Twin Disc's CEO Discusses F1Q 2014 Results - Earnings Call Transcript

| About: Twin Disc, (TWIN)

Twin Disc, Incorporated (NASDAQ:TWIN)

F1Q 2014 (Qtr End 09/27/2013) Earnings Call

October 22, 2013, 11:00 AM ET

Executives

Stan Berger - Investor Relations

Michael Batten - Chairman and Chief Executive Officer

John Batten - President and Chief Operating Officer

Christopher Eperjesy - Vice President-Finance, Chief Financial Officer and Treasurer

Analysts

Josh Chan - Robert W. Baird

Walt Liptak - Global Hunter Securities

Peter van Roden - Spitfire Capital

Operator

Welcome to the Twin Disc Incorporated first quarter fiscal 2014 financial results conference call. (Operator Instructions) I would now like to turn the conference over to Mr. Stan Berger. Please go ahead, sir.

Stan Berger

Thank you, Camille. 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 2014 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's intention, hope, belief, 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 the copy, please call Annette Mianecki, at 262-638-4000 and she will send a copy to you.

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 Michael Batten. Mike?

Michael Batten

Thank you, Stan, and I'd also like to add my welcome to you all to our first quarter 2014 conference call. Today, we will differ a little bit from our normal call format, and I'm going to ask John to take the lead to provide you with a brief review of the results of the first fiscal quarter as well as his outlook for the year. I will return at the end of the call with some concluding remarks. John?

John Batten

Thank you, Mike, and good morning, everyone. Welcome to our fiscal 2014 first quarter conference call. As usual, we'll begin with a short summary statement; and then Mike, Chris and I will be happy to take your question.

First, I'd like to cover just a few of the highlights from the quarter. Sales, as you know, were down slightly from the same period a year ago driven by lower sales in North America and Europe. Offsetting this were higher year-over-year sales into Asia.

Margins improved in the quarter due to an improving mix in control spending. And as we previously announced, we recorded an additional $1.1 million of the restructuring charges at our Belgium operation. Finally, our balance sheet continues to improve, despite the near-term financial results.

Turning to those results. Sales for the 2014 fiscal first quarter were $66.4 million, down from $68.8 million for the same period a year ago. The 3.5% decline was primarily driven by lower sales in the North American and European market. Higher quarter-over-quarter sales into Asia partially offset these declines, as demand for our pressure pumping transmission in China grew in the quarter.

Looking at our broader market. Global sales for our industrial products and marine transmissions were down slightly in the quarter, offset by the higher shipments of pressure pumping systems into China. Gross margins for the quarter was 31.1% compared to 28.2% a year ago and 27.2% in the previous quarter. Favorable mix, including the oil and gas transmissions was the primary drive for the improved margin.

Spending in marketing, engineering and administrative or ME&A expenses declined $1.1 million versus the same period last fiscal year from $16.6 million or 24.2% of sales to $15.5 million, 23.4% of sales. The lower ME&A spending for the quarter relates to lower stock-based compensation and incentive expenses and controlled spending throughout our global operation.

As we mentioned in the fiscal 2013 fourth quarter call, we recorded an additional $1.1 million charge for the restructuring of our Belgium operation and targeted reduction in the workforce. If you recall, the legal minimum was $708,000 was reported in the prior quarter, but negotiations had not been finalized when the quarter and fiscal year closed.

Looking at the bottomline, fiscal 2014 first quarter net earnings were $1.3 million or $0.11 per diluted share compared to $1.2 million or $0.11 per diluted share for the same period a year ago. EBITDA for the first quarter was $6.6 million versus $5.3 million a year ago and $4.7 million last quarter.

Turning to the balance sheet. We generated $8.9 million of free cash flow in the quarter. As a result, we were able to reduce debt, net of cash from $6.4 million at June 30, 2013, to $773,000 at the end of the first quarter. As we mentioned in the press release, we still intend to spend between $10 million and $15 million in capital in the fiscal 2014, as we continue investing in modern equipment and facility, our global sourcing program and new product.

The $9 million decline in our six months backlog from $66.7 million to $58.1 million certainly was a disappointment in the quarter. Incoming orders from North America and Europe were generally weak during the first quarter. We think that this was primarily due to the macroeconomic uncertainties in North America, including the buildup to the shutdown in Europe and also the inventory reduction activities at our distributors, dealers and OEMs.

We also recognized that during the fourth fiscal quarter of 2013 and the first quarter of this year, we announced reduced lead times across our product ranges. All of our production models are now within the six months window of the reported backlog. As a result, we are seeing some orders delayed to these shorter lead times.

Fiscal 2014 continues to be influenced by the same dynamics that have affected our business during the past fiscal year. We continue to see strong demand from our global commercial marine customers in international oil and gas market, which is somewhat offset by continuing weak activity from European markets and global mega-yacht customers. At this point, it looks like the recovery in North American oil and gas will be postponed another quarter or few, as the overcapacity situation continues even with the increased utilization of the pressure pumping fleet.

Middle to longer-term, we are well-positioned to take advantage of the global opportunities ahead of us. Our leading positions in the markets we serve, our innovative product development and our geographic diversity, reflect a sound strategic plan for the future.

