Q4 2019 Earnings Call
[laughter].
Welcome to the twin disc incorporated fiscal fourth quarter.
<unk> earnings Conference call and webcast. Today's conference is being recorded at this time I would like to turn the conference over to Mr. Stanley Berger.
Berger. Please go ahead Sir.
Thank you Liam on behalf of the management of twin disc. We're 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 2019 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 this conference call, especially those that state management's intentions hopes beliefs expectations or predictions for the future.
Our 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 actual results it I'm sorry.
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 FCC.
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 <unk> Nike to six to 68 4000, and she will send you a copy to you.
Hosting the call today are John Batten Twins this.
Chief Executive Officer, and Jeff Knutson, the company's Vice President Finance, Chief Financial Officer, Treasurer, and Secretary at this time I will turn the call over to Jon that John .
Thank you Stan and good morning, everyone welcome to our fiscal 2019 fourth quarter and year end conference call as usual ill begin with a short summary statement and then Jeff and I will be happy to take your questions.
Or just goes over the quarter results I will touch on some of the operational highlights the issues from the corner.
We continued to face several challenges in the fourth quarter that reflected in our results Jeff will provide more color on the details, but supply chain internal capacity continue to affect our ability to keep up with demand.
In the run up to the 85, hundreds because a lot of strain on our supply base in order to meet demand on other products, we had to move supply to other vendors are not always at the lower cost availability and quality were a primary concern because our customers could not wait. We also faced some suppliers, who went out of business or shifted focus away from our markets. We have been working hard to resource. These parts to a lower cost supply and are on our way to achieving this but we'll have to work through some existing inventory.
Additionally, our newer products like the 4001, our transmission to 7600 with the planetary output in many of our new industrial products are still working through inventory a prototype and preproduction pricing Q4 had a higher than normal percentage of new products, we should see improving trends throughout fiscal 2020, due to lower cost supply improved efficiency and pricing actions as we mentioned on the last call. We did have oil and gas push outs from Q3 and Q4 into the first half of fiscal 2020, which obviously affected the mix.
Internal capacity was affected by declining efficiency, partially driven by newer employees and increased training and a dramatic shift in mix in the second half of the year, we continue to get better by the month and reacting to the new demands and our new and our newer employees are coming up to speed.
Almost all of the inventory increase with the exception of that came from an increase in oil and gas demand on two transmission models. The 8500 7600 8500 is almost purely for new reconstruction or for direct 8500 replacement on an existing rig 7600 has been used widely in China and for it in and in North America for swap out of a competitive model. This is where most of our demand remains at the moment, but we do have an excess of inventory that we plan on whether we plan to bring down to meet the near term demand operational and functional changes have been made to make sure. This happens.
Looking at a more positive but positive developments in the air both our global industrial and Marine markets saw growth and we maintain a healthy backlog heading into fiscal 2020.
Now I will turn to a couple of our strategic objectives for a moment as we finish our first year with that we could not be more pleased with our progress of integration into the twin disc family. Most of the efforts in year, one were in finance HR marketing and engineering, our finance team did a great job, bringing the team up the FCC speed.
We delivered a coherent and unified approach at the major global trade shows and our engineering teams came together to forge a collective path forward, especially on the hybrid front. There is no doubt that that will greatly help us in our path of diversification going forward.
Our response to the North American and Asian markets has been extremely positive and we expect good sales growth in the coming years.
Our facility in Lufkin is under construction and we expect to be operational our fiscal fourth quarter with all of our North American produced industrial products. We will have a dedicated team solely focused on growing our industrial business developing and adding new products to our portfolio is a top priority for us in fiscal 2020 and beyond.
With that I'll turn it over to Jeff for some comments on the financials.
Thanks, John and good morning, everyone.
Ill briefly run through the fourth quarter numbers sales of $72.4 million for the quarter were down 1.3 million or 1.8% from the prior year fourth quarter.
The quarter decline is the result of a significant reduction in new build activity in North American fracking market, along with a related reduction in aftermarket activity. This decrease was partially offset by the addition of that propulsion activity and increased activity in our marine and industrial markets.
The quarter was also impacted by continued supply chain supply chain challenges, resulting in some delayed shipments and excess inventory.
We continue to see strength and positive momentum in nearly all of our markets, including the global industrial commercial marine and patrol craft markets.
For the full year sales finished up 61.9 million or 26%.
Adjusting for the vet acquisition, the organic increase is approximately 3%.
