Q3 2023 Twin Disc Inc Earnings Call

Greetings and welcome to twin disc fiscal third quarter 2023 earnings conference call.

At this time all participants are in a listen only mode.

A question and answer session will follow the formal presentation.

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As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host Jessica Knutson, Vice President Finance, Chief Financial Officer, Treasurer and Secretary. Thank you.

You may begin.

Thank you Doug and good morning.

And thank you for joining us today to discuss our fiscal third quarter 2023 result on.

On the call with me today is John Batten twin disc 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 companys actual results could differ materially from those projected in such forward looking statements.

[noise] formation 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 coffee this 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 different definition of non-GAAP financial measures and a reconciliation of GAAP to non-GAAP financial result.

Please see the earnings release issued earlier today.

By now you should have received the news release, which was issued this morning before the market opened if you have not received a copy please call. Our office at 2626, 384000, and we will send a release to you now.

Now I'll turn the call over to John .

Good morning, everyone and thank you for joining us today I'd like to start today's call with a few highlights from the quarter strong demand across our end markets, coupled with an easing supply chain constraints and in turn higher shipments translated into a 24% increase in sales year over year and double digit sales growth in our North American and Asia.

Ossific regions margins were adversely impacted by multiple factors, including a noncash LIFO charge related to a reevaluation of inventory and higher costs more than offset the pricing actions, we implemented mid quarter normalizing for the noncash impact of margins the operational accomplishments of our team whatever resulted in <unk>.

<unk> margin improvement, which has been and will continue to be a top priority.

Further we also generated nearly $7 million of cash from operations and ended the quarter with our highest backlog in more than four years and that's the largest backlog ever.

We have already taken a number of actions to respond to headwinds stemming from supply chain constraints in higher cost and we've been working with other strategic vendors to source components that are in short supply or that are currently sourced from a single supplier. The operational accomplishments of our team led to a significant improvement in shipments, which will allow us to continue to decrease inventory and further improve.

Lead times I'm also encouraged by the results, we're seeing from our collaboration between vet and rollout. The vet team has been working with our propeller manufacturer include more twin disc content in their designs and provide a better overall product to customers. There's been a noticeable increase in the number of applications of our hybrid and electric offerings and we're seeing a correlated incur.

<unk> in new orders as a result.

Our marine and propulsion systems product group continues to experience strong demand across end markets. We are seeing more activity within offshore oil and gas, which has translated into offshore oil and oil supply vessel inquiries something we haven't seen in several years.

As the geopolitical environment in the South Pacific continues to evolve we have concurrently observed a significant increase in the number of inquiries from U S and European governments for small military marine transmissions used in shallow water boats that has had a number of wins recently and has experienced its geographical reach beyond its core northern European markets book in <unk>.

Across North America, Asia Pacific and the rest of Europe , including Italy, which was a key luxury yacht market. We're excited about those we're excited about what those opportunities represent on.

On the land based transmission side of our business the lack of oil and gas investment over the past few years as increased utilization and the need to rebuild or replace fleets that said as we continue to see elevated demand with the oil and gas end market customers continue to face constraints on new engine availability from third parties, which has led to delayed orders for new transfer.

Mission instead, we've experienced increased orders for rebuilding existing transmission work, we are uniquely positioned to complete our E. Frac testing continues to progress and the feedback on the results to date remain extremely positive and we anticipate orders to begin shortly after this fiscal year.

Within the industrial product group, we continue to experience stable demand across end markets and have been able to maintain volumes in line with the spike observed last year, while it's still early days there has been a noticeable increase in op opportunities to work and to partner with key domestic Oems on a variety of exciting.

Projects. Additionally, we have seen the number of hybrid and electrification system applications continue to grow.

The greater twin disc content in these systems presents an opportunity to accelerate sales growth and expand the margin profile for the industrial product group.

Focusing on inventory and backlog for a moment strong end market demand persisted throughout the quarter, resulting in our highest backlog level in over four years and easing supply chain headwinds in operational execution enable twin disc to significantly improve shipments and reduced inventory on a dollar and percentage of backlog basis.

We are still experiencing shortage of certain components or materials and are working to find alternatives to mitigate these headwinds as we experience or are able to find and able to anticipate them. For example, one of our major suppliers hasn't been able to source enough material for a graphite ring the seals inside of a piston we've explored alternate suppliers as well as a change.

You'll either past require significant lab testing for extended time periods, where it presents its own challenges that being said the bulk of the supply chain headwinds faced in prior quarters like heat treatment and capacity constraints started to subside in the third quarter and we expect those trends to continue.

As we navigate and respond to each challenge that our business faces, we evaluate our options based on how they align with our commitments and long term strategy, we strive to be the leading hybrid and electric solution provider for our marine and off highway land based applications as we look to the future. It is clear the control system controls and systems integration.