That concludes my prepared remarks. And now Chris and I will be happy to take your questions. I should add that Chris is joining us from our plant in Belgium, so there might be a small delay in any responses to question that he is taking.

Camille, please open the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is from the line of Peter Lisnic with Robert W. Baird.

Josh Chan - Robert W. Baird

This is Josh Chan filling in for Pete. Just wanted to start off with gross margin, which was very strong this quarter. Is there any reason to think that mix was unusual or I guess asked another way, is this quarter's mix representative of what you think you will see for the rest of the year?

John Batten

I think that the high-20s to 30 is still possible going forward each quarter. We're having good aftermarket and industrial orders filling in the quarter. It just really is a question of how many 8500 another oil and gas products that we can get in the quarter. But we are very happy to get back above 30 and it's still what we're shooting for every quarter.

Josh Chan - Robert W. Baird

And then a question on the backlog decline. Is there a way you can talk about what market contributed to that decline? I mean I'm assuming that North American oil and gas has very little to do with it at this point, is that correct?

John Batten

That's correct. I would say there was a slight decline in all of the product categories. And in general that was driven by North America and Europe, just a quarter of orders. Then there was a slight decline also in the backlog for international oil and gas. But I am optimistic that that's going to rebound a little bit. I am also optimistic that the other backlogs will rebound. It was a very uneven quarter. As far as ordering, we had a bad month and a good month, then a bad month and October is turning out to be a better month. So just a very uncertain summer as far as in ordering pattern for product.

Josh Chan - Robert W. Baird

From your comments, it seems like you think that this is more temporary than anything, right?

John Batten

Josh, I certainly hope so. I think that the activity that we've seen as far as the market activity looks positive. I think people were reducing, whether it's our distributors, dealers, OEMs, reducing inventory over the summer. And I think it is a timing issue of when the orders come in for international oil and gas and some of the bigger projects that we have. So, yes, correct. I don't see it staying down at this level for an extended period of time.

Josh Chan - Robert W. Baird

And then can you talk about the shift in timing for the North American oil and gas recovery? And then I guess, in particular, I was wondering whether some of the field productivity improvement that is being achieved is actually contributing to a delayed recovery, if you will?

John Batten

To answer that last question, I do. I've been reading some of the other conference calls and press releases, and what I am seeing from the big guys is that their efficiency is up, their utilization is up and so they are working through that. It's a range between 15% and 20% overcapacity, slower than everybody thought they would. The unused units sitting on the floor are being taken, but it's just not as fast as everyone thought it would.

Josh Chan - Robert W. Baird

And then lastly, as China oil and gas becomes more and more important, is there a way that you can ballpark for us, how fast that market is growing for you?

John Batten

I'll let Chris take how far -- it is growing very nicely. I mean it's certainly not half of what the North American market is. But it's nice steady growth and it's turning into a very viable market. But it's not nearly the size of what the North American market is as far as millions of horsepower, number of rigs inside yet. But we are enjoying a very good market share in the country.

Operator

Our next question is from the line of Walt Liptak with Global Hunter Securities.

Walt Liptak - Global Hunter Securities

I wanted to ask a little bit about the oil and gas markets and try to get an understanding of discussions you've had with customers and if we can drill down into maybe the basins that are strong and which are weak?

John Batten

I would say that still the majority of the fleets have switched off of pure unconventional of Bakken oil and wet gas. We just see the number of hours being put on the rig a lot lower than they used to be. And in China, they are still easing into the pure unconventional horizontal drilling.

A lot of the rigs over there right now are still getting used to doing that type of drilling. So the rigs are definitely in the play, they are definitely being used on easier applications at this time. So I see the activity, everyone is striving with getting back to the unconventional. Striving to get back in, doing it a lot more efficiently with less equipment and people there. So that's what we're seeing right now.

Walt Liptak - Global Hunter Securities

We're hearing about 2014 CapEx increases. And maybe albeit small, is that something similar to what you are hearing?

John Batten

Correct. That's what we're hearing. If they will start to issue orders for new equipments sometime in calendar 2014.

Walt Liptak - Global Hunter Securities

So with the modest change or the push-out I guess, though in the outlook for oil and gas, how does that change your 2014 production schedules or any sort of changes that you need to make to capacity or pricing?

John Batten

Most of what we had actually planned on buildings in 2014 for oil and gas primarily, which were Asia. And we were hopeful that North America would come back. But if orders start to comeback in the first quarter of 2014 calendar that really would just affect our fourth quarter. So there will be some orders, some aftermarket orders, some probably replacement units.

But if what I am reading at the same press that you're reading is that they won't start ordering until calendar 2014. That really just affects our fourth quarter and would be later into the summer, the middle two calendars of the calendar year, the middle two quarters. So as far as capacity, we have capacity. Our lead times are under six months. So if we had orders today, we could react in our fiscal third quarter quite easily.

Walt Liptak - Global Hunter Securities

And kind of along those lines, you made the comment couple of times about all of your forward production is within that six-month window.

John Batten

Correct.

