Twin Disc Inc (TWIN) 2018 Q3 法說會逐字稿

Good day, everyone, and welcome to the Twin Disc, Inc. Fiscal Third Quarter 2018 Conference Call. Today's call is being recorded.

And now your host for today's conference, Mr. Stan Berger of SM Berger. Mr. Berger, please go ahead, sir.

Thank you, Rufus. 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 2018 third quarter and 9-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 statement. 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 a copy to you. Hosting the call today are John Batten, Twin Disc's President, 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 Batten. John?

Thank you, Stan, and good morning, everyone. Welcome to our fiscal 2018 third 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.

Before Jeff goes over the quarter results, I will touch on some of the operational highlights from the quarter. Sales for the quarter rose 45% year-over-year. Compared to third quarter sales a year ago, demand was up in most of our market. Obviously, the most dramatic increase year-over-year was in our land-based oil and gas transmission sector, but we also saw rising tides in many of our other markets as well. Demand was strong across our marine markets, and we have seen a nice industrial demand increase across both our forward and aftermarket businesses.

As we mentioned in prior calls, this is putting a lot of pressure on our supply chain. A lot of our management time has been spent on securing the parts and processes needed to meet this ramp up. The overall situation improved throughout the quarter, but we still have work to do. Many of our key suppliers are at full capacity, and we are adding additional capacity through new suppliers and new internal CapEx.

Sales for the quarter could easily have been $7 million higher if we were able to get all of the components necessary to meet the demand. Currently, we have about $6 million in CapEx on order, which will increase our internal capacity, primarily in gear production and in anticipation of assembly and test expansion.

As part of our cost rationalization process the past 2 years, we have moved some of our distribution depot functions back to Racine, when we divested our distribution entity in the southeastern part of the U.S. To improve our manufacturing throughput, we will be moving this activity out of the shop area to a new location and using this free space for new machine.

Our productivity slipped a bit in the quarter due to a lot of new hires coming online after January 1, but the trend should reverse as the productivity of the new employees improves and the new CapEx is installed.

Our gross margin for the quarter could have been 130 basis points higher except for a one-off warranty expense related to some marine transmissions in 10 fast supply vessels. While the marine gears were well past the standard warranty times, there were 20 that we felt were not meeting our internal threshold, and we decided to update them in this low-activity period.

With that, I'll turn it over to Jeff for some comments on the financials, and then I'll be back for an outlook at the end.

Thanks, John, and good morning, everyone. I'll briefly run through the third quarter numbers in a little more detail. Sales of $65.3 million for the quarter were up $20.3 million or nearly 45% from the prior year third quarter. This represents the fifth consecutive quarter of year-over-year growth, demonstrating a sustained and accelerating growth trend. The primary driver, as John mentioned, for improved revenue in the quarter remains the improved shipments of oil and gas transmission units into North America, along with improved North American aftermarket demand, which was also led by oil field activity.

In addition, we've seen increasing signs of growth to varying degrees in nearly all of our markets, including European and North American commercial marine, global patrol craft, pleasure craft, global industrial and Asian commercial marine.

The global offshore supply vessel market, however, remains depressed. For the first 9 months, sales are now up $52.4 million or 46% to $167 million. Our gross margin percent for the quarter improved by 220 basis points to 31.7% compared to 29.5% in the prior year third quarter. This improvement is primarily volume driven but also reflects improved operating efficiencies and a global reduction in fixed cost.

As John mentioned, margin performance for the quarter was somewhat hampered by an isolated warranty issue, resulting in an $800,000 charge in the quarter. Year-to-date gross margin through March is 31.6% compared to 27.4% for the fiscal 2017 9 months. Spending and marketing, engineering and administrative costs for the fiscal 2018 third quarter increased $1 million or roughly 7% compared to fiscal 2017, but decreased as a percent of sales from 30.5% in the fiscal 2017 third quarter to 22.6% in the current quarter. The increase in spending was primarily related to a $600,000 increase in the global bonus expense as well as a $400,000 currency impact. Similarly, year-to-date spending has increased $4.9 million or 13% but has declined as a percent of sales from 33.8% to 26.2% in the fiscal 2018 first 9 months.

We invested another $0.5 million in the quarter and now $2.5 million for the first 9 months related to restructuring actions to drive additional cost reductions and efficiencies, primarily in our European operations. With the improved volume and margin performance, our operating results improved by $8.9 million, from a $3.4 million operating loss in the prior year third quarter to a $5.5 million operating profit in fiscal '18.

For the first 3 quarters, operating results have improved by $17.9 million compared to the prior year, to an operating profit $6.6 million. The effective tax rate for the third fiscal quarter was 20.7%, reflecting the impact of the new tax legislation, along with some smaller favorable discrete items.

