Twin Disc Inc (TWIN) 2018 Q4 法說會逐字稿

Good day, and welcome to the Twin Disc, Inc. Fiscal Fourth Quarter 2018 Investor Conference Call and Webcast. Today's conference is being recorded. At this time, I'd like to turn the conference over to Mr. Stan Berger of SM Berger. Please go ahead, sir.

Thank you, James. On behalf of the management of Twin Disc, we are extremely pleased that you've taken the time to participate in our call, and thank you for joining us to discuss the company's fiscal 2018 fourth quarter and full year financial results and business outlook.

Before I introduce management, I would like to remind everyone that certain statements made during the course -- during this conference call, especially those that states 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 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 President and Chief Executive Officer; and Jeff Knutson, the company's Vice President of Finance, Chief Financial Officer, Treasury 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 fourth quarter and year-end 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 results and highlights from the quarter.

Many of you may not have been on the conference call in June after we announced the Veth deal, which then closed in July. We apologize for the short notice, but both Jeff and I were in the Netherlands for the signing and that day, we were meeting with all of the Veth employees. I just want to take this opportunity to reiterate how excited we are to have both the Veth people and products as part of the Twin Disc family. I encourage everyone to explore their website, vethpropulsion.com, to see their range of products and how they fit in with our marine business. This acquisition takes us to new levels, both in technology and horsepower without leaving our core competencies. With the vast majority of their sales currently in Northern Europe, we have the very real opportunity to grow their business in the Americas and Asia through our global distribution network.

You'll also note that we've had a 2-year relationship with them as their dealer in the U.S. and parts of Asia.

So just a few comments on the quarter. Clearly, this was our best quarter in quite some time. Sales for the quarter rose 38% year-over-year compared to fourth quarter sales a year ago, and demand was up in most of our market. In addition to oilfield transmission, shipments grew in most of our segment. Our industrial and marine demand continues to pose stronger results than the year ago levels. The strong margin performance also reflects the improved efficiency, expense control and the drop through on the volume effect. Our operations team did a very good job during the quarter, increasing both internal and external capacity through our supply chain. The $6 million to $7 million in CapEx that was on order last quarters is just starting to be delivered, so we anticipate being able to make incremental improvements throughout the coming quarters.

In the May call, we also touched briefly on the need for additional floor space for our domestic operation. Over the past 2 years, we had consolidated some of our depot and assembly operations back to Racine. With an increased activity in oil and gas but also in marine and industrial, we are actively pursuing options to move the depot and light assembly functions back closer to a port, most likely at the greater Houston area.

With that, I'll turn it over to Jeff for some comments on the financials.

Thanks, John, and good morning, everyone. I'll briefly run through the fourth quarter numbers. Sales of $73.8 million for the quarter were up over $20 million or 43% from the prior year fourth quarter. This represents the sixth consecutive quarter of year-over-year growth, demonstrating the sustained growth trend we've enjoyed since the middle of fiscal 2017. The primary driver has consistently been the improved shipments of oil and gas transmission units into North America, along with improved North American aftermarket demand, which has also been led by oilfield activity.

In addition, as John pointed out, we continue to see positive trends in nearly all of our markets including global commercial marine patrol craft and our industrial markets. For the year, sales finished higher by nearly $73 million or 43% to 247 -- $240.7 million. Our gross margin performance for the quarter was very strong with a margin percent of 37.3%, an improvement of 590 basis points from the prior year fourth quarter. This is the second-highest quarterly margin percent in the history of Twin Disc and its improvement is primarily volume-driven, but also reflects the very strong oil and gas and aftermarket mix, improved operating efficiencies and a global reduction in fixed costs. The full year gross margin finished at 33.3% compared to 28.7% for fiscal 2017.

Spending on marketing, engineering and administrative costs for the fiscal 2018 fourth quarter increased $4.2 million or roughly 30% compared to fiscal 2018. Most of this increase was driven by $1.7 million of transaction costs related to the Veth acquisition, a $1.8 million increase in incentive and stock-based compensation and a $300,000 increase due to currency. As a percent of revenue for the fiscal 2018 full year, ME&A expenses declined to 25.7% compared to 31.4% in fiscal 2017.

We invested $900,000 in the quarter and now $3.4 million for the full year related to restructuring actions to drive additional cost reduction and efficiencies, primarily in our European operations. With the improved volume and margin performance, our operating results improved by $6 million from a $2.4 million operating profit in the prior year fourth quarter to an $8.4 million operating profit in fiscal '18. Full year operating results have improved by $23.9 million compared to the prior year to an operating profit of $14.9 million.

The effective tax rate for the fiscal fourth quarter was 28.5%, consistently reflecting the impact of the new tax legislation, along with some favorable -- smaller favorable discrete items. Net profit for the quarter of $5.9 million or $0.51 per diluted share reflects the $4.8 million improvement over the prior year fiscal fourth quarter, resulting in a year-to-date profit of $9.5 million compared to a prior year loss of $6.3 million.

