Twin Disc Inc (TWIN) Q4 2020 Earnings Call Transcript

Good day and welcome to the Twin Disc, Inc. Fiscal Fourth Quarter 2020 Earnings Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Stan Berger. Please go ahead, sir. Thank you, Eduardo. 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 2020 fourth quarter and full year financial results and business outlook. Before introducing 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 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 facts that could also cause actual results to differ materially relate to the global COVID-19 crisis. Information concerning factors that could cause actual results to differ materially from those in the forward-looking statements are contained in the company's annual report on Form 10-K, copies of which may be obtained by contacting either the company or the SEC. 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 Mianecki at 262-638-4000, and she will send a copy to you. Hosting the call today are John Batten, Twin Disc's Chief Executive Officer; and Jeff Knutson, the company's Vice President of Finance, Chief Financial Officer, Treasurer, and Secretary. At this time, I will turn the call over to John Batten. John?

Thank you, Stan, and good morning, everyone. Thank you for taking the time to join our conference call. As you all can imagine, the fourth quarter was a challenge, but I thought our team responded very well and delivered results even above our expectations. And again, facing really in the fourth quarter, the third challenge that this team has had to face. The two headwinds that continued to push us before COVID were the global trade war, especially with China, and the Saudi-Russia oil war, which drove the price of oil down even before COVID. Then COVID on top of that really affected all of our markets that had remained somewhat healthy, whether it was marine or industrial. We saw a dramatic slowdown in projects and new orders. In general, I thought our team did a fantastic job globally, getting products out the door that mattered most to our customers. Priorities were always changing. And you never knew, particularly in Europe, which supplier was going to be open or closed and which customer was going to be able to take product and pay. Our facilities in Racine and the Netherlands remained open throughout the quarter, even with the forced shutdowns in Italy, Belgium, and Switzerland. Our team did a great job of bouncing back and getting everything out the door that could go out. Earlier in April, at the end of our third quarter call, we announced that we applied for and received the PPP loan, just over $8 million, and we used the vast majority of that to pay full salary, wages, and benefits here in North America, well, in the U.S. Racine and our Racine-based employees. Those funds ended on July 24, and we had to react based on the conditions that we faced and we see for the next few months. Jeff will provide more detail on those cuts. At the end of the third quarter call, we announced $4 million in cost savings from the PPP. Yet this morning, we announced just over $7 million. Those are in addition. That's just a ratchet up. Three months ago, we thought $4 million would be the right number, and today we think that figure is just over $7 million. A lot of things, I would say, we see some signs of life. Our average daily order rate has ticked up slightly. But it's certainly not back to the level where we're going to see the backlog growing. So it was necessary to make these cuts. Jeff, with that, I'll let you go over some of the numbers before I come back on the outlook.

