Twin Disc Inc (TWIN) 2016 Q1 法說會逐字稿

Good day, everyone, and welcome to the Twin Disc, Inc., first-quarter 2016 financial results conference call. Today's conference is being recorded. At this time I would like to turn the conference over to Mr. Stan Berger of SM Berger. Please go ahead, sir.

Thank you, Anthony. 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 first-quarter 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 which 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 Chief Executive Officer, President, and COO; and Jeff Knutson, the Company's Vice President, Finance, Chief Financial Officer, Treasurer, and Secretary. At this time I will turn the call over to John. John?

Thank you, Stan, and good morning, everyone. Welcome to our fiscal 2016 first-quarter conference call. As usual we will begin with a short summary statement, and then Jeff and I will be happy to take your questions.

Looking at the first-quarter results, sales for the 2016 fiscal first quarter were $37.4 million versus $64.8 million a year ago, a decrease of about 42%. You may recall from our last call, we had a number of customers moving up shipments in advance of our July and August shutdown.

Our largest client here in Racine was shut down for the entire month of July due to a very light demand. Many of the orders pulled up were to ship throughout the quarter, not just in July. This movement in orders -- coupled with the sharp decrease in demand in new orders and extended shutdown -- helped explain the significant difference in sales levels.

Looking at the end product market, the North American oil and gas market and the Asian gas and marine markets had by far the worst comparables year-over-year. This is the first quarter in over a decade that there were no forward market sales into the global pressure pumping market. The oil and gas aftermarket activity also saw significant reductions versus last year in previous quarters.

Looking at the Asian end market, the Chinese domestic oil and gas sector experienced a sharp, sudden pull-back as activity slowed and inventory grew. The slowdown in the Chinese economy also significantly impacted the regional marine market -- both offshore oil and gas vessels and tug and coal barge activity in Indonesia.

Sales into our other marine markets and industrial markets were down about 25% compared to last year in the previous quarter. Sales into our transmission market declined versus fiscal 2015 first-quarter levels by about 75%. This falloff is directly attributed to the extreme low levels of oil and gas shipments.

Gross margins for the quarter were 21.9% compared to 34.5% a year ago and 29% the previous quarter. The comparatively poor mix due to the extreme low level of oil and gas shipments and increased shutdown at our North American production facility were the primary drivers in the gross margin decline. First-quarter spending in marketing, engineering, and administrative -- or ME&A expenses -- decreased by $670,000 versus the same period last year, from $15.9 million to $15.2 million, which was our lowest first-quarter ME&A spending since fiscal 2011.

As we mentioned in the press release, the year-over-year reduction was due to cost-containment, currency fluctuation, and reduced bonus expenses that were offset by increases in stock compensation, pension expenses, and corporate development activity. During the quarter we sold our assets and the distribution rights to Twin Disc products in the Southeast territory of the United States for approximately $4.1 million, which resulted in a net gain of $500,000. I will come back to the sale later in the call. The net loss for the quarter was $4.3 million or $0.39 per share compared to net earnings of $4 million or $0.36 per share a year ago.

Looking at the balance sheet, we ended the quarter with total debt of $14.3 million, up $500,000 from the end of the prior fiscal year; and cash of $23 million, which was flat from the prior quarter; and an end result in a net cash position of $8.7 million. Mindful of the lower revenue levels, we are working to keep our working capital in line with these lower levels.

Inventories are 21% lower than year-ago levels and down 4% from the prior quarter. In the quarter our working capital reduced 13% from $112.8 million to $97.5 million. These reduction activities will continue for the foreseeable future.

Our six-month backlog increased from $34.4 million to $37.5 million. While we are pleased to see the increase, we remain cautious and can attribute part of the increase to the prolonged shutdowns during the quarter. General market conditions remain very weak, with just a few pockets of relative strength, such as the European marine market, the North American industrial market -- especially after market activity, and the global ARFF market.

