Twin Disc Inc (TWIN) 2017 Q1 法說會逐字稿

Good day, everyone and welcome to the Twin Disc fiscal first quarter 2017 investor conference call. Today's conference is being recorded. And at this time, I would like to turn the conference over to Mr. Stan Berger of SM Berger. Please go ahead, sir.

Thank you, Vickie. On behalf of the management of Twin Disc, we're 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 2017 first quarter 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 states management 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 are 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 the copy to you. Hosting the call today are John Batten, Twin Disc's President and Chief Executive Officer and Jeff Knutson, the Company's Vice President of 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 2017 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 question.

Before Jeff goes over the first quarter results, I just like to take a few moments to go over some of the key operational points for the first quarter. Despite 4.1% lower sales in the fiscal 2017 first quarter versus the prior year, gross margin improved from 21.9% to 25.6% which represents $8 million to $10 million of cost of goods sold that we have taken out of the organization in the past 12 months. Additionally, our first quarter M&A spending of $12.5 million is the lowest that we have spent in over a decade and this was done without sacrificing our product development pipeline.

A year ago after seeing the rapid decline in our backlog due to low price of oil, we set out to make our business "oil and gas-proof" and profitable at $200 million. We firmly believe that we are on track for a lower breakeven point.

When comparing our end markets to a year ago. It's hard to point to one that is currently doing better. A year ago we entered a new fiscal year with a larger, but declining, backlog its market conditions were quickly worsening. This year we have entered the new fiscal year with relatively stable trends from fiscal 2016. Our first quarter is historically the weakest quarter both on the topline and the bottom line and this should prove to be true this year as well.

Our sales group continues to spend a lot of their time going after new applications and is focusing heavily in our industrial market to expand our growth potential. While I am happy to report that we have won new businesses in several different applications, we are in the early stages of shipments and still in weak market condition.

And now I will turn it over to Jeff who will quickly go over the results for the quarter.

Thanks John, and good morning, everyone. I'll summarize the first quarter results. Sales of $35.8 million for the first fiscal quarter were down about $1.5 million or approximately 4% from the prior year for the first quarter. This decline is largely due to reduced activity in the Asian market for the Company's commercial marine products. North American and European commercial marine and industrial products demand was stable compared to the prior year.

I would also point out that while the year-over-year comparison is relatively flat, global demand for the Company's oil and gas related products remained severely depressed through the first quarter in line with global market activity. FX had just a small positive impact on sales in the first quarter compared to the prior year.

Despite the $1.5 million decline in sales, as John mentioned gross profit increased by nearly a $1 million and our gross margin percent improved by 370 basis point to 25.6% in the current quarter compared to 21.9% in the prior year first quarter. This positive result is reflective of the Company's aggressive cost reduction initiatives over the past several quarters in response to very difficult market conditions in many of our end markets.

Spending on marketing, engineering, and administrative costs of $12.5 million declined $2.8 million or 18% compared to the prior year first quarter and was also a result of previously announced cost reduction actions and a global focus on managing costs along with reduced pension expense and lower spending on corporate development activities in the quarter.

We remain committed to optimizing our cost structure in light of current market dynamics, recording an additional restructuring charge of nearly $600,000 in the second quarter related to manpower reductions that are US and European operations. With the improved margin performance and reduced ME&A spending in the quarter our operating loss improved nearly $3 million compared to the prior year on lower sales volume.

Our effective tax rate after adjusting for not deductible losses in a full valuation allowance jurisdiction was slightly higher at 39.6% due to jurisdictional mix and reduced foreign tax credit. Net loss for the quarter of $2.7 million, or $0.24 per diluted share, was improved from the prior year loss of $4.3 million, or $0.39 per diluted share. EBITDA for the first quarter was negative $1.8 million an improvement of $2.4 million compared to the prior year first quarter.