Sure. Okay. Thanks, John. Good morning, everyone. Briefly around the fourth fiscal '20 fourth quarter numbers, sales of $59.4 million for the quarter were down $13.1 million or 18% from the prior year fourth quarter. The decline from the prior year, as John mentioned, was principally driven by the ongoing effect of the COVID-19 pandemic on the global economy, the significant reduction in the North American fracking market, along with the softening in the global marine and industrial markets. The oil and gas decline, in particular, accounted for approximately $8 million of the fourth quarter reduction in sales. For the full year, sales were down $55.8 million or 18.4% compared to the prior year, with foreign currency exchange contributing $4.8 million to this decrease. The fourth quarter margin percent was 23.2% compared to 22.7% in the prior year fourth quarter. Favorable gross margin performance for the quarter versus the prior year was a result of some targeted cost reduction efforts on key products along with a global focus on cost reduction. The margin percent for the full year fell to 22.6% compared to 29.6% for the fiscal '19 performance on a more difficult product mix. If you recall, we had a $6 million product performance charge that we reported in fiscal year '20. Spending on marketing, engineering, and administrative costs for the fiscal '20 fourth quarter decreased $1.2 million or 7% compared to fiscal '19. The decrease is a result of a broad-based focus on reducing costs, particularly reduced professional fees, salary expenses, corporate travel, marketing activities, etc. With the oil and gas market struggling over the past four quarters now, along with the downturn associated with COVID-19, we have aggressively pursued cost reduction opportunities to compensate for the decline in gross profit. For the full year, ME&A spending was down $8.3 million or 12%. As John just noted, and as we announced in the press release this morning, we have taken cost reduction actions that will provide $7.2 million in annualized savings, primarily at our domestic locations. To be clear, this is not in addition to the $4 million in savings we discussed at our third quarter call. It is a reaction to the full utilization of the PPP fund and the current market conditions, indicating that we needed to again take aggressive action to put our cost structure where it needs to be for the next few quarters. The current action reinstates the savings that we announced earlier with an additional $3.2 million of annualized savings. We recorded a restructuring charge of $200,000 in the fourth fiscal quarter, similar activity to what we've had throughout the year, primarily related to ongoing cost reduction and productivity actions at our European operations. With the reduced fourth quarter volume and challenging product mix, we reported an operating loss of $1.5 million in the quarter, compared to a breakeven quarter in the prior fiscal year. For the full year, operating profit has declined by $58.8 million to an operating loss of $40.3 million compared to an operating profit of $18.5 million in fiscal '19. The fiscal '20 year-to-date result includes $5.1 million of restructuring charges, the $6.1 million product performance charge I noted, and the $27.6 million impairment charge recorded in the third quarter. Adjusting for these items, the year-to-date operating loss would have been approximately $1.5 million, or a $20 million decrease from fiscal '20 on a $56 million reduction in sales. The effective tax rate for fiscal '20 was just 9.5%, significantly lower than the prior year rate of 25.6%. The current year rate was significantly impacted by the $26.7 million impairment charge recorded in the third quarter, which resulted in a 13.3% decrease to the current year effective rate. The current year rate was also impacted by the GILTI provisions of the Tax Cuts and Jobs Act, which required the inclusion of foreign income but prohibits certain foreign deductions and credits. In a domestic loss position, the GILTI inclusion decreased the year-to-date effective rate by 2.8%. The net loss for the fourth quarter of fiscal '20 was $1.8 million, or $0.13 per diluted share, compared to a net loss of $0.8 million, or $0.06 per diluted share in the prior year fourth quarter. And for the full year, net loss of $39.8 million or $3.03 per share compared to a net profit of $10.7 million or $0.83 per share in fiscal '19. EBITDA of $1.3 million for the quarter was down from $2.9 million in the prior year fourth quarter. For the full year, EBITDA finished at negative $30.2 million compared to $29.9 million positive EBITDA in fiscal '19. The current year EBITDA includes a $27.6 million impairment loss recorded in the third quarter. As we indicated during the third quarter call, challenging market conditions made it highly likely that we would not be in compliance with the leverage ratio covenant included in our BMO credit agreement for fourth quarter reporting. We began discussions with BMO during our fourth fiscal quarter and were able to finalize an amendment to address this issue on July 22. This amendment removes the leverage ratio covenant beginning with the recently completed fourth quarter of fiscal '20 through the fourth quarter of fiscal '21 in favor of a cumulative minimum EBITDA covenant. Certain projections indicate compliance with this revised covenant but do require improving market conditions through fiscal '21. Inventory was down $7 million in the quarter and $14 million in the second half as reduction efforts remain a priority. With solid inventory improvement and good working capital results, operating cash flow was positive $4.3 million in the quarter. Capital spending was at the lowest level for the year at $1.5 million for the quarter, resulting in a positive free cash flow of $2.7 million for the final quarter of the year. As we address what we anticipate will be a challenging fiscal '21 market environment, we will be deferring all nonessential capital spending and expect to invest $7 million to $9 million during fiscal '21. And with that, I'll turn it back to John for some final comments.