Turning back to the sale of our distribution entity for the moment, we have worked over the last few years to keep our balance sheet in position to make a key strategic acquisition or to weather a sudden and steep downturn -- but not both at the same time. It is becoming ever more clear that the return of North American oil and gas is increasingly unpredictable and unlikely to happen in the next few quarters. As a company we have to be profitable, assuming oil and gas forward market sales are zero. This will force us to make hard capital allocation decisions, like the sale of Twin Disc Southeast.

In selling the distribution entity to one of our independent North American distribution partners, we can use this capital for increased product development and other growth initiatives. Our global footprint, especially the manufacturing footprint, is a result of growth investments in markets like the European pleasure craft market and the global oil and gas markets that are under extreme pressure. Until this quarter we have had the volume in other product markets in addition to certain minimum in oil and gas to maintain acceptable margin.

In addition to the $6 million of cost reductions announced in the fiscal 2015 fourth quarter, we have identified another $4 million of annualized savings across the Company that will be implemented in the second quarter. Looking specifically at our manufacturing entities, we are targeting a 15% reduction in our cost structure through a variety of actions which will be rolled out over the next few quarters.

Given the uncertainty in many of our traditional markets -- the reliance on Asia and other emerging markets for growth, and the ability of macroeconomic forces like OPEC to have such an impact on key markets like oil and gas --- management recognizes that we need to simplify and to reduce the complexity of the Company if we are to be profitable without a forward-market oil and gas component, but to remain capable of delivering when that demand returns.

Turning quickly to the outlook: on the last call we talked about how the first two fiscal quarters in 2016 would be our most challenging. This has only become more apparent as we saw orders pushed out during late August and September.

Thankfully, the trend has become somewhat better in October. But it's still too early to tell if this is a blip or a real inflection point. This doesn't change our short-term plan to address our cost structure to the new reality of $50 oil. That concludes my prepared remarks, and now Jeff and I will be happy to take your questions. Anthony, please open the line for questions.

Thank you. Today's question-and-answer session will be conducted electronically. (Operator Instructions)

Walter Liptak, Seaport Global.

I wanted to ask about the oil and gas markets. And I guess it's completely understandable that there would be no pressure pumping sales in the quarter. But I wonder if we can maybe get two data points from you: one, what are you hearing from your salespeople, and what are they hearing from customers regarding when their excess inventory of equipment will be consumed? And then I wonder if you'd comment on parts sales during the quarter?

Well, first -- let's see. I think if there's going to be any return to forward-market activity, I believe -- for us, anyway -- it will happen in China first, just because they don't have the dollars and the unit excess inventory that's here in North America. And certainly as a percentage of the fleet, there's not the same level of access.

So I could see forward-market units to Asia continue -- resuming in the next couple of quarters. That's not out of the realm of possibility at all. North America is just another conundrum. I would have said that a year ago, we were at that point where, by and large, all of the excess capacity had been consumed. And we saw that with new orders.

Now, with the level of operators in distress -- and by and large, of the fleets that we're in, those operators I don't think are the ones who are much distressed, but they do have excess capacity. Now, that's coupled with the ones who are in distress, and there is a lot of excess capacity. And I've read probably the same things you have -- that that could be anywhere from, again, 25% to 40%, which puts us back in North America where we were a couple of years ago, with a lot of excess inventory.

The difficult part, Walt -- the one that's hard to predict -- is: how will that excess capacity find its way into the hands of the people who are not in duress and can use it? That's the million-dollar question. And we just don't know. Is that two quarters? Is that a year?

So that's why we remain cautious, that -- you know, we think our stuff -- our stuff is being used, so there is an aftermarket component. But when are new units going to come in North America? I think it's going to be very specific and very targeted. They will replace a spread here or a spread there, or we'll get to do a retrofit.

But I just don't know the answer to that, Walt. I think we are -- at a minimum, this is another year to two years of North America shaking out the excess inventory. And with respect -- you asked about aftermarket. The aftermarket component, the rebuild, dropped significantly. It didn't go to zero, but my guess is two-thirds -- 50% to two-thirds of what we were doing a year ago to this past quarter.

