Twin Disc Inc. F3Q09 Earnings Call Transcript

Apr.21.09 | About: Twin Disc, (TWIN)

Twin Disc Inc. (NASDAQ:TWIN)

F3Q09 Earnings Call

April 21, 2009; 02:00 pm ET

Executives

Michael Batten - Chairman and Chief Executive Officer

John Batten - President and Chief Operating Officer

Chris Eperjesy - Vice President, Finance and Chief Financial Officer

Stan Berger - Investor Relations

Analyst

Paul Mammola - Sidoti & Company

Peter Lisnic - Robert W. Baird

Andrew Cash - Point Clear Value Management

Operator

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the Twin Disc 2009 third quarter financial results conference call. During today’s presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be opened for questions (Operator Instructions).

I would now like to turn the conference over to Stan Berger. Please go ahead, sir.

Stan Berger

Thank you, Brandi. On behalf of the management of Twin Disc, we are extremely pleased that you’ve taken the time to participate in our conference call, and thank you for joining us to discuss the company’s fiscal 2009 third quarter and nine-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 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 Mianake at 262-638-4000 and she will send you a copy.

Hosting the call today are Michael Batten, Twin Disc’s Chairman and Chief Executive Officer; John Batten, President and Chief Operating Officer; and Chris Eperjesy, the company’s Vice President of Finance, Chief Financial Officer, and Treasurer.

At this time, I will turn the call over to Mike. Michael

Michael Batten

Thank you, Stan and good afternoon everyone. Welcome to the third quarter conference call. Stan has mentioned I will start with the brief statements then John, Chris and I will be available to answer your questions.

Sales for the third quarter were $69.3 million compared to $85.8 million for the fiscal 2008 third quarter. Foreign currency translation negatively impacted sales by $2.9 million for the current three months.

Moving into the third quarter, we knew that Twin Disc was not immune for the challenges faced in the global economy, where we saw signs of softening in certain markets such as oil and gas as early as the first quarter, our overall business remained firm. However beginning in February and accelerating during the remainder of the third quarter, we experienced a significant downturn in volumes and orders in the mega yacht market and an order reversal in the industrial market that we have not experienced during the first six months.

As the slowdown developed in these markets, we began the process of aligning our global cost structure with the changing business levels, including reducing production primarily at our European operations, which are closely tied to the mega yacht markets, as well as adjusting employee and inventory levels at our subsidiary. We will continue to take appropriate actions to manage our cost structure to maintain the level of profitability that we feel the company can achieve during slowing sales.

On the other hand, our market diversity and niche market focus has helped us somewhat to insulate Twin Disc from the impact of the global slowdown as certain of our markets actually experienced growth in the third quarter.

Sales to the petrol boat and commercial marine markets were up during the quarter. In addition, demand for airport rescue and firefighting vehicles has remained good and we continue to benefit from market share gains at one of our major ARFF customers as well as from their increasing success in the global marketplace.

Gross margin as a percentage of sales was 27.6% than the current quarter compared to 31% in last year’s comparable period. Our gross margin was negatively impacted by lower sales volumes, unfavorable product mix, increased warranty and pension expense as well as the impact of foreign currency translation.

Marketing, engineering and administrative expense as a percentage of sales was 21% for the third fiscal quarter compared to 17.4% for the same three months a year ago. Due to a significant reversal of an accrual for stock-based compensation in the third quarter of fiscal 2008, earnings were approximately $2.3 million that reflected the decline of our stock price during that quarter a year ago.

Stock-based compensation expense for the current quarter was $2 million higher. This was partially offset by a reduction of $1.5 million in accrued bonus compensation and $824,000 for foreign currency translation. Net earnings for the fiscal 2009 third quarter were $2.9 million or $0.26 per diluted share compared with $7.9 million or $0.70 per diluted share for the same period last year.

Our balance sheet and overall liquidity remains strong. The company has $12 million in cash, maintains a debt to total capitalization ratio of 33.2% and has funds available under an existing credit facility of $35 million credit revolver until October 2010.