Provides greater sales and margin opportunities than a continued focus on individual components would we.

We've also noted that the vet business has had a lot of success recently and we expect that trend to continue as we extend and expand that business across geographies and markets.

As with the acquisition of debt or M&A M&A priorities continue to be focused on industrial and marine technology, especially for the hybrid and electrification solutions, where we strive to be the leading provider.

Further we need to modernize and optimize the global footprint of our business to be more efficient and improve customer response and lead times.

As we think about capital allocation and more specifically returning capital to shareholders I think it's important to clarify our approach first we will continue.

Priority using the reduction of net debt, which we've been able to accelerate in recent quarters as we've closed on the sale of various facilities around the world.

Twin disc has historically paid a dividend to shareholders and we have a strong desire to resume paying a dividend. However, we won't use debt to fund it we will only resume the dividend. After we've established a track record of free cash flow generation and have a positive outlook on the cash generation potential.

Potential for the business we.

We continue to make investments within our business to fuel growth through research and development geography geographic diversification and expansion and our marketing efforts. We will also continue I continue to evaluate and pursue bolt on and transformational acquisitions that align with our strategic and financial fit characteristics as well as other consideration.

<unk>, which was consolidated on slide nine.

As we look forward I think it is important to provide clarity around our near term expectations of external factors and the actions. We are taking in response, we expect broader manufacturing and supply chain headwinds to continue to moderate while the acute components shortages, especially those sourced from European suppliers are likely to persist or resolve and then reemerge else.

We're in the portfolio over the next several quarters, we're doing what we can do and anticipate and to address these headwinds as early as possible.

We have not experienced a reduction in raw material costs. Despite the lowering prices of key commodities are pricing actions to restore and protect margins are already in effect and at the moment, we do not expect lower raw material cost of being a material driver of margin improvement in the near term. Our team continues to progress on our plan to modernize our legacy facilities equip.

<unk> processes and geographic footprint. This work has and is expected to continue to deliver improved shipments lower inventory reduce lead times and lower costs, all of which will contribute to better margins and cash flow for twin disc with that I will now turn it over to Jeff to discuss the financials Jeff.

Thanks, John Good morning, everyone. We delivered sales of $73 8 million for the quarter up $14 5 million or 24, 4% from the prior year driven by strong demand across our end markets, especially within our marine propulsion systems and land based transmission product groups.

As John mentioned shipments improved significantly in the quarter and we're seeing light at the end of the tunnel for our supply chain.

Net income attributable to twin disc for the quarter was $2 7 million or 20 cents per diluted share compared to $2 2 million or 17 cents per diluted share in Q3 of fiscal 'twenty two.

Approximately 20% year over year improvement in net income was primarily the result of our sales performance and lower income tax, which was driven by the geographic mix of earnings.

Bring in propulsion systems and land based transmission, both delivered double digit growth sequentially and year over year, while our industrial products group delivered another quarter of sales in line with expectations.

Looking at sales by geography, we saw year over year and sequential increased sales within North America, and Asia Pacific regions were primarily driven by efforts to diversify the vet business outside its core northern European markets.

That has had a number of wins recently and currently boasts a record high 12 months order backlog, we see a clear path to further growth in this business as John mentioned within the luxury yacht market that is now partnering with rollout our high end propeller design and manufacturing firm to design and develop components that are more fluid dynamic and leverage additional content from tip twin disc.

Gross margins of 26, 1% a decrease of 370 basis points from the prior year period were negatively impacted by noncash write down of domestic inventory as a result of LIFO accounting in the quarter. We expect this to similarly impact Q4, as we continue to reduce inventory to pre COVID-19 levels.

As John noted, we have seen commodity pricing continue to trend down but that has not yet translated into decreased prices ferraro, our raw materials twins.

Twin disc doesn't buy raw steel instead, we buy forgings castings, which have held firm on pricing today, we expect our raw material pricing to remain elevated throughout 2023 and implemented additional pricing early in the third quarter as a result.

I wanted to take a moment to highlight the progress we've made with our balance sheet and leverage ratio since the end of fiscal 'twenty, two or three short quarters, we've been able to reduce net debt by approximately $7 million. Our cash position is now 14 million, which is approximately 12% higher than at the start of fiscal 'twenty three EBITDA is up 14, 8%.

Compared to the year ago period, primarily driven by higher depreciation and amortization with net debt of $17 3 million at the end of Q3 and EBITDA over the last 12 months of $23 4 million our leverage ratio has gone from 1.1 acts to 0.7 acts in just three quarters.

The balance sheet progress, we've achieved is foundational to our pursuit of bolt on or transformational M&A opportunities as well as a key factor in our ability to optimize the global footprint and operational efficiency of twin disc.