All right. Just a quick look at the outlook. As you can imagine, our big takeaway from Q4 is that the second half of 2020, the first part of our fiscal '21 would be very challenging in all of our markets. Orders were not strong; that's reflected in the backlog. Although I would say in July, the average daily order rates did improve, showing some signs of life, but they have a ways to go. In some other areas, we had active projects in oil and gas in China, some military projects in marine that are close to fruition, new applications, and volume in North American industrial customers with our new products and work from our customers in the North American oil patch, with our 8,500 working strong and working every day. We continue to be impressed with our team in the Netherlands and their resiliency to drive projects through to fruition, get new projects and do this all remotely around the world without traveling. We also continued in the fourth quarter and up to now active projects in design and getting product ready in hybrid and electrification projects with cranes, vehicles for oil and gas and in marine. So our product development continues to push forward despite the market conditions around us. A little bit of clarification in the press release on operation on the Lufkin facility, we took possession on August 1. We plan to be in production with our first model likely in the middle to late second quarter, and we are very optimistic that this will drive future growth in our industrial business as we have a team in Texas focused on our customers every day on this product, which has a very different cadence than the other products at our 21st Street facility, which are the oil and gas transmissions, ARFF transmissions, and marine transmissions, with a different cadence and different suppliers. We are optimistic about the future of the Lufkin facility in our industrial business. Regarding the Racine facilities, we're reviewing work from home and a reduction in headcount; we are exploring how to consolidate into one facility here in Racine and support each other as one team, one facility. So we're actively looking at that, assessing how we can be more cost-effective here in corporate and Racine-based operations. Other than that, I'm going to open it up to questions now. Eduardo, could you open the line up, and Jeff and I are happy to take questions.

I'll take our first question from Noah Kaye at Oppenheimer.

To start with one thing that stood out to us is, sure, I'm reading the press release right, a 26% increase year-over-year for the fourth quarter for Veth. Can you talk a little bit about how you're able to achieve the growth there? And should we be expecting it to continue to outperform in future quarters, considering the market trend?

So no. It's John. I guess just to provide color, I would say the fourth quarter last year was a little bit worse than expected, and this quarter is a little bit better than expected. If I had to give you my thought, I would estimate it's more like a 10% increase. But again, the Veth team and that product and the markets that they serve have done a much better job holding up year-over-year in the crisis. So can we expect continued growth in favorable comparisons? I think if there's one area in our business right now, that's the area that can perform the best amidst all the headwinds we are facing.

Is that share gains, or is that end markets? Can you talk a little bit about their position? And I think you commented as well on some of the sales synergies starting to translate. So I just want to tease that out a little bit more.

I'd say it's a mix of share gain and the market growing. So it's got two tailwinds. We have a great product, a great team. They're now part of a global Twin Disc team, which helps open doors and ease people's minds on having global service for that product. We also see more vessels being built with that technology. So where other markets are facing headwinds, they are facing the COVID-19 headwind, but they have tailwinds that are also helping them.

Yes. On oil and gas, it seems like the producers are indicating they are essentially done with CapEx for the year, right? So, basically, they'll be on the OE side. We will continue to see headwinds in your first fiscal half of '21. How is the aftermarket holding up? What are sort of the dynamics like and what are our share dynamics there?

It's slower. I would say aftermarket is slower than I would have expected, given the rate at which our rigs are working. So I would have expected a little bit more aftermarket activity. What's happening right now is that it's not a new playbook. If a rig needs maintenance within a certain dollar amount, they'll park it and use another rig instead. So we have to navigate that a little bit. Fleet horsepower is reducing as people are scrapping fleets. Currently, we are just battling that situation; we are getting some aftermarket activity, but I would have expected more given the activity we know about and our rigs being used. I think there is future demand coming, I just cannot predict when that's going to be. But we're not banking on it for the next six months.