A six months backlog as of March 27, 2009 was $81.5 million compared to $120.7 million at the beginning of the year and a $125.7 million at the end of March 2008 are expected to be down. The acceleration of the decline in our backlog during the past two months was disappointing.

Although it was difficult to predict the extent of a downturn on our business, we remain committed, improving our niche global markets with exceptional products and services. We are optimistic that once the global economy stabilizes, we will be in an improved competitive position with differentiated products to offer our existing and new customers.

We are introducing three new products for production in fiscal 2010. Specifically we have developed a hybrid-ready transmission that helps lower the environmental and noise pollution of boats emit, operating at low RPM, a joystick control system refining Twin Disc electronic and BCS boat management technology that will complement our existing QuickShift marine and finally a new 7500 series transmission designed for use in the oil and gas market for pressure pumping applications in the 1800 to 2250 horse power range to complement our 8500 series transmission.

That concludes my prepared remarks, and John, Chris and I will be happy to take your questions now. Brandi, you can open up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Paul Mammola - Sidoti & Company.

Paul Mammola - Sidoti & Company

Can you quantify for us how much of cost you’ve taken out of the business thus far?

Michael Batten

It’s difficult to quantify the specific cost. What has been taking place is that in our European operations we’ve incorporated [Somaj] or [Cassa Integrazione] and John, you might want to speak about what’s happening there.

John Batten

Paul, at a variable staffing level in Italy, its both for the hourly and the salary groups and in Belgium as of the moment it’s just for the hourly group. We can go up to 50% either Somaj or Cassa Integrazione where we pay for the times that are in the plan and the government picks up 80% of the remaining time out of the plant.

Both in Belgium and in Italy we started that process during the third quarter as to initiate the process you have to go through vacation time or use the vacation time first. It really didn’t kick in that much in the third quarter at all; it’s going to be a fourth quarter activity going forward. There were permanent reduction at some of the distribution subsidiary of employees but the real effect of all of these actions that we are taking will be going into next quarter.

Paul Mammola - Sidoti & Company

Okay. So, am I correct to assume that the $2.5 million sequential pick down in ME&A is basically on lower sales rather than primarily sort of cost cutting initiatives?

Michael Batten

We will be continuing to add the actions that are required in face of softening business fall. So, we probably haven’t seen the full extent of the actions, what John has described, probably not the full expense.

Paul Mammola - Sidoti & Company

Okay. That’s helpful. On CapEx, I know you are planning on adding to some machinery. Is that still the case as to some of the events out there kind of curtail the original plans?

Michael Batten

The softening economy has curtailed our plans. I think we announced at some point in the last quarter, we think our CapEx forecast from probably about $16 million to $17 million that’s planned for the year, down to the neighborhood of $12 million and that actually could be a little bit softer than 12 as well.

Paul Mammola - Sidoti & Company

Okay. Can you elaborate on the features of the near 7500 horse power transmission as of today, and how you intend to approach that market? Also who is the biggest competitor for that unit?

Michael Batten

John, do you want to speak for that?

John Batten

Sure. The 7500 is designed specifically for the oil and gas market. We are going to promote it based on technology. It is the ratios in this transmission that are designed specifically for pressure pumping. This is not a vehicular transmission that’s being converted. It’s going to be significantly lighter than our 8500 and some of the other competitors in the high horsepower markets. It has an aluminum housing, we’ve eliminated the torque converter and we’ve introduced some of our clutching technology, which in this transmission is called the master clutch.

So, we are going to be shifting in between the ratio steps without a torque converter, but with a master clutch in front of the transmission. We are introducing more technology in the clutches which we refer to as balanced clutches, which help the performance and the reliability of the clutches going in between the higher shift of the transmission.

The largest competitor in this market would be Allison, but in the size to weight package we’re very competitive, we’ll be able to fit in same rigs, the over-the-road rigs that don’t require special permit as the Allison, very competitive in the weight range as well.

Paul Mammola - Sidoti & Company

Okay. That’s certainly helpful. Then finally Mike, given your experience, how long do you think the energy cycle like we’re in can persist the trough with the reduction in rig count that we’ve seen in North America?

