Twin Disc Inc (TWIN) 2026 Q2 法說會逐字稿

Welcome to the Twin Disc, Inc. fiscal second-quarter 2026 conference call. We will begin with introductory remarks from Jeff Knutson, Twin Disc's CFO.

Good morning, and thank you for joining us today to discuss our fiscal 2026 second quarter results. On the call with me today is John Batten, Twin Disc's CEO.

I would like to remind everyone that certain statements made during this conference call, especially statements expressing 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.

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.

Any forward-looking statements that are made during this call are based on assumptions as of today, and the company undertakes no obligation to publicly update or revise these statements to reflect subsequent events or new information.

During today's call, management will also discuss certain non-GAAP financial measures. For a definition of non-GAAP financial measures and a reconciliation of GAAP to non-GAAP financial results, please see the earnings release issued earlier today.

Now I'll turn the call over to John.

Good morning, everyone, and welcome to our fiscal 2026 second-quarter conference call.

Despite a challenging operating backdrop, our diversified portfolio continued to demonstrate resilience as demand remained robust across marine, defense and select industrial applications. This strong demand continues to fuel confidence in the positioning of the business as our 6-month backlog reached a record level once again during the quarter.

As anticipated, tariff impacts were elevated in the quarter at approximately 3% of cost of sales as they continue to create friction across the industry, influencing customer behavior related to order placement timing and shipping lead times. Importantly, these impacts reflect modest delays in timing rather than lost orders. In response to these pressures, we continue to make progress implementing the mitigation strategies we've outlined in previous quarters, including pricing discipline, operational enhancements and footprint optimization.

During the quarter, we advanced planning efforts focused on evaluating footprint utilization and operating flexibility across our existing manufacturing network, including actions such as adjusting production flows or where appropriate over time, relocating certain activities to reduce structural tariff exposure.

For example, we are planning to move ARFF assembly to our Lufkin facility, which allows us to assemble product in a tariff-advantaged environment and reduce the impact of import duties on finished goods. In the coming quarters, we'll expect tariff-related impacts to moderate, mix to improve and our mitigation tactics to take effect. Our actions, combined with a record backlog, leave us well positioned to capture underlying demand and drive further progress toward our long-term growth and profitability objectives.

Defense continues to be a strategic growth driver for Twin Disc as demand builds across multiple programs and geographies, supported by elevated defense spending in the United States and NATO. Defense-related opportunities represent an increasingly diversified and durable portion of our total backlog, up 18% sequentially as governments prioritize the modernization of marine, land-based and autonomous platforms.

We continue to support a broad range of defense platforms, including naval vessels, autonomous and unmanned systems and land-based applications. This includes higher content items on US Navy patrol and autonomous vessel programs as well as drivetrain and power transmission solutions supporting NATO land-based vehicle initiatives.

Overall, our defense-related pipeline exceeds $50 million, which in combination with our robust backlog reflects our growing presence in the defense market. To support this growth, we have a substantial portion of the required capacity in place today, particularly in North America, leveraging our existing footprint and operational flexibility. Investments regarding capacity are expected to be related to European demand focused on test stands and assembly capacity, not machining capability.

Now let me walk you through the segment performance. Our Marine and Propulsion business demonstrated mixed results as sales were flat year over year. Robust demand across workboats, government and specialty marine applications, supported by ongoing interest in higher content systems, hybrid propulsion and advanced maneuvering solutions drove performance during the quarter.

However, this strength was partially offset by challenges in our commercial marine business in Asia Pacific amid a dynamic environment. Veth propulsion specifically performed at a high level during the quarter with customer engagement remaining strong.

We also continue to see progress in autonomous and unmanned vessel applications where Twin Disc technologies are increasingly specified on higher-value platforms. Aftermarket activity experienced some short-term softness late in the quarter, driven largely by customer timing and year-end dynamics.

Encouragingly, early indications in the subsequent period point to improving activity, reinforcing our view that demand environment remains constructive. With land-based transmission, sales decreased 8.1% year over year to $17.5 million, primarily driven by shipment delays to ARFF customers. Oil and gas customer behavior remained cautious, particularly in North America, where rebuilds and refurbishments continue to outpace new equipment purchases.

That said, we are beginning to see signs that this cycle is maturing, which could support replacement demand over time. Internationally, oil and gas demand showed early signs of improvement, including increased activity in China, where customer engagement exceeded our initial expectations.