Our balance sheet remains in a very strong position with net cash of $6.4 million, debt to total capital of 7.8%, and over $11 million of availability and our revolving credit facility. After reducing inventory 17% in the prior fiscal year, inventory was relatively flat in the first quarter of fiscal 2017, hampered somewhat by a supplier issue.

While free cash flow was negative $3.2 million for the quarter, this reflects an improvement of $1.6 million from the prior year first quarter and continued a positive trend on a trailing 12-month basis. We remain committed to optimizing free cash flow including close management and prioritization of capital spending on key new products, global sourcing and process improvement.

And with that, I will turn it back to John.

Thanks, Jeff. And now I'll spend a quick moment on our outlook. While our backlog dropped from $35.7 million to $33 million during the quarter, we remain optimistic that there are enough opportunities in front of us to make this fiscal 2017 a better year than 2016 both from the topline and bottom line. No doubt that the markets are still facing headwinds that we have been very encouraged by the recent application and quoting activity in the oil and gas market, specifically the pressure pumping area.

I don't think any of us realized the full extent of the percentage of the Northern American frac fleet that is non-operational. We have heard anywhere from 35% to 50%. While it's hard to know the true number. It is clear that the days are picking up functioning frac rigs for pennies on the dollar are over.

Furthermore, the amount of cannibalization of operators' current fleet has been significant. We have quoted more replacement units and new units in the last month than we have in the last year and a half. We will be able to book and to ship in the second quarter if these orders materialize. We are not calling this a recovery, but it does appear that even to continue at this level of activity, and at this price of oil, the overall fleet needs some refurbishment. As always, we will manage our balance sheet hope we will be able to respond to this new business but any corporate development opportunity that comes our way.

Finally, on behalf of Management and the Board, Jeff and I would like to thank all of you for your continued interest, your questions today, and your continued support of the company.

That concludes our prepared remarks. And now Jeff and I will be happy to take your questions. Vickie, please open the line for questions.

Thank you. (Operator Instructions). And we will take the first question today from Josh Chan with Baird. Please go ahead.

Hi, good morning John and Jeff.

Good morning, Josh.

Good morning, Josh.

Good morning. Just wanted to ask for a little bit more call on the oil and gas comments, obviously those are very encouraging. So basically how broad based are those discussions and what does that tell you about kind of the inventory on the field? Do you think you know the inventory has been absorbed at least in certain regions?

Yes. Again it's going to be the percentage of operational versus non-operational will be different in every company. But kind of the themes that we're hearing is a lot of people were out in the last two quarters, last year trying to pick up good rigs for pennies on dollar.

And it seems that those were picked up a long time ago and there is a frustration that you can't find good rigs for sale. And so those that are in need of equipment are having to buy equipment that needs refurbishment, and so the trade off now is do we refurbish this, replace it, or do we buy new equipment.

I would say on balance right now, Josh that it's what we're seeing is it's probably 60/40, 60% of what we've been quoting is new -- for an actual new, a completely new rig, 40% would be for replacing, well we know that they're replacing the transmission at least and they're probably having to go through the engine and the pump. But it's been primarily I would say to this extent most of it has been in North America and most of it's been in the Texas area. So obviously even for some harder applications, higher horsepower.

Okay. What do you think you know the activity picked up in the last month that quickly I guess? And then what do you think is the urgency in terms of customers placing orders? Do you think --

I mean a lot of the companies that we've been dealing with, it always seems that they're dealing with a 10/1 CapEx budget. And so I think a lot of them have been getting quotes out because they need to do some work or they're going to have budgets that have been approved in October -- that's just been historically our experience both Canada and Texas.

I think the realization that they've been running the rigs a long time, and I've mentioned in the past calls -- we knew that our equipment was running but we knew that it was lasting a long time but we had hoped that there has been a somewhat higher order rate for the aftermarket parts to support it. It seems that we're coming to that point that even to continue, we're going to see some aftermarket activity and then of course some unit activity.