Michael Batten

Yes, that’s a good question, Paul. I think that going forward is that there is global demand that we’ll advice the energy market that has other reasons why we have confidence in covering the market with 7500 is that we believe unlike the last rig of fashion oil, which is referred in the early 80s. This time around, there is more in the way of global demand that is going to be worked out in all our markets than in the past.

So I see while there is softness, and there is no doubt about it. I see that the market will likely come back sooner rather than later, Paul.

Paul Mammola - Sidoti & Company

Okay. That’s helpful, Mike. Then, last one from me. Do you supply anything for BJ services for their offshore drilling operations?

Michael Batten

Not at the moment, but we’ll leave it at that.

Operator

Your next question comes from Peter Lisnic - Robert W. Baird.

Peter Lisnic - Robert W. Baird

Good afternoon, everyone. I guess first question, if you can maybe talk a little bit more about profitability, it sounds like you have pulled some levers here in the quarter or in the third quarter I should say, in response to the demand environment. I’m trying to get a better sense as to just how much more can you do and given what you’ve done, what sort of detrimental margins should we be thinking about for the business?

Michael Batten

That’s a lot of questions. Mostly where we have responded is where the demand at this point, we’re seeing the demand fall. This has been largely in this quarter are concentrated at our subsidiaries, primarily focused on the mega yacht market and as John described, the actions taken there. Clearly if softening continues, then we will address that elsewhere throughout the company, clearly we will be and are looking at all the options that we have.

Obviously, looking at all areas of the company in terms of cost reduction, both variable as well as fixed and we are in the process of valuating what further actions are required.

Peter Lisnic - Robert W. Baird

Is there a way that you can may be get us a sense as to, given what you saw at the end of the quarter, may be give us a sense as to how significant those levers might be in terms of both cost that will run through the income statement and then what the benefits would be?

Michael Batten

Well, we have got a number of different possibilities and here at this point, we are not going to be specific about what kinds of actions that we are contemplating or going to take, but maybe not being responsive in that regard, but at this point also we have to think about what actions are telegraphed or they are actually taken.

So we are looking very clearly at our margins with respect to what is required to maintain levels of profitability that we know that we are going to have to take. Clearly we are looking at our covenants and fully intend to make sure that under any demand scenario we’ll continue to make those covenants with a big cushion of when we are on being able to make that.

Now that’s what’s really driving our decision making at the present time, both from the bottom-up so to speak and say at any given demand level, what do we got to do, what is the number, what are the actions, what is the height of the possible to make sure that we generate the right kind of margins to give cushion on the covenant.

Peter Lisnic - Robert W. Baird

Okay. All right, no need to apologize I totally understand not being able to give us all the granularity that sometimes we need, but the other thing I wanted to ask with pursue was pricing in terms of what you are seeing there by end market, can you maybe talk about what you are seeing on the pricing front?

Michael Batten

Okay. I’m going to turn back to John.

John Batten

Do you mean pricing as in our pricing out or pricing as we are receiving material and goods in?

Peter Lisnic - Robert W. Baird

Well, we always want the complete answers. How about both?

John Batten

I would say, as you can probably imagine the market places are not very receptive to pricing in this current atmosphere. We have been very aggressive over the last 12 months in pricing, particularly when we were seeing the levels of surcharges not decreasing. Those has been started to subside dramatically in some places or as the forward market not very receptive to price increases, we’ll continue to look at that going forward.

Material increase is coming into all of our operations with possible exceptions in some specialty forgings and key components like bearings. Everything else seems to have calmed down over the last --

Peter Lisnic - Robert W. Baird

Then, since it was brought up in terms of the covenants, my guess is that just looking at it you have a 2.5 times leverage ratio covenant that you have to meet, but even if things, I think it markedly worse my impression is that you are not really pushing the envelope all that much, can you maybe one of you comment on some of the stress testing you have done and how that things could get before you actually crept that leverage covenant?

Michael Batten

Well. It’s Mike, Peter, what you are not told to say at this time as we are going to anyway want to follow those covenant. We are just gearing the boats so to speak to make sure that under any kind of demand scenario that we make sure what we don’t trust the covenants.