As you think about the commentary around the prospects for compliance with the covenants, you are expecting a gradual recovery over the fiscal year. If you had to pinpoint it, where would that be?

I would wait until calendar '21.

In terms of end markets improving?

Yes. I'm not expecting end markets to improve until calendar '21.

That’s helpful. A last one: You mentioned potential cost savings. It sounds like you're contemplating potential real estate consolidation in Racine. If you were to do that, what kind of implied savings would you expect?

We would aim for seven-figure savings in operating expenses. We're currently at the point with work from home arrangements, and the number of people in the office every day—under 8 mostly now—so it's right to analyze how we can operate and potentially have a different style of office versus dedicated office spaces. We have started the analysis on how to fit everyone from the corporate office into our North American operations facility. It would be a challenge, but it's absolutely worth exploring, given the significant reduction from what used to be 40-50 people in the office daily.

We'll now take the next question from Josh Chan at Baird.

Just if I can dovetail off of the cost savings question. So of the $7.2 million annualized, how much of that did you realize this year? And how much does it leave for next year? Do you think that those savings are more temporary in nature, just in response to the demand, or are they structural costs?

Yes. I can jump in. John, you can comment. Based on the actions and timing, we could see 80% of that within this fiscal year. I would say that it is a reaction to the markets and the incoming order rate. As markets recover, I think we would adjust our cost structure accordingly. It is impacting everybody in Racine in one way or another, and it's not what we would consider a permanent situation. It's a temporary response to the current market environment.

That makes sense. You talked about the average daily order rates improving. Are you seeing it across many markets or specific spots?

I would say yes. The aftermarket, marine, and industrial have shown improvement. In our new unit order segments, whether it's ARFF, military, or oil and gas, typically come in large amounts. We are seeing metrics in marine new unit orders, industrial new unit orders, and aftermarket. These daily order rates have shown some improvement from the bottom in April. We're just stepping up out of the basement, but at least they are moving in the right direction.

That makes sense. Definitely a positive sign, but a greater improvement would be ideal.

Yes. The bottom was in April. And it has improved month over month since then.

I appreciate the details there. Last question on gross margin; in 2020, a few items impacted it. How do you see margins shaping up in '21 compared to '20?

That's a good question. As you know, mix is such an important factor for our margins. With a similar mix, without that $6 million charge in '20, we would have been about 25%. We had outstanding cost reduction efforts this year, which is demonstrated in our fourth quarter year-over-year improvement. So annualized with the same mix, we could do slightly better than 25%, even with what might be softer volumes. I believe we will get some good cost savings, and we aim to be in that range, hoping for improvements in our mix and volumes coming back in oil and gas in the second half, which would drive us into the higher 20s.

I want to clarify the PPP impact on the P&L, if it does? Am I right that this is forgiven assuming you spend it down against employee expenses? So that's right. Is there a P&L impact? Also, how much of it was in the fiscal fourth quarter versus how much might have gone into the first quarter?

That's a good question for Jeff.

Good question. Yes. The spending was an expense, right? There was no forgiveness assumed in our fiscal fourth quarter, so no P&L impact as it relates to PPP forgiveness. We spent approximately $6 million of the $8.2 million within the fourth quarter and the remaining $2.2 million in the first fiscal quarter of '21. We will apply for forgiveness later in August. There is a formula that is followed and specific spending requirements, and we focus on ensuring the funds were utilized correctly, which is one of the reasons we returned wages to normal levels when we received the funds. More information will come when we do our first quarter follow-up, so we can provide a clearer picture.

There appear to be no further questions as of right now. I'll turn it back to the speakers for any additional or closing remarks. Please go ahead.

Thank you, Eduardo, and thank you, everyone, for joining our conference call today. We truly 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. We look forward to talking with you after the close of the first quarter. I don't know if the call will be the last day of October or early November, but it will be after our Annual Meeting. So Eduardo, now turn it back to you.

Thank you. And this concludes today's call. Thank you for your participation. You may now disconnect.