Net profit for the quarter of $4.3 million or $0.37 per diluted share reflects a $6.2 million improvement over the prior year fiscal third quarter, resulting in a year-to-date profit of $3.6 million compared to a prior year 9-month loss of $7.5 million. Positive EBITDA of $7.2 million for the quarter reflects an $8.9 million improvement over the fiscal 2017 third quarter.

On a trailing 12-month basis, we are now at $14.5 million of EBITDA, which includes the restructuring charge -- restructuring charges of $3.1 million over that period. The balance sheet remains in a very strong position, with $7.5 million of net cash, debt-to-total capital of 5.3% and $27 million of availability on our revolving credit facility. While inventory has increased $13.8 million since the end of fiscal 2017, this reflects growing demand as inventory turns have increased 23% over the prior year results. This increase is supported by the continuing growth of our 6-month backlog, which reached $116.3 million in the quarter, a 150% increase over the prior year-end and a 37% increase over the second quarter. The inventory increase also includes a positive exchange impact of $2.4 million.

Free cash flow was negative $4.2 million in the third quarter, hampered by the growth in inventory and timing of sales within the quarter. Through the first 9 months, we've reported $3.4 million in negative free cash flow compared to negative free cash flow of $2.7 million in the first 9 months of fiscal 2017.

Cash flow performance has been impacted by volume-driven increases in working capital. The $15 million increase in working capital compared to the prior year third quarter represents 24% of the increase in trailing 12-months sales volume.

In addition, we started to ramp up CapEx, as John noted, after an extended pause. We anticipate capital spending to fall in the 60 -- $6 million to $8 million range for fiscal 2018, as we invest in modern equipment, global sourcing programs and new products.

And now I'll turn it back to John for some final comments.

Thanks, Jeff. And I'll just spend a quick moment on the outlook. Our 6-month backlog increased, as Jeff mentioned, 37% in the last 3 months and is 130% higher than a year ago. And I would say that the biggest change since our last call is the market improvements in areas outside of North American pressure pumping, particularly Asia. In short, it's a better mix of backlog. We have seen a lot of new order activity in Asia, both in marine and oil and gas, and the continued aftermarket demand across all of our product lines signals that the markets are coming to life. Our industrial marine shipments are up almost 10% year-over-year. And with respect to land-based oil and gas, the market is very active, and we expect it to be for some time to come.

The attendance at last week's OTC show in Houston was extremely busy and many of our customers had a very positive outlook through 2019 and into 2020. We share that optimism. But it is our goal to use this opportunity to invest in new products and technologies to diversify our business.

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

(Operator Instructions) And for our first question, we go to Josh Chan with Baird.

Yes. If I can start on North American oil and gas, I mean, obviously that drove the quarter for you guys. Could you talk about just kind of the conversations that you have -- you're having with the customers and sort of the lead times? And whether you think that the market is undersupplied and will be for some time? Or whether you think it's sort of balanced with the capacity that's coming on?

My sense, Josh, is -- well, [we've had] very positive conversations down in Houston. I'd say we're in that phase where a lot of the orders that we currently -- a lot of our production [builds] for our customers are kind of in midstream, and we're already in discussions for the follow-on orders. And my sense, and I think the sense of our entire team that was down there, is that we're still in a state of undersupply, and I think there's more investment to come. I don't know how long it's going to last, but it certainly seems that there's a lot more runway, and we're talking multiple quarters. So I think the overall sense is that the market's healthy. There's still a lot of rebuild activity going on. A lot of new equipment being added. And so we're looking out -- deliveries for us are 8 to 9 months out. So everything that we would be scheduling now would probably be at the very end -- well, not very end but it would be in the first calendar quarter of 2019, so our third quarter -- third fiscal quarter of fiscal '19. So overall, the best OTC in many years for many reasons.

Right. That's good to hear. There's some visibility on that. So I guess, like on the backlog, could you talk about kind of the amount of concentration or diversity in terms of -- did you get like one large order that drove the growth? Or was there a number of orders that kind of contributed to the very strong backlog this quarter?

Probably should have been a little clearer. It was multiple orders from different customers, different region. And I would say the most -- the thing that made us the most optimistic was Asia coming to life in a couple markets. Commercial marine and oil and gas orders that we hadn't seen with that type of significance in 2 or 3 years. So that's why I say a better mix of backlog. It wasn't just all driven by North American oil and gas. Certainly, a big part of it, but it wasn't the only part.

Right. That's encouraging. And then following up on some of your comments about the -- looks like -- it sounds like there's a lot going on in terms of hiring, in terms of kind of adding capacity. Could you talk about whether you're having trouble kind of finding people? And how are you managing sort of the moving pieces between that and equipment coming in and all that?

