrelated products, completely unrelated.

Basically, trying to buy spare parts in the US and sell them into China, but using our name to do it.

It's more using domain names, using our Company logo, using the Twin Disc name. But we aren't talking about significant or recurring costs, at this point.

Okay. Got it. Great. Thank you.

Our next question is from the line of Rand Gesing with Neuberger Berman. Please go ahead.

Hello, guys.

Hello, Rand.

Do we have to do the call at 3:00 every quarter, or -- ?

No. Typically, as you may recall, we've been doing it earlier. We just originally had a conflict this morning.

Rand, you can blame me. It was my fault.

It's a little long in the day to wait to hear you guys talk about what's going on. In Europe, it sounds like you have a little bit of incremental weakness versus year ago. Can you size it? Are your revenues in Europe down 5% to 10% from last December quarter?

I would say that -- Chris has the sheet in front of him. It basically mirrored the percentage of what we were down.

Okay. And I guess you went through the end markets and it's probably out there, but I didn't -- for me, Europe, what's really materially weaker?

We have basically a lot of our European operations rely on the marine horsepower segment of, let's say, 100-horsepower up to 1500-horsepower. And that is the market globally that is still the weakest, and particularly in Europe. So that's the market that has affected them the most.

Okay. So that's still pleasure.

It's pleasure craft, small work boat, just it's a whole bunch of markets that that's the horsepower range where they produce.

Okay. All right. So you'd say that's the bulk of it, is the pleasure space?

Yes.

And -- excuse me, is that horsepower range.

Within marine, correct.

Okay. Any sense for what your market share is in China in the oil and gas, or is it sort of still rapidly developing?

It's rapidly developing. We have a pretty good market share, I think.

Is it different than what you would see in other oil and gas markets?

Yes. I would say overall our market share in China is higher than it is in North America, just recognizing that we came in from the high horsepower here in the US when the main part of the market was 2300-horsepower and below.

Right.

And China has been focusing on the higher horsepower frac rate.

Right. Okay. Great. Thanks. That's all for me.

all right. Thanks, Rand.

Thank you. I'm showing no further questions at this time. I'd now like to turn the call back over to Mr. Batten for closing remarks.

Thank you, Camille. And thank you for joining our conference call today. We appreciate your continuing interest in Twin Disc and hope that we have answered all of your questions. If not, please feel free to call Chris or myself. We look forward to speaking to you again in April, following the close of our third quarter.

Camille, now I'll turn it back to you.

Thank you. Ladies and gentlemen, that does conclude the Twin Disc Incorporated second-quarter FY14 financial results. Thank you for your participation. You may now disconnect.