We recently received a strong order for our 8500 transmission and continue to see favorable demand trends in the region moving forward. International ARFF demand remained healthy. We continue to advance next-generation electrified and hybrid solutions that position us well as customers evaluate longer-term fleet upgrades.

Our industrial business continued to benefit from the breadth of our portfolio and the contributions from recent acquisitions, with sales up 22% year over year to $11.5 million. Demand remains steady, and we are increasingly leveraging Katsa's engineering and manufacturing capabilities across the broader organization. While the quarter included temporary operational disruptions, we are encouraged by underlying customer demand and the opportunity to drive higher content solutions across industrial applications as we work to enhance mix, further differentiate our offerings and support long-term margin performance.

Our backlog of $175.3 million was up 41.4% year over year and 7% sequentially. This record backlog remains a key strength for Twin Disc, providing solid visibility into the second half of fiscal 2026, reflecting underlying demand across our markets with particular strength in global defense-related applications. Inventory levels increased during the quarter, primarily due to delayed shipments.

However, inventory as a percentage of backlog improved by approximately 400 basis points sequentially, underscoring the strength of our backlog position. As these dynamics unwind and backlog converts, we expect working capital to improve as we move through the remainder of the year.

Moving forward, our long-term strategy remains unchanged. We are focused on global footprint optimization, operational excellence and a disciplined capital allocation. We are continuing to streamline our organization and operate as a more integrated global platform, an important enabler of our tariff mitigation and capacity utilization strategies as improved cross-business coordination allows us to better centralize sourcing, optimize resource allocation across sites and respond more quickly to changes in demand or cost dynamics.

Looking ahead, while near-term volatility remains, we are confident in our ability to execute through the cycle. Our diversified end markets, growing defense exposure, strong backlog and ongoing operational initiatives position Twin Disc to improve performance as conditions normalize and we deliver sustainable value over the long term.

With that, I'll now turn the call over to Jeff to discuss our financial results in greater detail.

Thanks, John. Good morning, everyone. During the second quarter, we delivered $90.2 million in sales, up 0.3% from $89.9 million in the prior year period, primarily driven by strength in the Marine and Industrial Product groups as well as the addition of Kobelt.

On an organic basis, adjusting for M&A and FX, revenue decreased approximately 7.9% in the quarter, partially due to shipment delays related to customer attempts to time tariff impacts. Second-quarter gross profit rose 3.2% to $22.4 million and gross margin improved 70 basis points to 24.8%, reflecting the absence of inventory-related charges recorded last year, partially offset by unfavorable product mix in the quarter. ME&A expenses were $20.7 million in the second quarter compared to $18.9 million last year.

The increase reflects the addition of Kobelt as well as ongoing wage and professional service inflation. Net income attributable to Twin Disc for the quarter was $22.4 million or $1.55 per diluted share compared to income of $919,000 or $0.07 per share last year. This large year-over-year improvement is due to an income tax benefit of $21.8 million, primarily related to the reversal of the domestic valuation allowance. EBITDA was $4.7 million for the second quarter, representing a 25% decrease versus the prior year due to higher ME&A expenses, tariff-related impacts that affected mix and nonrecurring items.

Geographically, sales growth was led by North America and Europe, supported by sustained demand for Veth products and incremental contribution from recent acquisitions. As a result, North America represented a higher share of quarterly revenue, while Asia Pacific and Latin America made up a smaller portion, reflecting regional market dynamics, a trend that we expect to continue and should soften tariff impact moving forward.

Net debt increased to $29.6 million in the second quarter, primarily reflecting our strategic acquisition of Kobelt. We ended the quarter with a cash balance of $14.9 million, down 6.4% from the prior year.

Turning to cash flow. We generated $1.2 million in free cash flow during the second quarter, representing a meaningful sequential improvement from the first quarter. This improvement was driven primarily by stronger operating performance and disciplined capital spending. However, working capital remained a headwind during the quarter as shipment delays and customer behavior resulted in higher inventory levels.

As these shipments convert and backlog is executed, we expect working capital to improve and cash generation to strengthen as we move through the second half of the fiscal year. As such, our focus remains on disciplined inventory management, converting backlog into cash and improving overall cash flow consistency over time.