Sure. It's a mix of finding additional suppliers, dual- and triple-sourcing certain components, hiring and adding CapEx. Certainly, I would say the 2 most challenging, just as far as time, is finding additional suppliers and new employees that you can bring in and train and get them up to speed. Certainly, the CapEx, it's going to come in, we have guys that know how to run those machines, guys and gals. And that's going to be rolled out over the next few quarters. But I -- we made a big -- a lot of headway was made in this third quarter. A lot more to do. But I feel a lot better right now than I did 3 months ago. But certainly, hiring, it's for everybody. But finding people here that want to work in manufacturing has always been a challenge. But the guys that are coming out of the trade schools are going to fit nicely with the machines that we have coming in.

Okay. And then I guess the last question that I have is on free cash flow. So given the increase in demand and then I guess the working capital investment, should we think of free cash flow as more of an investment year this year in '18? And how would cash flow look potentially into next year, when you take into account working capital and CapEx and all that?

Yes. I think that's fair, Josh, to look at this year as an investment year. I think -- I don't know how sustainable 45% year-over-year revenue growth is going to be. So I think we'll see some leveling off of working capital when we get into next fiscal year, but I think we'll see more CapEx. So I think those 2 might bounce a little bit. But we're certainly looking to see positive cash flow generation when we turn in to fiscal '19.

And for our next question, we go to Jim Dowling with Jefferies Company.

Yes, you've specifically referenced streamlining the operation, and you're talking about CapEx and getting new equipment in basically to make the business more profitable. I didn't go back and look, but if you went back in your history when the last time you were in a very strong uptrend, where would you categorize the potential for future margins versus your past peak margins?

I would say -- the potential peak is higher. I'm going to say that 300 basis points higher, 500 basis points higher. But it's higher, Jim. And it's going to be a combination of new CapEx and a lower fixed cost. Basically, our last peak, just a rough number, we had 250 hourly employees here in Racine where the demand was. The trade-off this time when we get to those peak levels is we'll have more CapEx with fewer heads and fewer facilities around the world. So I would say that if we do everything right, at a minimum, I could see 300 basis points higher [at a] peak.

(Operator Instructions) And for our next question, we go to Simon Wong with Gabelli & Company.

Just look at the backlog, can you quantify how much of that is related to oil and gas versus your other new businesses that came in during the quarter?

Sure. I -- Simon, it is roughly half is what [we'll] consider land-based oil and gas. And the rest is -- I guess the rest is every other market. The rest is the rest. So that's why I say it's a much better mix of backlog, because if you go back 12 months, 18 months, 2 years, the half of our backlog is significantly better than it was at the bottom just a year or 2 years ago.

Okay. And then for the -- again, staying on the backlog, are you able to identify how much of that is new build versus replacements?

That -- sure. So if I'm just going to look at the units, I would say -- I might be off by 10%, I'm going to say, at least 3/4 is new build, 1/4 is for replacement. And then certainly, the aftermarket component of it all is the 100% replacement. But if it's any -- if it's significantly different than that, we'll let you know. But that would be the rough order of magnitude.

When you say new build, you're lumping in a rebuild to it [just as a] new build category, is that correct?

Yes. So I am saying that 75% of what we have on order, roughly, is for new rig construction. Ground up, they're building the new trailer, new engine. Probably 1/4 of our units are going into replacement for units that they're not going to rebuild again but they're going to keep the rig going. And then, obviously, 100% of the aftermarket business is for the rebuild activity.

Okay. Now in terms of your incremental, is the higher warranty expense the main driver of the low incremental margin for the quarter? And how should I think about that going forward?

Yes. That's exactly right, Simon. So without that, we would have been about 130 basis points higher in the quarter and that was the onetime. That issue is very discreet and accounted for within the quarter. So we would expect the margin performance to sort of follow what the Q3 pro forma would've been without that.

Okay. Just by rough calculation, I'm looking at 45% incremental without the higher warranty expense. Is that what I should be looking for going forward?

In that 40% to 45%, I think as we get -- as we compare -- as the comps go forward, we're comparing to very favorable mix quarters over the past, say 2 or 3 quarters. So we won't necessarily see the 45%, maybe it's drifting more towards 40%.

Okay. And then finally, [BSL]. Is there anything driving the jump in the quarter?

Yes, there is. We -- as John noted, we had a lot of sort of operational supplier histories that caused shipments to be more heavily weighted to [right] towards the end of the quarter. So obviously, those last 3 weeks of the quarter were not collectible within the quarter, which drove days up significantly.

And with that, ladies and gentlemen, we have no further questions on our roster. Therefore, I will turn the conference over to you, Mr. Batten, for any closing remarks.

Thank you, Rufus. 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 Jeff or myself. We look forward to speaking with you again in August following the close of our fiscal 2018 fourth quarter and year-end. Rufus, I'll now turn the call back to you.

Thank you, sir. Ladies and gentlemen, this will conclude today's conference. Thank you for your participation. You may now disconnect.