Okay. Given that it may take a year or two, with that sort of an outlook, I guess kind of getting to the cost-cutting aspect of it, what kind of timing can we think about for getting to that breakeven level? Either this year or next year? And then, if that's too difficult to address, maybe what kind of revenue level overall are you at breakeven?

Okay. Those are all good questions. What we are looking at and what we are addressing, starting this quarter and really through the remainder of the fiscal year, is we are going to assume forward-market oil and gas at zero. And we are going to organize ourselves so that we are profitable at that level.

Will we be able to get to that run rate by the end of the fiscal year? That I don't know. But that is where we're headed. And certainly, if there's an oil and gas component, our breakeven level is much more attractive if there isn't -- just the margins in that are higher -- but now we've been -- you know, it's been one pause of about 2 1/2 years of real strong forward market activity in North America.

But we had the Asian component, which was certainly enough to keep us with good margins and profitable. Now with the Asian component going on and off, overlapping North America, it's just not a very comfortable picture. So we're going to position ourselves so that we can be profitable without oil and gas forward market. So it's going to take a few quarters, Walt, to do that. But we'll get there.

Okay. Good -- yes, good luck with that. It's obviously a major undertaking. You know, I wanted to also ask you a question about the sale of the distribution asset. What started the strategy for selling distribution? Maybe thoughts around -- you know, is this -- how much more do we have to go? How much money can we raise as you exit that?

Well, part of it was done to maintain a clean balance sheet. But it was also done -- it's just what are we going to -- our strategy on how we allocate capital and what we use our capital. And then I wouldn't necessarily jump to the conclusion that we are under a strategy to sell all distribution entities. That's not the case.

But if we can find a partner within the Twin Disc family that can do the job that we were doing -- or, I would add, probably do it better, because in certain areas they will have more product line, and they can actually make that entity stronger -- it seems best for Twin Disc and its products if someone else handles the sales in that territory, and we take that capital; and we either can invest in reducing our cost structure, new product development and engineering here at the plant, or we can go out and buy a product line that we can then spread throughout the entire Twin Disc organization.

So we actually embarked on this transaction before the dramatic turn-down in the first quarter. But in the middle of the first quarter it became very apparent that that was in fact a good decision -- that we can use that cash, use that capital, and invest it in other places, knowing that the Twin Disc product in that territory will be taken care of as well as or better than what we were doing. So it is a strategy, just recognizing that -- you know, what is our core competency? What can we do here with Twin Disc management for our customers? Should we be investing that $4 million in the distribution of the Southeast territory of the United States? Or should we be investing in new products for the global Twin Disc family?

Okay. So should we look at the Southeast asset sales as, like, a one-off? Or should we expect that there's going to be more from quarter to quarter?

I would say that we are taking -- you know, given -- just take the assumption that we are taking, that we have no oil and gas forward market. It forces you to make difficult decisions about capital allocation.

And I wouldn't -- it's distribution businesses; it is manufacturing subsidiaries; it is product lines. So we have said that there are a lot of options on the table to realign our cost structure. And this decision was just one step along with the mid-Atlantic region, which was a much smaller territory that we did last fiscal year.

Okay. Great. Thanks. I'll get back in queue.

Josh Chan, Baird.

If you can just go around to your different end markets -- certainly it was a tough quarter, but I was curious to hear how the markets compare versus your expectations coming into the quarter?

I guess overall -- say 42% down. I would say, by and large, that we expected to come down. We were at $65 million roughly a year ago. Our expectations, given the plant closures, were probably more in line with being at $50 million. So this was, again, double what we had anticipated being down -- and really driven by one area with the effect on one plant.

And it was -- we knew that North America oil and gas was going to be down. The aftermarket component surprised us a bit. But we were surprised at how quickly things turned off in China, really kind of in late August into September. So that wasn't anticipated: China oil and gas going to zero, the marine activity in the region slowing down so significantly. So that really was the surprise that, I guess, that -- taking us from $65 million to $50 million, we figured that that has going to happen; but going from $50 million to $35 million really was unexpected severity in China.