And I think it's just everyone's been running the rigs and doing the same thing rather than buy a part. If they had it sitting on another rig somewhere they've just been stealing it from that. So that seems that everything is I can't say because we don't sell to everyone in the market, so I'm dealing with our set of customers that they've come to the point where they can't continue to steal from parked rigs because that's already been done.

Okay. That's encouraging. That's good to hear. So on the margin front you mentioned that Q2, you should see kind of a seasonal step up and you've done some cost reduction. So should we see kind of a step up in Q2 gross margin as well versus what you did in Q1 which is very, very good already?

Yes. I would say if I would hope to see a step up but I would just like to prepare you that it may be flat. We also run into the amount of shipping. The first quarter and the second quarter both are challenged they have fewer shipping days than in the second half of the year.

It's really going to come down to the aftermarket component that's going to help on the gross margin line and how we do there. And certainly if we get some oil and gas orders that we can book and build in the second quarter, I definitely would see a strengthening. But I would just caution that any real gross margin improvement opportunities in the second half of the year, from where we were the run rate in the first quarter.

Okay. And then you mentioned that you won some new business, what markets are those in?

It's industrial. It's been some components that go into oil and gas that are not transmission. They are pump drives, pump drives on some airport type equipment. Tugs moving planes around, which shifts some into the military for some compressor applications. Some of our new PTOs that are coming out are remotely actuated for some snow plow applications in Canada.

So the snow plows are bigger than you and I used to and just some taking business back and some woodchipping with the new age PTOs. So it's been pretty balanced but again it's just in its infancy and again the overall markets are struggling. So hopefully going forward in the quarters and years to come, this is a good base for growth.

Okay. And lastly for me it sounds like you're expecting maybe a little bit better demand soon. How do you balance kind of near-term costs with having enough capacity to support kind of the initial uplift in demand?

That's a see-saw, it's a balancing act. Kind of want to get some clarity on whether or not this activity -- how big it is, how sustainable it is. Is this -- what we've been quoting and hopefully get, is it just a blip or is it a sign that the business -- the oil and the frac fleet has bottomed out as far as new construction and refurbishment activity and do we see growing trends?

It is a concern we have taken a lot of costs out. The majority of the cost has been here in our Racine operations which had the biggest impact of Asian marine coming down and oil and gas coming down. So fortunately it's localized and this is something that we can monitor on a week-to-week basis as far as what resources we need here to capture the business going forward.

But we went into the oil and gas downturn with a significant amount of inventory that we have. So our ability to respond on any up cycle right now as far better than it ever has been in the past.

Okay. It sounds good. Thanks for the time and good luck in the next quarter.

Thanks, Josh.

We'll now go to Walter Liptak with Seaport Global.

All right, thanks. Good morning, guys. Good work on the hard work of managing through the downturn. It looks like it did show up in the gross margin. I am wondering if you can just continue the conversation about the oil and gas market. So I wonder if you can maybe put in perspective what the quoting activity you talked about over the last month, maybe number of units, type of units, geographic region --

Yes, Walt it's been primarily the 8,500 and its variants to 8,700 which is the 3,033 horsepower variant. It's been primarily for my kind of I would say Eagle Ford applications, higher horsepower. But understand that it's going to be these rigs needed either have come out of dry gas or need to be used in dry gas and everything else. There's been a little bit of activity in interest in the 7,500 for some lower horsepower activities, but primarily it's been 2,500 horsepower and above.

One of the trends that I think that we're seeing on a macro level is that there are probably going to be fewer players, rig builders going forward. Just some of them have not made it through, some of the rig builders, some of the smaller operators. And what is the trend going forward? Are there going to be larger frac builders, is it going to be more of a lease-type activity to the big guys for oilfield services?

So I'm encouraged to see that the demand has still been now coming out of the slump at least on the quoting activity in the application on the higher horsepower side because that definitely bodes well for us, that's our sweet spot. So certainly it hasn't picked up yet significantly north of the border in Canada and certainly it hasn't picked up in Asia.