Positive EBITDA of $9.9 million for the quarter reflects a $6.6 million improvement over the fiscal 2017 fourth quarter, and on a trailing 12-month basis, we are now at $21 million of EBITDA, which includes the restructuring charges of $3.4 million.

The balance sheet remains in a very strong position as we close out fiscal 2018, with $10.3 million of net cash, debt-to-total capital of 3.3% and $45 million of availability on our new revolving credit facility.

As you know, we closed on acquisition of Veth Propulsion in the first week of our fiscal 2019, resulting in additional borrowings of roughly $61 million. Our initial review of fiscal 2018 pro forma results reflecting this acquisition leaves us in a comfortable position in relation to our new debt-to-EBITDA covenant level of $3.5 million.

While inventory has increased $17.8 million since the end of fiscal 2017, this is consistent with the growing demand, as inventory turns have actually increased 17% over the prior year results. This increase is supported by the remarkable growth in our 6-month backlog, which reached $115 million (sic) [$150 million] in the quarter, a 148% increase over the prior year-end.

Free cash flow was positive $3.5 million in the fourth quarter, with strong earnings and reduced working capital, offsetting an increase in capital spending. For fiscal 2018, we have reported free cash flow of slightly above breakeven of about $200,000, which was in line with the fiscal 2017 results. This comes despite an increase in capital spending of $3.2 million and a volume-driven increase in working capital of $12 million. The increase in working capital represents just 16.6% of the increase in sales for the year, reflecting our efforts to control the working capital investment required to support the growing volume level.

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

Thanks, John -- thanks, Jeff. I'll just spend a quick moment on the outlook. For fiscal '19, we're heading in with a backlog, as Jeff mentioned, up 148%. Note it was down slightly versus the end of the third quarter, but this was due mainly to the rescheduling of non-oil and gas business outside of the 6-month window.

In addition to strong orders from our oil and gas customers, we've also seen an increase in demand from our industrial and marine customers. The heading into 2019, we feel very good about another strong year as we celebrate our 100th anniversary and begin our 101st fiscal year.

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

(Operator Instructions)

We will take our first question today from Tim Wojs with Baird.

I just got a few more modeling questions. I guess, if I look at the gross margin and really strong performance there in the fourth quarter, and you've done a lot to kind of take some cost out of the business. I'm just curious, what you would think is kind of a normalized incremental margin today relative to maybe -- and how that compares maybe relative to history? I know it makes things kind of a bit hard there. But just kind of curious what you're thinking normalized incrementals should look like from here?

Yes. I mean, we ask ourselves that a lot, Tim, because we have seen a very strong quarter. Obviously, this was -- and we've never seen a margin level like this at these volume levels. So you're right, we have taken cost out, but we're also benefiting from a very strong mix. So as far as incremental, I think, we saw something like 53% on an incremental volume this quarter. I think that was very strong.

I think as we head into the first quarter, what we realized is the first quarter is always challenging with the shutdown and the restarting the factory after shutdown, lower volume levels. So I think we're looking at the fourth quarter as one that will be challenging the math, especially as we roll into the first few quarters. But our expectation is to stay in the mid-30s. I hope that answers your question.

No. No. That's helpful. And then I know you've given EBITDA margins for that. But is there a way to kind of think about what the gross margin should look like, so we can just kind of make sure the modeling is accurate?

Yes. I'll be honest, Tim, we're still figuring out because they have never reported in a U.S. level, breaking out their cost between cost of goods sold and ME&A the way we need them to. So we believe their margins will be in line with, sort of, in that 30% or 35% range is what we think it'll shake out to, but we're still working through the details there.

Okay. And then any sense for what the purchase accounting impacts for that could be? Just, my guess is you probably include those in your reported numbers. Any sort of just kind of dollar figures there, estimates that we could think about?

I'll say it's still pretty early. We're going through the valuation work now. But I think we'll have some pretty significant amortizations to talk about in particular, the year 1 amortization of a write-off of inventory. I think that's something we would expect would be significant at this point.

Okay.

So significant -- when I say significant, in the, probably, $4 million to $5 million range year 1 is what we're estimating.

Okay. Okay. Great. And then when we think about -- so it looks like you're planning for a pretty considerable uptick in CapEx for this year. So how should we think about free cash flow as you look at fiscal '19? I think you've been breakeven the last couple of years. Should -- even though you've had higher CapEx, I mean, should you be able to generate positive free cash flow in fiscal '19? Or is that the target?

It is. Yes. I think, we continue to target -- I think depending on the timing, the spending on that cash -- on that capital, it will be a little bit lumpy. So I think we'll have some pluses and minuses. But I think we'll continue to drive to be positive free cash flow.