Okay. And then the somewhat of a rebound of yours -- I don't know if you want to call it a rebound in October, but improvement, I guess -- was that in China as well? Or were you seeing slightly better trend in October versus those two months?

Actually, I would say so far the blip has been mostly North America that's been driving it. And holding steady in Europe. But kind of the improvement over what we saw at the end of the first quarter to the beginning of the second quarter really, I would say, is driven by North America, but not oil and gas.

All right. All right. And then, on the gross margin line, is there a way to ballpark how much impact the production shutdown affected the quarter? I guess asked another way, what would normal gross margin have been like at the lower demand levels excluding the shutdown?

Josh, without -- assuming that same volume, without that shutdown, gross profit would have been lower, would have even been lower. So really what you have to do, I guess, is model what sales would have been in the quarter if we hadn't announced the shutdown. It would've been marginally higher. I think there's probably a few million related to under-absorption at the facility that was driven that we work able to recover from the shutdown. But it still would have been a very difficult quarter.

Right. Okay. And then on the cost savings, you announced a $4 million cost savings initiative; and then you also talked about a 15% manufacturing cost reduction. Should we look at those as different programs? Are they related somehow?

They are related. I would say of the $4 million, about -- slightly more than half of that would be cost-of-goods-sold related.

Okay. That make sense. And then is there a way for ME&A expenses to come down beyond the portion that's distributable from the $4 million? Or how should we think about that line relative to -- as revenue comes down, potentially?

Yes, I think that's a good question. Obviously, there are a lot of fixed costs in that layer, and that's what we're trying to attack as we look at our structure around the world. I think as John pointed out, it was a relatively low quarter for ME&A. Compared to our previous several years, it was the lowest quarter since the first quarter of fiscal 2011. That being said, we know that that's an area that we need to try to drive some cost savings in. And that's what we will be looking at over the next weeks and quarters.

And my last question is on sort of John's comments about capital allocation. So am I reading it right that with the proceeds that you are receiving, John, from the sale of distribution or whatever else that you might do, you are looking at new product development organically to try to accelerate growth?

Both, Josh. I would not take off the table corporate development activities, acquisition -- whether it's product line, a company, or internal product development.

Okay. So it could be a combination of all of them?

Yes. It could be a combination of all of those. But realistically, as I mentioned, we've been maintaining the balance sheet the way we have to get that key strategic acquisition or to weather a downturn. But certainly right now with the severity of the downturn, the primary focus is on the existing business at hand and making that profitable. But we do not want to lose sight of growth initiatives, whether it's organic product line or a company.

Great. Understood. Thanks so much for your time.

Rand Gesing, Neuberger.

Can you give us a sense for what's left as it relates to distribution?

Sure. We have mill log equipment, which is in the Pacific Northwest of the United States. So that would be Oregon, Washington; and then it also extends into Canada, with British Columbia, Alberta, and Manitoba. And then we own our distribution facility for Australia. And we have our master distributor in Singapore, which handles all of our Asian dealers. And then our Company Twin Disc SRL is our distributor for Italy. Those would be the distribution companies that are left.

Okay. So if I was to try to think about it just in terms of revenue flow-through, have you sort of sold maybe almost half of your distribution by these two pieces?

No. On a sales level it would probably be -- boy, not even 10%. Between 5% and 10%.

Okay. Okay. Okay.

Yes, the entities that remain are significantly larger in revenue than the Twin Disc Southeast or the territory that was above them.

Okay. I guess what I'm sort of backing into a little is sort of what's in the piggy bank in terms of proceeds you could potentially do. Obviously you are not going to do all of them, because you are not going to get the good partner fit.