This year over year growth was driven by oil and gas demand primarily in the first half of the fiscal year, along with improving sales and industrial product, which grew over 10% from the prior year.
Our gross margin performance for the quarter was severely impacted by an unfavorable product mix.
With lower fracking demand for new rig construction and reduced aftermarket demand being the primary drivers.
The fourth quarter margin percent was 22.7% compared to 37.4% in the prior year fourth quarter.
In addition to the mix impact we are forced to move some production as John mentioned to higher cost suppliers in order to meet the growing demand as some of our land based transmission system.
We're already pursuing alternative vendors or improved pricing to address this issue in the fourth quarter result includes the impact of that that acquisition and related purchase accounting amortization.
Excluding the bat noncash purchase accounting amortization gross profit was approximately 24.2% for the fourth quarter.
For the full year gross profit finished at 29.6% compared to 33.5% in fiscal 18.
Again, adjusting for the whip write up amortization that that acquisition in fiscal 19 gross profit would have been 31%.
With the challenging product mix in the second half of the year, we are focused on driving cost reduction and pricing actions to improve margin performance.
Spending on marketing engineering and administrative costs for the fiscal 18 fourth quarter decreased $1.8 million or 10% compared to fiscal 18.
The decrease is the result of reduced bonus and professional fees along with the impact of the mill log sale, partially offset by the addition of that propulsion that relate to purchase accounting amortization.
For the full year, I mean expenses fell to 23.6% of revenue compared to 25.4% for fiscal 18.
Included in the fiscal 18 results or to other operating items totaling 1.6 million.
These relate to an $800000 gain on the sale of the mill log business in assets and an $800000 adjustment to an accrual associated with the vet propulsion acquisition.
While the fourth quarter operating results were essentially breakeven on the challenging margin performance. The full year operating income was 2.4 million or 15% higher than fiscal 18.
The effective tax rate for fiscal 19 was 25.6% compared to 33.1 for the prior year.
The current year reflects rate reflects the benefit of a full year impact of the new tax legislation.
Which was enacted in mid year in fiscal 18.
The prior year rate was also negatively impacted by discrete adjustments related to rate changes related remeasurement of deferred tax assets and liabilities.
The fiscal 18 bottom line has improved by 1.1 million to a profit of $10.7 million or 83 cents per diluted share compared to a profit of 9.5 million or 82 cents per share in the prior year.
Positive EBITDA of 6.1 million for the quarter reflects a 3.8 million declined for the prior fiscal 19 fourth quarter, but brings the full year result to 29.9 million and 8.9 million improvement over the prior full year.
The balance sheet remains healthy as we close out fiscal 19 with.
The impact of the 61 million that acquisition and subs subsequent 32 million equity offering.
Remaining the headlines for the year, we finished the fourth quarter with 30.1 million of net debt.
Debt to total capital of 18.9% and a debt to EBITDA ratio of 1.26.
Well the inventory did come down $2.3 million in the quarter inventory reduction efforts were hampered by customer driven delays.
In delivery into fiscal 2020.
Six month backlog finished the quarter at 100 million, which is down 14 million for the Q3 level.
Operating cash flow was positive $6.7 million or free cash flow is positive $3.6 million in the fourth fiscal quarter with improving working capital numbers is contributing to the positive results for the quarter.
And now I'll turn it back to John for some final comments.
Thanks, Jeff now spend a quick moment on our outlook.
A lot of management time was spent on the integration of that in fiscal 2019. Many of the actions that we were looking at to consolidate back office functions, particularly in Europe will put on hold as we did the acquisition and then the integration.
Moving forward, we will continue our efforts to reduce fixed costs in conjunction with their efforts on variable material costs.
That provides us the critical mass and access to talent, we need to build a European team, we're already using their experience and develop our marine hybrid line and we look to expand these electrification efforts into our industrial and transmission lines. There has been a lot of talk about electric frac rigs and while the current number is relatively small we see this is a growing trend in the future we will be ready with solutions for our customers who wish to pursue this option.
Many of you also probably saw our press release in May the gym fire Tag has rejoined twin disc as our president and Chief operating officer. After spending four years as the Chief Executive Officer of Bemis manufacturing Jim's intimate knowledge of our people products and facilities will be very beneficial in the coming years, as we rationalize our global global footprint and product portfolios.
Finally, we want to convey the message that management continues to focus on diversification and growth even as we address the short term margin challenges in front of US. We will continue to explore further opportunities to grow our industrial business and to enhance our hybrid development.