So really it's -- the first glimmer of hope, it's here in North America, primarily in Texas. But as I mentioned in my comments, we've had more activity in the last month than we have in the last year and a half, which is good to see. And we're hearing kind of the same themes and the same facts or the same comments from multiple different people. So through triangulation we feel that there's at least a blip coming up for refurbishment activity on the existing fleet.

Okay. I wonder if you can help us with maybe the sense of urgency from the quoting that you are getting. You made it sound like it could turn in the second quarter or is this something where we have to wait for CapEx budgets to get refreshed for 2017?

I think everyone is very -- no matter how big or how small the companies are, they want to make sure that they have approval, the purchasing, and engineering and the operational guys, they want to make sure that obviously they have approval. But it is kind of one of those that -- while I get the feeling that when we get the order, when we get an order, the delivery is going to be how quickly can you get X number here?

So I know it's going to be a rush and we certainly can get units out in this, the calendar fourth quarter of 2016. I have no doubt about that. We could probably get not a huge number out, but a pretty good number. So everything that we've really been working on so far, they want by the end of the third quarter.

Okay. And it sounds like in the past and I think in this call you commented that the products are really performing well --

Yes.

And you're getting great utilization out in the field. Do you get a sense that you are gaining new customers?

Yes, because a good portion of what we quoted is on the refurbishment side is to replace someone else's transmission not ours. So that's a market share and a new business win.

Oh okay. All right. That's great. And then maybe just to broaden the conversation into some of the other product categories, any change in the outlook for pleasure craft or work boats?

Well, I'll start with pleasure craft. I think that we have been bouncing along the most recent bottom. I would say the pleasure craft still has never recovered from the 2008 level, but we've been very happy with the success of our Australian subsidiary with the joystick getting new business. We've won new business here in North America. It's just that it's coming off such a low level that the incremental gains have not been enough to offset what we've -- what the commercial markets have done and specifically the offshore oil and gas.

So as we've seen gains in pleasure craft, it's been dwarfed by the slowdown in offshore which kind of came after the pressure pumping slowdown ,specifically in Asia and then in North America. Still have applications orders shipments for North American oil and gas offshore, but it's been very, very, very slow in Asia.

And when you couple that with -- we had a lot of business in the coal barges that bringing coal from Indonesia to China. We had some inventory there, so we're selling out of inventory, but hopefully as we go into 2017 that will improve.

Certainly everything that we're hearing from our markets is that calendar 2017 should be a better 12 months than calendar 2016. But for offshore oil and gas, I think, to get back to what we consider good healthy levels is going to be at the end of 2017 going into 2018.

Okay. And in industrial, you've been some kind of choppy I guess in bringing all the chemical products. I wonder if you can comment on any trends you saw in the quarter?

Yes. Again I go back to the comments I made last year. We were surprised that how much of our industrial business and our customers business was driven just by the activity in oil and gas. We're seeing, I would say, the industrial orders have been stabilized. I'm hopeful that calendar 2017 again will be a better year. We are certainly going into 2017 have more possibility for growth because we have more applications that we're on.

And the sales group here has been reorganized and we have different groups focused on direct OEMs, different groups focused on distribution. So I think we're getting a lot more coverage and a lot more focus. So I'm hopeful that even in the stable market conditions we're going to grow our industrial business in calendar 2017. And we should be able to do it.

Okay, good. Thank you.

(Operator Instructions). And it appears there are no further questions. I'd like to turn it back to John Batten for any additional or closing remarks.

Thank you, Vickie. And again, thank you for joining our conference call today. We appreciate your continuing interest in Twin Disc and hope that we've answered all of your questions. If not please feel free to call Jeff or myself directly here in Racine. We look forward to speaking with you again in January following the close of our fiscal 2017 second quarter. Vickie, I'll turn it back to you now.

Thank you very much. That does conclude our conference for today. I'd like to thank everyone for your participation and have a great day.