Twin Disc Inc Q3 FY2024 Earnings Call

Thank you for being here. My name is Alex, and I am your conference operator today. I'd like to welcome everyone to the Fiscal 2024 Third Quarter Results Conference Call. All lines are muted to avoid background noise. After the speakers finish their remarks, there will be a question-and-answer session. Now, I will turn the call over to Jeff Knutson, Chief Financial Officer. Please proceed.

Good morning, and thank you for joining us today to discuss our Fiscal 2024 Third Quarter Results. On the call with me today is John Batten, Twin Disc’s 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 company's actual results could differ materially from those projected in such forward-looking statements. Information concerning factors that could cause actual results to differ materially from those forward-looking statements are contained in the company's Annual Report on Form 10-K, copies of which may be obtained by contacting 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 definition of non-GAAP financial measures and a reconciliation of GAAP to non-GAAP financial results, 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 262-638-4000 and we will send the release to you. Now I'll turn the call over to John.

Good morning, everyone and welcome to our fiscal 2024 third quarter conference call. Let's begin today's call with some highlights. We delivered solid results in the third quarter, continuing the trends seen throughout the year. As we continue to capture healthy end-market demand, we achieved another quarter of margin expansion, as well as robust free cash flow generation. These consistent results underscore the long-term impact of operational improvements we've made throughout our business in recent years, as well as ongoing tailwinds provided by disciplined working capital management to support overall performance. In line with our strategic focus on expanding our presence in the Industrial and Marine Technology markets, we are pleased to have announced our recent agreement to acquire Katsa Oy, a leading manufacturer of high-quality power transmission components and gearboxes based in Finland. This acquisition will broaden Katsa's global reach as we leverage Twin Disc's global sales, distribution, and service network, while also generating cross-selling opportunities through Katsa's existing customer base as we tap into its long-standing relationships with leading European OEMs, similar to the dynamics we've achieved with that. With our strong balance sheet and flexible financial profile, we will continue to explore similar strategic opportunities to drive sustained growth for Twin Disc. Moving on to results by product. Sales in marine and propulsion systems increased 3% year-over-year. The global commercial markets have remained active, providing a strong foundation for sustained demand. We continue to see an uptick in government defense spending, tied to recent geopolitical turmoil, leading to an increase in patrol boat projects and other activities linked to fleet readiness. Veth continues to perform well, supporting overall growth in Marine and Propulsion as the mega yacht market remains strong. We saw a solid 16% sequential increase in six-month backlog, driving the recent inventory build to support rising demand. This uptick underscores the enduring strength of the Veth and Rolla partnership which has created an additional competitive edge for Twin Disc by unlocking additional growth opportunities within both new and established markets. We also continue to capture increased demand for workboat marine transmissions, particularly in the Asia Pacific region due to the resurgence of projects for inland tugs in the region. A portion of this business is being driven by solid demand for coal tugboats utilized for transporting raw materials and coal from Indonesia to China. We will continue to focus on tapping into these regional opportunities to position the business for further growth. On to the land-based transmission business. Sales decreased 3% year-over-year, driven in part by sustained exports to the Asian oil and gas market. That said, even if sustainable energy is still a focus globally, oil and gas exploration activity remains strong, and we are encouraged by demand in the North American oil and gas market. Additionally, the increasing demand remains quite strong, which we will be even better positioned to capture with the addition of Katsa. Similar to last quarter, sales in our Industrial segment remained off, declining 15% year-over-year. This dip can largely be attributed to reduced demand from our lower horsepower range of our offer. Additionally, while commoditized products have experienced continued weakness, demand for more sophisticated higher content products has been relatively more resilient. We remain focused on advancing our OEM partnerships, which are crucial for our long-term growth strategy and allow us to leverage synergies and reach new markets effectively. Next, I'll speak to inventory and backlog. One of the key indicators for our company's strength is our backlog, which has been steadily increasing over the past six months. We are pleased to report that our backlog continues to grow both sequentially and on a year-over-year basis. Critically, inventory as a percentage of backlog has continued to trend downwards as well, reflecting our commitment to ongoing operational efficiency. Looking ahead, we anticipate further progress in inventory reduction during the fourth quarter of 2024, as we continue to work through our backlog supporting continued cash generation. I'd like to briefly address our long-term strategy before Jeff takes us through the financial details. Our commitment to innovation and adaptation is at the forefront of our long-term strategy. We are steadfast in our mission to expand our presence in hybrid and electrification solutions for marine and land-based applications. As demonstrated by our agreement to acquire Katsa, we are committed to our efforts not only to develop but also acquire cutting-edge technologies that meet the demands of customers in our global markets. Our recent success in expanding the Veth product line into untapped markets and regions also underscores our dedication to broadening our reach and solidifying our position as an industry leader. Moreover, our operational initiatives are geared towards enhancing efficiency and responsiveness, exemplified by the ongoing rationalization of our global footprint. By streamlining operations, we not only boost our competitive edge, but also strengthen our ability to cater to our customers' needs. With a keen focus on industrial and marine technology sectors and protecting those with a hybrid-centric focus we are poised to capitalize on emerging opportunities and further augment our portfolio. In closing, our unwavering dedication to innovation, operational excellence and strategic partnerships will continue to drive our success and deliver value to all our stakeholders. With that, I will now turn it over to Jeff to discuss the financials. Jeff?