But is there anything we should think about in that math of what you've done? $5 million versus -- you know, obviously it's not going to be -- I'm not going to get exact numbers. Obviously I'm not trying to. But I'm just trying to understand a little bit about -- if you transact a couple of these, what could sort of be monetized? So I guess what I'm asking is: is the Southeast business -- is there something incredibly attractive about that or profitable that it would have made that slug of revenues much higher multiple to you guys than --?

No, I would say that there were a couple of -- again, we embarked on this activity last fiscal year when we were having a great year. So this wasn't a distress move, so to say. But when we're looking at it, the territory of the Southeast United States -- for us it was the least profitable of the distribution entities. And typically what happens is -- we acquired this territory, boy, over 20 years ago, before I started with the Company. So it was 20 years ago.

And over time, this distribution entity had migrated to just the Twin Disc product lines. So our industrial products and our marine products. It didn't have a whole lot of other lines.

Typically what happens -- or what can happen -- not necessarily, but what can happen is if we own a distribution territory, the other lines -- the other companies that are represented for whatever reason -- maybe we don't focus on it as much, or they pull that line because they think we are competitors. So you end up doubling down on cyclicality.

And in the Southeast territory of the United States it had been very heavily pleasure craft. Obviously Florida, the Georgia territories. So it became more challenging for us. Great Lakes Power Products -- the company that acquired it -- has a lot more lines that they can bring to the territory and help fund the activity there. And they are right next door to us.

So it was an adjacent territory. It made sense. They can leverage their cost and their management system. So it really just seems -- in all honesty, when we started out, it's how do we better serve the customers and our products in the territory? Who can do it better than we can? Because we are struggling with this, and we don't want to invest more time and more capital in it. How do we invest less time, less capital, and do a better job?

And then it became obvious that we turn to one of our neighboring partners. So that's how it came about. The timing was pretty good, actually. They had it concluded in the first quarter, because it was nice to get that capital back and keep it dry for something else that we think will benefit the entire Twin Disc family -- not just the customers in the Southeast territory.

Right. Okay. Okay. I think it makes good sense. I wasn't following you quickly enough -- in your prepared remarks, you said something, and then you laid out euro, marine, North American industrial, and global ARFF. I wasn't sure whether you were seeing some transition there or what point you're trying to make.

The comments on those markets were the ones that had the best comparables to a year ago. So it hadn't fallen off at 25%.

And there's just a few pockets that really didn't -- pretty much everywhere we looked this year versus last year, the comparisons were negative. The exceptions were the European marine market -- it sounds counterintuitive, but comparatively that did well; aftermarket for North American industrial was okay; and then the ARFF market. But anywhere else you look, it was not nearly as good comparison.

Okay. What do you sort of feel, to the degree that you have any sense, Asian non-oil and gas? The work boats and things of that nature -- is though -- you know, given the sort of negative news we're hearing, deceleration in China, should we sort of feel like that market is going to be soft for you guys over the near-term?

I think it will be at least a quarter or two. Again, I'm confident that that activity will recover somewhat by the end of the fiscal year. There's just a lot of activity in this. It's a lot of wins and losses, but we will get out there and through the remainder of the year get more wins than losses. But no, it was a -- Rand, I can tell you it was a sharp contraction in the middle of the -- well, towards the end of the first quarter.

Right. Okay. And I guess my last question is: it sounds like you guys are pretty well along in terms of things you are thinking about doing, levers you are thinking about pulling to bring the cost structure down. But it sounds pretty dramatic to me.

And I'm just wondering: how sure are you that you are not going to cut into some bone here? Or are you willing to do that? Because that's pretty Draconian to say, hey, one of the key markets that we had high margin -- oil and gas -- we can't rely on in the plan. And so we are going to size the business for that. So just your comments there would be helpful.

Sure. I didn't mean it to sound Draconian, but we have to accelerate some of the decisions we were considering making, just given going from at the peak of oil and gas in 2012 $350 million down to $265 million. Now currency played a big impact on -- the $265 million last year was much better than the $265 million the year before.