Walt Liptak - Global Hunter Securities

Does that mean that you're expecting that your production levels are sort of matching what your backlog level is? So we should see a similar level of revenue in the coming quarters unless we see a buildup in backlog?

John Batten

No. There will be lot of turnover in the backlog. You have never really been able to add our six-month backlog, double it, and get the forecast for the whole fiscal year. So it's not a perfect measurement. The backlog can come up. If you go back three years ago, you saw how quickly the backlog comes up. And there's potential to have a six-month backlog that more than doubles what our production would be -- sorry, for the whole fiscal year.

So it's an indicator. It's not a perfect indicator, but you will see that when we reduce lead times, people will tend to order to those lead times. So all of our industrial products are well within quarter, so well within three months, and all of our marine, and oil and gas is now within six months. So if they needed it in six months or if they needed it in four months, they're going to order it four months out. So the backlog is partially a reflection of what's happened with our lead time.

Walt Liptak - Global Hunter Securities

So as we're thinking about the quarter that we're in, the visibility that you have, it's sort of on a month-to-month basis, to some extent?

John Batten

Correct. The visibility is much better on the second quarter than it is on the third quarter or the fourth quarter, which is different than it was in 2010, when the backlog bottomed out. The visibility there was much better in months four, five and six than been it was in one, two and three.

Walt Liptak - Global Hunter Securities

Some of the macro industrial data points are starting to pick up a little bit. I am wondering, you talked about some of the industrial end-markets and airport, the ARFF business, as being stable. Any recent trends within the last month or two suggesting anything is getting bigger or getting better?

Michael Batten

I would say October. As I mentioned at the beginning, I think to Josh's question, the month of October as far as orders is a much better indicator than the first quarter. I mean that is a much better sign than the first quarter, with a much stronger order month. I think that the markets have picked up. And maybe it was just a quarter of adjusting inventories and I think the leading economic indicators that we are watching suggest that the general industrial production should be increasing in the next few quarters.

Operator

Our next question is from the line of Peter van Roden with Spitfire Capital.

Peter van Roden - Spitfire Capital

Just a quick question to start off on China. Who are your customers there? Are you guys working with the U.S. pressure pumping companies or is it more Chinese manufacturers?

John Batten

It is almost a100% Chinese production, whether it's [ph] FJ, Yantai Jereh or Baoji. I'm not going to try to pronounce the fourth one, because I'll butcher it, but its domestic Chinese producers.

Peter van Roden - Spitfire Capital

Are your margins, they're kind of similar to what you would see in North American pressure pumping?

John Batten

They are basically spot-on to what we see in North America.

Peter van Roden - Spitfire Capital

And then, if you're so to just to look out a couple years and think about margins in the context of a North American pressure pumping recovery? Would you ever get back to that kind of 2011, 2012 number or was there a decent amount of pricing that you guys were getting because the market was so tight?

John Batten

I think we would get that. If we got back to that type of volume in oil and gas in North America, our margins would comeback to the mid-30.

Operator

I'm showing no further questions at this time. And now, I'd like to turn the call back over to Mr. Batten, for closing remarks.

Michael Batten

Thank you, Camille. As all of you know by now, I will be stepping down as CEO, effective November 1, and this would be my last conference call with you. While I have been an employee of Twin Disc for 43 years and while I have many wonderful memories and I have to admit that some memories are truly challenging times during the 1980s, I want to focus my remarks on the successor team and the future.

As I look ahead I see a bright future for Twin Disc. The company is well-positioned for a continued success in the years to come. We have embarked on the strategy of product innovation and differentiation as well as market and geographic diversification that will spur the growth and profitability of Twin Disc going forward.

We are either number one or number two in each of our product market sectors. And we will continue to build on these core business areas for the future. Most importantly, we have developed a successive management team that has the knowledge, experience, discipline to execute the strategic plans and delivers a value that our shareholders expect from us.

Each and every year and over the long haul they seek to maximize our economic profit, defined as our earnings in excess of our cost to capital. This management team knows how to manage a complex mix of products, markets and cultures in a cyclical global environment. This is not an easy task. As a small cap company, we face all the challenges of large cap multinational enterprises, many times our sizes. However, we view this is an opportunity and a competitive advantage.

And finally and most importantly, the team exemplifies the tone at the top character traits that are necessary to lead a successful company. Integrity, honesty, respect for the dignity of others and leadership by example defines the value system of the successor management. All in all, I have great confidence in our successor team. They are very capable people and capable managers and they will do a fine job going forward.

In closing, I would like to thank our Board of Directors for their role in supervising the succession plan and providing their valuable input along the way. In addition, I would like to thank the directors, both present and past for their support to Twin Disc management over the last 30 years. Our management team and I in particular, are truly benefited from their wise counsel and constructive criticism.

And finally and most importantly, I would like to thank all of you, our shareholders, for your continuing support over the past three decades. I've got to know many of you personally and appreciate your counsel and friendship. Thank you, again for attending the conference call today. And I know that John and Chris look forward to speaking with you again in January following the close of the second fiscal quarter.

Camille, now I will turn the call back to you.

Operator

Thank you, sir. Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!