That concludes my prepared remarks, and now Jeff and I will be happy to take your questions. Ian Please open the line for questions.
Thank you see you would like to ask a question for you signaled by pressing star one on your telephone keypad.
The speaker phone. Please make sure your mute function is turned off what are your signal to reach.
And again Thats star one to ask a question.
Well take our first question.
Comes from Noah Kaye of Oppenheimer. Please go ahead.
Hi, good morning, gentlemen, thanks for taking my questions.
You know first if we can touch on the margins you pointed to a number of factors here you know mix.
Supply base challenges.
Can you give us a little bit more granularity on this or how much did mix way.
On margins in the quarter.
And then any detail you can give on some of the other factors.
Yes, I can I can jump on that one.
No and mix was there kind of related I guess in some way so the mix.
The low margin on the on the products that drove the negative mix is really a result of the sourcing issues that that John described so we've got the lower margin products. The the newer transmission products that drove if you're if we're comparing Q4 to Q4 almost $9 million of unfavorable impact on the on the margin line. So that really was the driver and that's why we're focused on the.
The cost profile of those products that are driving that negative mix as well as pricing on those products.
Right the business the legacy business really the.
The vet.
Margins I think you previously commented that there that kind of around twins typical margin in the low to mid thirtys. So so that was not.
If I understood right that was not a drag on margins.
That was a little bit of a drag they they finished the year and I'm, excluding the amortization piece right. So the amortization was about 4 million to 4.1 million for the quarter or for the year, excluding that they were around 28% for the full year.
And it it they've got a little bit of mix as well in their project. So Q4 in particular was was a challenging margin quarter for for that.
Hmm.
Okay, and then you know Oh, no I could add a little bit of color if I look at the the transmission products.
Where we had to shift suppliers I guess with a full year looking back.
Those units in general we're probably in the end I don't have the exact numbers in front me, but.
Their margin went down by about 5% based on shifting to having to shift into different suppliers. If that makes sense. So the gross margin on them probably deteriorated over the year with that supply about 5%.
Which we are working to reverse right now.
Right right and then you commented too.
Expectations that that margin should improve.
You know sequentially over the coming quarters.
As you take action.
You know roughly how should we think about that Uh huh.
Can we kind of get back to.
You know the margin levels that.
No we would typically expect what sort of more of a.
Steve Absolutely I mean, we're looking to get back to.
At a bare minimum.
Kind of being where we were for our year end gross margin during the down cycle at the high Twentys approaching 30.
It is it's a combination of and we've already begun shift finding different suppliers are being able to go back to other suppliers that were lower costs and and pricing. So.
Typically, though our first quarter is usually our lowest margin quarter because of the shutdowns in the U.S. and in Europe .
Hmm, so I expect to see in most of our pricing actions start in September and October .
So I think the real improving that you'll see it probably be in the second quarter.
Okay. That's very helpful. We shouldn't then it might be important.
Sure.
Okay, that's very helpful.
And then just on the development front in your prepared remarks, you mentioned your development at the Marine hybrid line of products that you might be looking to take that into some of your other end markets just.
Can you maybe update us a little bit on what what kind of adoption, you're seeing or expecting to see for the hybrid products.
On the Marine side, and then kind of how we should think about that entering the portfolio a person yeah. We're.
We're seeing.
We're seeing it it's fragmented certainly we're seeing a lot of urban areas in Europe demand for hybrid tugs, so being able to operate at low speed mode on.
From that from the Genset or batteries and particularly in marine what we're seeing.
Hybrid in the sense of not not diesel electric.
For these type of tugs, but running off the genset or running off of propulsion engines.
We're seeing that for passenger ferries and then a lot of the canal boats.
River traffic in Europe , and we're seeing that for tugs in the U.S. and in Asia. So.
It's.
But its I went on to say, it's it's it's not a tidal wave it's happening application by application.
And we're and we're seeing it both for the vet Z. drives and for our our current marine transmission product line.
So it is we are working as one team to develop the controls.
Controls logic to be able to do this across all of our products.
Okay, and then just on how quickly you grill crudes introduce a new fracking product.
We are working on current projects right now.
You know I can't say, when they're going to be in the field, but they are in development right now with with with end customers. So.
And I would say there is we probably won't have one single solution it will be different solutions tailored to different to different customers.
But.
What I would like to say you'd see something this fiscal year, but I cant bank on that.
No off it but it's it's it sooner rather than later.
Okay. Thank you very much for the color.
I will jump back.
Okay. Thanks.