Okay. Okay. And then the last one, John, just on the overall market within, maybe, oil and gas. I mean, how do you feel -- position wise, you guys are maybe relative to some of your competitors, do you feel like you're gaining share or do you feel like you're kind of just growing in line with the market? And then secondly, how would you consider the pricing environment today than maybe other oil and gas recovery situation?

All good questions and wrapped up in one question. Certainly, the market is growing, so we're enjoying that. I do believe we're gaining market share. We're gaining market share and our units going in to replace existing units and rebuilds and refits for other customers. So I do think we're getting some incremental market share. But there is no doubt that the overall market is growing.

And it's really looking back at a lot of the rebuilds that weren't done really between 2014 to 2017. So there is new unit construction, we think we're gaining incremental market share there. There's the refit activity of our units going in and taking out other brands, so I think we're gaining some market share there.

But really, what's one of the limiting factors for the whole market in general is just capacity and getting that supply chain even further up to speed. And we're addressing -- as I mentioned in the beginning in some of the comments, we're going to help address some of our internal capacity by getting some additional square footage down in oil and gas country, down in Texas, to help free up some space here in Racine, which we need for new CapEx. But also to expand our existing assembly operation here in Racine.

So I think you'll see some additional chess moves from us in the coming months to help grow our capacity and our market share even further.

Okay. And then how would you characterize just the pricing environment today relative to other private companies? It sounds like it should be pretty good.

Price is -- the pricing opportunity, certainly, is better. I mean, everyone's reading the same headlines. Shortage of supply, inflation, tariffs. It's really -- as long as you can keep your delivery up to match what you have to do in pricing, I think you'll be okay.

(Operator Instructions) .

And next we'll hear from Simon Wong with Gabelli & Company.

Just a couple of quick questions. With the Veth -- with the completion of your Veth acquisition, what percent of your business is now energy-related?

Yes, Simon. That's a good question because that percentage fluctuates drastically depending on the year we're in. Obviously, with Veth, it lowers that base -- what would you...

I would say, probably lowers that by 10%. Yes, I would say by 10%.

Yes. Maybe...

So about 30%.

Maybe it's 1/3, maybe we're looking at between 30% and 40% as we roll into fiscal '19.

So about 100 -- it looks like a $100 million of your business is energy-related. Would you be -- in a more strategic question, would you be interested in further reducing the cyclicality of business by separating the energy and marine business? Or do you think the energy business has enough scale to stand on its own?

I think the energy business on its own, as it relates to us is hyper-cyclical. I think that would be a tough business to stand on its own. What's nice is how -- in our transmission business, we have military, we have ARFF, we have oil and gas.

In marine, we have energy-related and offshore, but we also have the brown water and the push boat activity. So -- and then you have industrial as a base that has some energy in oil and nonenergy. I think the business is, in marine and transmission, are best left together, because using a lot of the same technology and assets to play in different markets.

Okay. And then just on the energy side, I'm hearing or seeing the pressure pumping market to be balanced, slightly oversupplied. I'm mostly hearing the providers, some of the service providers are seeing white space on the calendar. Can you describe how your order rates have been holding up in light of all this, are your customers delaying or deferring deliveries, given that dynamic?

Yes. We -- I would say, months have been lumpy, but in general, quarters have been equally as strong. And we certainly, Simon, have not seen any request for white space or delay in delivery.

Okay. That's good. And then on the -- going back on the Veth acquisition, any incremental or extra expenses associated with integrating this acquisition?

There will be some. Sure. I don't think it will be -- in terms of cash expense, I don't think it will be a real -- I don't think it will move the needle in fiscal '19. I think we had recorded a great bulk of the transaction cost to get the deal done in fiscal '18. So that should be behind us. I think we'll see some marginal incremental cost for integration.

Okay. And finally just wondering your tax rate is 28.5%, a little higher than I expected. What's the reason for that? And what's the outlook for '19?

Yes. So if you remember we're -- because of our June 30 fiscal year, our tax rate is blended this year. So it's part of the old rate, part of the new tax law. So it will go down as we roll into fiscal '19 statutory in the U.S. So we would expect it to be in that 24%, 24.5% kind of range, depending on the mix or where the earnings are taking place.

(Operator Instructions) .

And that will conclude today's question-and-answer session. I'll now turn the conference over to Mr. John Batten for any additional or closing comments.

Thank you, James, and 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.

We look forward to speaking with you again in October, following the close of our fiscal 2019 first quarter. And hope that many of you, shareholders, will be able to join us for our Annual Meeting in October, when we celebrate our 100th anniversary, and you'll have a chance to look for yourselves at our 100th anniversary gallery at the first floor of corporate headquarters.

James, with that, I'll turn the call back to you.

Thank you. That will conclude today's conference call. Thank you for your participation. You may now disconnect.