On the leverage side of it, clearly we have got working capital reduction over and underway of the working capital has peaked. They are seeing that now is beginning to work down, not pretty aggressive plan to reduce inventories and of course receivables in a softening environment.

So we see cash coming in, but clearly what we need to do from a margin point of view to maintain margin and cash flow as well, but we all see it as a major concern. I only pointed that we are looking very much at the bottom up to make sure that we do our job, get cash, maintain our cost structure, maintain the EBITDA that we need.

Peter Lisnic - Robert W. Baird

Okay. Yes, it didn’t look like too much for concerned here either so, and just that one to clarify. Thank you very much for your time and help.

Operator

Your next question comes from Andrew Cash - Point Clear Value Management.

Andrew Cash – Point Clear Value Management

I know it’s kind of a moving target question, but at these low levels of business conditions, I was wondering if you could take a stat at give me a rough idea of how much cash flow, do you think you generate for the repay in the placement market.

Michael Batten

The aftermarket is a significant market for us, Andrew and typically it various a bit by product line, but on general it runs 25 to 30, maybe a little over 30% of our typical sales. The percentage can vary by how much new business in the cycle we’re generating on the forward as a sizable cash and profit generative force.

Andrew Cash – Point Clear Value Management

Obviously during a slowdown, I would assume that number goes up during the business slowdown?

Michael Batten

On a percentage basis, it is.

Andrew Cash – Point Clear Value Management

Yes, on a percentage basis. So, maybe 25 to 30 are being more representative of what happened in 2008?

Michael Batten

Typically, yes.

Andrew Cash – Point Clear Value Management

Okay. How much capital spending would be associated with that level of business activity?

Michael Batten

Aftermarket?

Andrew Cash – Point Clear Value Management

Yes, in the aftermarket?

Michael Batten

In the aftermarket, basically fees were off of the forward market, the same machine that generate the in-house product, generate also the parts for the aftermarket. So you don’t do specific capital expenditures for the aftermarket.

Andrew Cash – Point Clear Value Management

Okay. So, there should be lot of free cash flow associated with the aftermarket business which you call it?

Michael Batten

You look at it that is incremental basis, yes.

Andrew Cash – Point Clear Value Management

Okay. The other question I have is kind of a big picture here. I mean, the stock market acts like kind of the worst is over here. Do you think that that’s just mere speculation, and do you think there is a fundamental reason for the recent investor enthusiasm?

Michael Batten

That’s a good question. I mean, the stock market tends to anticipate does not what it feels what economy is going to do.

Andrew Cash – Point Clear Value Management

Or else guessing

Michael Batten

Well, that’s right. Our guess is what the stock market is going to do, but clearly I don’t know. Really it’s a question of how far ahead does the market get to the real recovery in the economy and of course the economy gets the beginning of the cycle kinds of activities. So the marketplace I think right now looking at some optimism that the current recession isn’t going to be as deep or protracted as it might be and could recover late 2009 or early 2010.

Andrew Cash – Point Clear Value Management

As far as your visibility, you got your backlog that you track, do you think that you are nearing the bottom on your backlog or do you have some sort of indication that there might be an up tick by the end of the year?

Michael Batten

I think that our backlog could slide a little bit further. We are going into a seasonal situation where historically if you look at our backlog numbers, we tend to now begin to show the summer months, which is the slow quarter for seasonal. The six months starting in the end of March, fourth quarter and our first quarter next year. So the first quarter July to October through September is always a softer backlog period for us.

So we are going to have backlog numbers that are going to be softer than we normally have at the other times to the year.

Operator

(Operator Instructions) At this time, there are no further questions in the queue.

Michael Batten

Okay. Thank you, Brandy. Everyone, I appreciate that we all do the management team and appreciate your attending this conference call and we look forward to speaking to you again in three months. In the mean time, we hope you have a good day. Thank you.

Operator

Thank you. Ladies and gentlemen, this concludes the Twin Disc 2009 third quarter financial results conference call. This conference will be available for replay. You may access the replay system at any time by dialing 303-590-3030 or 1-800-406-7325 and entering the access code of 4055769. Thank you for your participation. You may now disconnect.

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