Thank you.
Next question comes from Tim Wojs.
Please go ahead.
Hey, gentlemen, good morning.
Good morning, Tim.
So I guess just first question on the on the gross profit cadence I just want to make sure I kind of get it.
Right ballpark here, what are you thinking kind of high Twentys low thirtys gross margin for the year or do you think that's more of a run rate that you can exit the kind of back half of next year at.
Tim I'll answer first that's what I think for this year, that's where we're going to exit exit the year.
Okay. Okay. Okay got you that's helpful.
Okay, and then you would you would expect it to be.
You know probably down in Q1 relative to what we saw in the fourth quarter, and then and then kind of builds.
Much more of a step up in Q2, and then going into the back half the year.
Correct.
Okay got you great. Thank you.
And then just a housekeeping question, how how big was the North American oil and gas business in the quarter, if you're able to say that.
I'll, let Jeff give you the numbers, but most of almost all of our activity.
Was repair aftermarket or rig units going into rigs that were taking out <unk>, replacing competitive product in existing rigs in the north American market.
I think that was almost all of that I think we had a maybe.
A handful of units that went into new rigs in the quarter.
Yes, very that's very Thats right.
With you.
Okay. Okay got you.
And then when we think about just free cash flow for next year, Jeff how should we think about.
If you kind of look at working capital.
In Canada, it sounds like you'll release, some working capital maybe in the first half of the year with inventory you know how should we think about just kind of a ballpark estimate for what free cash flow could look like in 2020.
It's always a tough one to answer and I know, it's it's a that's a that's an important point yeah. We're certainly focused on bringing inventory down we have inventory as John pointed out a big part of our inventory growth is in that oil and gas market. So a lot depends on the market dynamics, there and how much how much we're able to move through but we're certainly we expect to be positive free cash flow.
Quarter by quarter, and certainly for the full year.
I would say something on the order of what we did in Q4.
For a for a court a quarterly number you're saying.
Yes.
Okay.
Gotcha.
Okay.
Okay and then.
I guess I guess last last question last question here that that I had when we think through.
How you're thinking about kind of the oil and gas market in 2020, John <unk> should we expect.
Do you think this is kind of the the the bottom quarter. I guess Q4 do you think you start to see a sense more rebuild activity in the first quarter and then kind of building into the year. How would you kind of frame I would I would say firms that.
And when do you think new could actually start to ship it.
A more meaningful way.
Hey, I don't I'll start with your last question first I don't see new rig construction happening in any meaningful way until calendar 2020.
And I do think it.
Well the for our first quarter be like our fourth quarter I expected I personally and driving for an expected are the first quarter will be a little bit better for our shipments the oil and gas for replacement.
So I think that that should be better in the first quarter.
But it could easily be the same quarter as the the fourth quarter I mean, it's it's because it because the activity requires some rework on the rigs.
We're.
We're beholden to how they're doing on on on getting the rigs ready for the transmission. So.
But yeah, it's going to be.
My My hope is that it's a little bit better, but it could be the same as the fourth quarter, but certainly we have the demand there for that growing replacement market.
Okay.
Thanks, guys. Good luck good luck on next fiscal year.
Thank you thanks to him.
Thank you.
Our next question comes from run giving of Neuberger. Please go ahead.
Hi, guys.
Hi, Brad.
On the on the transmission are the are you guys sort of like the third players in the market there, what's what's sort of currently available.
Oh and I mean.
There are a whole bunch of well there's two.
Two ways of looking at it you can do it with a variable frequency drives.
Or you can do it with a DC motor and transmission. Obviously, we are again. He frac is is when compared to diesel engine.
Frac, it's it's very expensive.
Hi, maintenance, but it is a growing option so.
We are pursuing all avenues, but I would say our primary Avenue is you know DC motor and using a transmission to control the <unk> of the shaft into the pump so.
I don't think anything changes with the main players of of the kind of the three transmissions that are in the market.
But again you know it's it's it's your we're building a team and expertise that that we have at VAT on on providing the best solution for our customers and we think the most cost effective.
We we think you know when we had this out in a few years that we will have a very compelling.
Product portfolio solution for those who are looking to do ie frac.
Okay.
As it relates to.
You know it looks like that.
Gross profit was down almost a little over 10 million quarter on quarter Q4, you mentioned 9 million was.
Sort of the mix issue or just wanted to sort of confirm that that's that's I guess the bulk of.
The bulk of the down.
Gross profit.
Yeah right.