Although lower sequentially, gross margin improved 70 basis points compared to the prior year period, reflecting the absence of prior year inventory-related charges. Margins in the quarter were pressured by several temporary factors, including unfavorable mix due in part to delayed aftermarket shipments as well as incremental costs associated with an isolated warranty replacement. While these near-term pressures weighed on results this quarter, they are largely timing related or nonrecurring in nature.

Moving forward, as shipment patterns and mix normalize, we remain confident in our ability to deliver sustainable, profitable growth. From a capital allocation perspective, our priorities remain unchanged. We continue to focus first on supporting the business through organic investment, including capacity, operational efficiency and product development while maintaining a strong and flexible balance sheet.

We remain disciplined in our approach to capital deployment with an emphasis on preserving liquidity, managing leverage and selectively evaluating acquisition opportunities that align strategically and meet our return thresholds. At the same time, we continue to balance growth investments with cash generation and working capital efficiency, particularly as we focus on converting backlog into revenue and cash in the second half of the fiscal year.

I'll now turn the call back to John for his closing remarks.

Thanks, Jeff. In closing, while the second quarter included near-term challenges, the underlying fundamentals of our business remain strong. Demand across our core markets continues to be supported by a strong and diversified backlog with growing defense exposure and a portfolio that is well aligned with our customer needs.

We are actively addressing the factors that impacted results during the quarter, including mitigating tariff exposure, improving operational execution and continuing our focus on converting backlog into revenue and cash. As these actions take hold and shipment patterns normalize, we believe Twin Disc is well positioned to deliver improved performance over the balance of the fiscal year.

With that, I would like to open the line for questions.

(Operator Instructions) David MacGregor, Longbow Research.

This is Joe Nolan on for David. So this quarter, you guys faced a pretty difficult revenue comp of up 23%. Year ago compares get a little bit easier in the second half, but are still up low double digits. I guess my question is, just with the delayed shipments and some of these factors, just wondering how much push forward on some of that business you got from 3Q? And what do you think is achievable for top line growth for the balance of the year?

Yes. I mean, it's a good question, Joe. I think tariffs are unpredictable. I think we expect to see good growth in the second half and sort of progressing from Q2 to Q3 to Q4. So with three and four being our stronger quarters, I don't really have a percentage growth, but I think we should trend like what we did in the previous years as we grow through the year.

We had the noise in Q2, right, which it's a little bit unpredictable what customers are going to do regarding tariffs, and it's unpredictable how the tariff environment will evolve day-to-day, week-to-week. But given some consistency in that, I think we're set up for a pretty good second half revenue-wise.

Got it. Okay. And then on gross margin, could you just talk about the puts and takes and sequential gross margin bridge from first quarter of '26? I know you mentioned the delayed shipments, and I believe you mentioned a warranty cost impact, if I heard correctly in the prepared remarks.

Yes. We had a few things happen. So some isolated things. I think if we get into the details of it, they're all kind of not huge impacts, but they move the needle. For instance, as we invoice tariff revenue, so the tariff expense flows through our revenue line with no margin, that serves to gross up our revenue and dilute our margin percentage. That has an impact of 50 or 60 basis points compared to Q1.

We had an operational delay at our factory in Finland. We had an isolated quality issue that we recaptured in the quarter. Those two in combination are about 60 basis points. So those are what we would call kind of noise in the quarter that wouldn't recur.

And then the rest is essentially mix. So aftermarket being our higher-margin business saw some delays in the quarter, again, with customers pushing out shipments and orders related primarily to tariff and timing of when they're going to get that inventory. And outside of that, it's project-related revenue and margin at that -- some of that was a bit of a drag on the quarter compared to Q1.

So kind of a broad-based mix impact outside of those few discrete items impacting the quarter.

Got it. Okay. And then just on tariffs, it sounds like you're expecting tariff impact to moderate as we move through the year. If you could just maybe give any detail on just how mitigation efforts are going on your end and just kind of how you expect that impact to trend through the year?

Yes, Joe, I would -- it's John. So I guess what -- so the tariffs, the 232 right now, our assumption is that we're going to have the same percentage on steel and aluminum. So we're not -- so what's going to help the overall mix of the tariff impact is that we're going to be selling more products that aren't as affected as much by the tariffs. The primary -- so the products that have the most impact are ARFF transmissions where a lot of it is sourced -- a lot of the components are sourced overseas.