Building on the near term expectations that John laid out I'd like to take this opportunity to reaffirm our medium term targets over the next three to five years, we believe the execution of our strategy will deliver revenues of approximately $400 million with gross margins of 30% to get there we will need to take advantage of and extend our leadership position across.

Hybrid electrification opportunities continue expanding the geographic reach of the vet business and evolve our business practices to adapt to the ever changing operational environment.

So see a path to delivering consistent free cash flow conversion of 60% through streamline supply chain operations, optimizing our manufacturing footprint and remaining disciplined with our capital spending.

And before we open the line for questions I'd like to leave you with a few key takeaways the robust demand and sales momentum experienced in Q3 is expected to continue through Q4, we've seen the bulk of our supply chain headwinds moderate and are working to resolve component shortages faced in the quarter. Our teams have been working tirelessly to improve our operational efficiencies and that is.

Allowed us to ramp up shipments in Q3, and our position in Q4 for success.

I think it is also important to highlight our current capital allocation priorities framework for M&A opportunities and reaffirm our confidence in our strategy and ability to achieve our medium targets medium term targets.

That concludes our prepared remarks, John and I will be happy to answer your questions.

Yeah.

Thank you ladies and gentlemen at this time, we will be conducting a question and answer session. If you'd like to ask a question you May press star one on your telephone keypad, a confirmation tone will indicate your line is in the question queue you.

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One moment, while we poll for questions.

Yeah.

Okay.

Once again that is star one to ask a question.

We do have a question from the line of Simon along with Gabelli funds. Please proceed with your question.

Hey, John and Jeff how are you.

Simon how are you.

Just starting with the or oil and gas business or how how.

How big how much revenue was that in the AR in the quarter.

Okay.

So it's a little bit hard to break that out real cleanly, but it was obviously a big part of the quarter aftermarket and forward market.

I would say.

25% to 30% in the quarter.

Topline.

Okay.

How much of that new equipment versus consumables or aftermarket.

I would say, it's probably more than half.

Aftermarket, maybe 60 40 aftermarket versus new equipment.

Most of the new equipment headed to Asia.

Oh, okay.

Sorry, just to clarify to 325% to 30% of that total oil Oh.

Total revenue or just land based transmission.

Of total.

Okay.

And then.

On the oil and gas are what are you seeing from your customers I mean, given the recent.

Volatility in oil prices and lower natural gas prices are they continuing activity or are you starting to see them park equipment, but what what.

Are you seeing there.

So Simon we haven't seen any slowdown in the rebuild activity they.

They may have idled, some equipment, but I think it's mostly equipment that needs to be rebuilt.

Or replaced.

And every conversation that I've had whether it's for Asia or North America.

The rebuild activity is going to continue and they're actively looking at new spreads because some of it particularly north America traditional frac rigs are going on their fourth fifth maybe sixth rebuild.

And there's still there's.

We're seeing that that is going to continue through the rest of the calendar year.

And Vale ability of engines is still out.

A couple of quarters, so probably wont scene.

A significant the traditional Frac fleet.

Some build but you know I expect to see that at the end of this calendar year.

Okay, Great and then one more oil and gas question.

And your last upcycle, how big was the offshore is a part of the business off with you guys.

Oh, sorry, Simon that.

Offshore was.

Historically, a very big component.

But I would say you know just that that was probably <unk>.

High single digits, 10% of our business. When it was that are you know when it was.

Near its peak.

Yeah.

Okay, 10% it.

It can be a meaningful contributor going into next few years, if all should really comes back as CEO .

Industry say, yes. It is.

Okay. Just 111 last question I'll jump back into the queue with eight outside of the oil and gas are eating and D of your new product pipeline that you're excited about.

That you can talk about.

Well, just I would say a lot of the industrial.

Just real products some of R. R. P T OS.

Whether its electrically shifted or hydraulically shifted.

Those are starting to gain traction and really what's exciting or the amount of hybrid and electrification applications project quoting that we're doing and the systems. You know the hinkley is the one that we've been able to talk about but we should have some exciting industrial ones to talk about and and.

I'm guessing we'll have you know through this calendar year and certainly next fiscal year, a lot more coming out where you know the full system is provided by twin disc.

Okay. So a lot of on train develop and that's been a bit hampered them in our controls group has done an amazing job.

Resourcing a lot of just the base components that were in such short supply over the last 12 months to 18 months.

Okay, Alright, great. Thank you guys.

Thanks, Kevin.

There are no other questions in the queue I'd like to hand, the call back to management for closing remarks.

Thank you Doug just wanted to take a moment to thank our teammates around the world for their perseverance and hard work. Please reach out if you have any further questions for Jeff or me have a great rest of the day and we look forward to speaking with you at our fiscal 'twenty three year end conference call later this summer.

Yeah.

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation you may disconnect. Your lines at this time and have a wonderful day.

Yeah.