The fourth quarter of last year, let Jeff do the numbers, but it was probably the height of new rig construction shipments for us and aftermarket rebuild it was a.
Fourth quarter of last year was.
Was an incredible quarter.
Okay, Yeah, we knew that.
I was going to be a different comp when we presented it so yeah. That's it it's it's a mix is the big story.
Okay, and what we've said to think of sort of like your four walls, where we're having inefficiencies can you just sort of.
Is it how meaningful is that I guess I'm trying to understand obviously you're getting in boarded.
From satellite combinations.
So Randy it's it's mid and the internal efficiency as is.
It's it's twofold, obviously, there are external factors and internal factors.
Supply base, not knowing what parts, you're going to get in and where you know you're we're trying to build what we can in each month, because more hand to mouth with a few suppliers is one issue. So it drives inefficiency if you're building one product and then you realize you are not going to get all the parts and you have to pivot secondly, and a big factor we in the in the prior 18 months I don't you do have to go back to.
The early seventies or you know kind of post World War, two or went twin disc started the amount of new people that we added in Racine is the most I've seen.
In my career and I know when I started we hadn't had a hiring.
Ramp up like that since probably the late sixties early seventies.
It just took a while to get people trained and up to speed, particularly on some of our new products that are a lot more technical and and and more complicated to build.
So I see that improving you know.
All the employees have had you know you know six months to 12 12 months under their belt have been trained so I see that inefficiency, you know employee efficiency, improving but as we you know find all the suppliers and get a more steady stream in when we can we can bank on it you will see our efficiency improved output didnt prove.
And inventory start to come down so I I do believe we've turned the corner.
And we'll see some improvement throughout the next four quarters.
Okay.
The last question I had was a if we think about your situation I think you called it out in the press release sort of 40% as marine.
How do you feel like that's a I'm, hoping it's a it's a grower as we head into 20.
This was sort of thinking like that you know apples to apples.
For the acquisition is that a is that a sort of a mid single digit grower do you think.
As we look to 20.
I think our traditional product lines down the marine transmission product line and propellers in surface drives I think that is it a minute you know a mid single digit grower.
I think we have the opportunity to beat that with the vet product line provided that you know the markets in Europe remained stable.
I see good growth opportunities in North America, and Asia in the coming years. So I think we can we can beat that with the vet product line.
Okay.
And I guess I do have another question just popped up you guys see in the next 18 months doing another sort of non.
Oil and gas or add on is your pipeline.
Such that is that you could do that.
Obviously got some manufacturing.
Things going on too so maybe.
But that is the goal I mean, we do want to bring we wouldn't do not want to take the eye off the ball on our Lufkin facility I personally believe in management does believe that this silly can have is as much of an impact of twin disc is that that acquisition getting the industrial products out of our 20 Onest Street operation into a you know a dedicated facility with a dedicated team.
I think going to be when we look back a few years from now it will be as impactful. The twin disc is the vet acquisition was.
Okay.
Alright, great. Thanks for the update guys. Good luck.
Brent.
Thanks Ryan.
Thank you.
Take our next question from Mario Gabelli of Gamco investors. Please go ahead.
Hi, Mr. Gabelli actually had to step into a meeting its Christina Brock from Gamco investors. Mr. Gabelli question, what is different this cycle from previous cycles I know a couple of dynamics have been touched on but if you could just I'm sorry.
It would be great.
Really what I was talking about the oil and gas cycle, yes.
Okay, well I think the difference this time.
The easy one is the price of oil is a lot higher.
The last cycle, we saw volume disappear because of pricing in Asia, and North America. There wasn't a lot of rebuild activity, we weren't replacing competitive product with our 7600.
But that is that has changed this cycle, we still see.
You know the price of oil remaining strong we see a lot of activity. The equipment is being used and used hard. So we see continued rebuild activity on the horizon and our order board for units to replace competitive product has never been higher so that that's I mean, that's what gives us a little bit of.
Of optimism that this cycle will be better than that 2015 2016 cycle.
Great. Thanks, so much.
Okay. Thank you Christina.
[noise].
Thank you I guess you'd like to ask your question Thats Star one.
At this time, we have no further questions.
Okay final question about the star one.
[noise].
It looks like we have no further questions Mr., Pat I'd like to hand, the call back to you.
All right. Thank you 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 and we look forward to speaking with you again following the close of our fiscal 2021st quarter, even now I will turn the call back to you.
This concludes today's call. Thank you all for your participation you may now disconnect.
And.