But the numbers of units that's still utilizing the temporary layoffs in Europe -- (inaudible). The recognition that the marine markets, as far as pleasure craft, aren't going to return to peak levels. Some of our plants have been able to transition and serve patrol boat and commercial market. Others haven't been as successful with their product lines.

So, Rand, it's not Draconian. They are just logical decisions, given that we can't rely on -- we were able to rely on since 2011 a base business of -- if we assumed fiscal 2012 was 100% oil and gas, that was like the maximum. We had been quite happy with that 25% to 25% level, if that's what Asia was going to give us, and a lower level of North America.

But now we have to be prepared that we could go multiple quarters with it actually being 0%. And then we do have -- that takes us from an acceptable absorption level to an unacceptable absorption level. So, again, your comment on cutting to the bone -- I certainly don't want to make decisions that, when oil and gas comes back, we are unequipped to react, because that would be truly an unacceptable result.

So that's why we are not announcing everything now or rushing into it. We want to make very informed decisions on how we want to be positioned in the future. But we have to be less complex, because just the volume in oil and gas in the margin is not there to cover up necessarily any inefficiencies with -- you know, if we're -- the number of facilities and $350 million in the cost structure is one thing. If you are saying now at $200 million -- we can't afford that same cost structure.

Right. Okay. Great. Appreciate it. Look forward to seeing you soon.

(Operator Instructions) Walter Liptak, Seaport Global.

Based on the last questions, I started thinking about what the revenue run rate might be for the next quarter. And I know you don't give guidance but, I mean, just directionally, your backlog is at $37 million. You saw your order trends in the quarter. Are you thinking that next quarter is going to be flat from where you were this quarter? Or is it going to be down?

It will be a better quarter. Sales will be up, just because there won't be -- just fewer shutdown days, so more shipping days. The mix as far as the product -- we are still assuming zero oil and gas. So it's going to make it difficult that way.

But I think you're see higher shipment levels. I don't expect it will be -- will it be enough to get us to breakeven? Unless we can cram a lot more oil and gas in the end as far as aftermarket, I don't think so. But historically, when we don't have an oil and gas component, we are going to have to the historical quarterly performance of Twin Disc -- although not at a loss. I wouldn't say that.

But the first quarter is by far the worst quarter of the year; the second quarter is better; third quarter is better; fourth quarter is better. And it basically kind of tracks the number of shipping days throughout the year in each quarter, the number of shipping days in each quarter, and just the seasonality of low order activity and the summer.

I see that trend now continuing, where each successive quarter of the year will be better. Where do we cross the breakeven point? Is it the second quarter or one of the second-half quarters? I'll be honest, Walt. I don't want to make any promises, but it will be difficult to do in the second quarter, just given that we will be taking some -- we are taking cost reduction activities kind of in the middle of the quarter.

Okay. All right. Great. Good luck, guys.

Ryan Curdy, Pacific Ridge.

Earlier you mentioned expectations of reducing net working capital. Can you just kind of walk us through that -- what your CapEx plans are? Also I think the last call you guided to $10 million for the year. Your balance sheet is already pretty light compared to where it was, say, five years ago in the last downturn. Just kind of what your thoughts are in terms of cash flow for the year?

Yes. We are looking at, obviously, working capital in terms of inventory, driving that down. But at the same time, as John said, being prepared for a recovery in oil and gas. That's a component that we were very mindful of, that we need to be ready and be poised for that recovery.

CapEx -- you are right; historically we are in the $8 million to $11 million range. I think we are very good at being flexible in identifying those key components that we need to spend on and possibly delaying some of the discretionary spending as we work through a difficult period. So I think we would probably estimate today between $5 million to $8 million in CapEx -- primarily some maintenance type items and some high payback machine tools.

Got it. Thank you.

And it appears we have no further questions in the queue at this time.

All right. Thanks, Anthony. 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 Jeff or myself.

We look forward to speaking with you again in January following the close of our fiscal 2016 second quarter. Anthony, I will now turn the call back to you.

That does conclude today's conference. Thank you for your participation.