We assemble and test in Racine, Wisconsin and then ship out overseas. So we get a big 50% tariff on a lot of the parts, and we ship the transmission out from Racine. The other part -- the other components -- sorry, the other product line that's the most affected is our industrial products at Lufkin. Again, a lot of those parts come from India. They're now tariff at 50% and the majority of the shipments are into the US. So there's a tariff impact there.

One of the things that we're doing, and it won't really -- it won't affect this fiscal year, but it will set up '27 is we're moving assembly and test of the majority of the ARFF transmissions down to Lufkin, which is in a free trade zone. And so we can bring the parts in from India or wherever they're coming in from, assemble and test and paint in Lufkin and then ship out, and we won't have the tariff impact.

And that's about -- right now, the tariff impact on those units is probably 10 full percentage points of gross margin. So thankfully, in the balance of the year, the ARFF transmissions aren't as big a percentage of sales as they were in the second quarter or the first half. So the margin improvement we're slated is to take effect in fiscal '27.

So that's the big -- I would say the biggest thing that we're focused on right now is changing the location of assembly test paint of our ARFF transmission to mitigate the gross margin percentage. But that won't have an effect on the balance of this year. We'll see that in the first quarter of fiscal '27.

Got it. Okay. That's helpful detail. I also just wanted to ask about Veth margins. You guys had a nice margin performance. I assume those margins are continuing to improve. Can you just talk about your confidence in that business and confidence in growing margins over the next few quarters?

Yes. It's John again. So they have done a great job coming out of COVID where a lot of projects were quoted at a fixed price, and then we saw the inflation and supply chain issues. They've done a much better job at estimating their costs, building in known inflationary increases. But then just on pricing discipline, understanding the value in the marketplace and going after markets that appreciate the value of what they're selling.

So I'm fairly confident that they can continue this level and even continue to grow. They have now tapped into our supply chain in India and are finding alternate sources that may have been sourced in Europe in lower-cost countries. So pretty confident in that group. They're doing a very good job understanding their business, what the cost drivers are, how they can mitigate it and more importantly, where they can find value in the market to warrant a higher price.

Got it. Okay. All right. And then also on oil and gas, the international oil and gas business, you mentioned seeing some improvements in China and then that exceeded expectations. Can you just talk about what was happening there?

Yes. So I can't make a direct correlation, but we got the order more or less within a week of Venezuela. So I can't say that it's a direct correlation, but it seems like the activity for domestic production in China started to grow when they realized that there may not be a reliable supply chain coming from someplace else. No one said that, but it was just kind of interesting timing when we had been hearing that for the last quarter of the calendar year, so our fiscal second quarter that things were slow.

They had too much inventory sitting idle. And then all of a sudden, the very first week of the year, they basically came in -- what he anticipated. We were hoping for a budget for the entire fiscal '26. They came in with one order and exceeded that budget.

Got it. That is interesting timing. And then just last one for me. Can you just update us on, I think, military orders? You said backlog up 18% sequentially. Just talk about the strength in that business.

Yes. Joe, I'm a broken record. It's really, again, two buckets primarily. It's the unmanned vessels that the Navy are doing. We got more orders for those vessels. And in Europe, at Katsa and Finland, more orders for the -- sorry, the 6x6 and the 8x8 that are being built for the NATO countries. So the OEM got more orders from more countries, and therefore, we got more orders from the OEM.

So that is -- the focus for us is to make sure that we have the capability to -- we can meet production today, but we're fully anticipating that both programs are going to grow significantly. We've been told that. So there's focus here in the US to make sure that we have capacity for those marine transmissions and likewise, in Finland, make sure that we can grow, that we have the capacity to meet that growing demand, and keep all of our other business.

So we're hyper focused on both of those areas.

(Operator Instructions) There are no further questions. I would like to turn the call back over to John Batten, CEO, for closing remarks.

Thanks, Jericho. We hope that we've answered all of your questions today. If not, please contact either Jeff or myself, and we'll answer as quickly as possible. And again, we continue your continued interest in Twin Disc, and we look forward to speaking with you in May after our third-quarter results.

Jericho, we will turn the call back to you.

Thank you. This concludes today's conference call. Thank you for joining. You may now disconnect.