Thanks, John. Good morning, everyone. We delivered sales of $74.2 million for the quarter, up $389,000 or 50 basis points from the prior year period as overall demand remains solid. Net income attributable to Twin Disc for the third quarter was $3.8 million or $0.27 per diluted share compared to $3.3 million or $0.24 per diluted share in the third quarter of fiscal 2023. Gross profit margin increased to 28.2% compared to 26.1% during the prior year period, and gross profit increased 8.7% to $20.9 million. This improvement reflects the realization of previous price increases, continued easing of supply chain headwinds and successfully executing our operational playbook. Marine & Propulsion Systems reported 3% growth, while land-based transmission and industrial sales reported a year-over-year sales declines of 3% and 15%, respectively. Looking at top-line distribution across geographies, sales continue to increase across the Asia Pacific and European regions compared to the prior year, supported by robust demand, while the proportion of sales in North American markets declined. We also saw a notable increase in sales within the Middle East, in particular, Turkey, which drove sales up $2.2 million year-over-year with increased sales for offshore wind projects. We continue to strengthen our balance sheet due to solid cash generation delivered in the third quarter. We reduced debt by $24.1 million to negative $6.8 million compared to the prior year period. And ended the quarter with a cash balance of $23.8 million, approximately $9.8 million higher versus the prior year period. EBITDA remained strong at $7 million compared to the same amount during the prior year period. We continue to decrease our leverage ratio this quarter to negative times, putting us in an excellent position to invest in our business while executing inorganic growth opportunities. As noted earlier, gross profit margin for the third quarter increased to 28.2%, expanding approximately 210 basis points from the prior year period, again, due to cost reduction initiatives and the impacts of operational efficiency. Looking towards the fourth quarter, we expect challenging year-over-year comparisons due to the historically strong results delivered in the prior year period. That said, we do anticipate continued strength in margins and cash generation. Now on to capital allocation. With our solid balance sheet strengthened by ample cash generation, we continue to explore strategic opportunities for M&A, particularly in those areas that align with our vision for the future. Our focus on marine technology, industrial, and the hybrid electric sector underscores our dedication to staying at the forefront of innovation, and these areas present significant upside potential and complement our existing capabilities and expertise. Simultaneously, we are allocating capital towards internal investments aimed at driving organic growth and operational excellence. This includes substantial investments in R&D to foster innovation expansion into the geographic markets to capitalize on emerging opportunities and the continued strengthening of our marketing efforts to drive market penetration. Furthermore, we remain committed to consistently returning capital to shareholders through share repurchases and dividend payments. Overall, our capital allocation strategy reflects a balanced approach aimed at driving sustainable growth and fostering innovation while maintaining financial prudence and flexibility. I'd like to now turn the call back over to John to share his closing remarks.

Thanks, Jeff. Before we open the line for questions, I'd like to highlight a few key takeaways from our quarterly results. Our third quarter performance highlights our continued operational excellence, marked by a notable margin expansion and robust cash generation. Our strong balance sheet, bolstered by consistent profitable growth and solid working capital management positions us favorably to navigate market uncertainties and take advantage of strategic growth opportunities. Looking ahead, we maintain our cautiously optimistic outlook driven by sustained demand dynamics. Our resilience amid external challenges reaffirms our agility and adaptability in capturing market opportunities, and our performance not only reflects our operational prowess, but also underscores our commitment to delivering long-term value to shareholders. I'd like to thank all of our teams for their continued hard work and dedication to supporting our business this quarter. As we approach the end of the fiscal year, we look forward to continuing our growth journey as we drive Twin Disc forward and generate long-term value for our shareholders. That concludes our prepared remarks. Jeff and I will be happy to answer your questions.

Thank you, we will now begin the question-and-answer session. We have one question from Simon Wong with Gabelli Funds. Please go ahead.

Hi, this is Rita filling in for Simon today. Maybe just my first question here. I guess how much of this quarter's revenue is derived from oil and gas customers? And I guess what is the breakdown between new equipment and consumables.

Yes, it's a good question. I would say it's been a pretty normal quarter for oil and gas. In terms of percentage of revenue for the quarter. I'm doing some quick math probably around 10% to 15%, kind of evenly split between consumables and units.

Thank you. My second question is about what the company is observing regarding North American frac customers.

I would say this is John. We've noticed an increase in new spare parts orders this calendar year and we have a few limited units being sent out. However, our outlook suggests that this will likely increase for the remainder of the calendar year, especially considering the current situation in the Middle East. I believe we will also see more activity both at home and in Asia.

Okay, thanks. Can you share how you perceive inventory in relation to backlog for the upcoming quarter as you manage your inventory for the fourth quarter of fiscal year 2024?

I believe it will continue to decrease gradually. We are not expecting a significant change. I think we will see a trend similar to what we have experienced in the last few quarters.

Okay. And then just my last question here. I guess any update on the timing of closing of the Katsa acquisition? And does the acquisition need approval from Finland's Economic Minister to close?

Yes. So we did get that approval this week, and we should be closing, I would say, around the end of the month within 30 days to 40 days will be closed.

Okay, thank you, that’s all my question.

Thank you.

Your next question comes from the line of Will Nasgovitz with Heartland. Please go ahead.

Good morning. Thank you for taking my questions, and congratulations on a strong quarter, especially with the free cash flow generation. It's great to see. I'm curious about the industrial side. In your opening remarks, you mentioned some aspects related to that. Are you noticing any signs of stabilization? You experienced a sequential pickup in broader ordering within the industrial segment. Overall, any insights on the Industrial segment would be appreciated.

I can say that this past quarter has been our best for orders in several quarters. It's been widespread, particularly in the lower horsepower range across Europe, the US, and Australia, which are our major markets. We have seen a slight increase, and this last quarter showed significant improvement in orders. Additionally, we have orders for some gearboxes with electronic controls. While things are looking more positive, we still have a long way to go to return to our previous levels.

Okay. And then the acquisition, as I recall, maybe it was $30 million in revenue or something around that level. Can you just provide any additional perspective on just like the margin profile of the company? And is it a new end market, new customers? And just some additional color would be useful.

Sure. I would say the margin profile aligns well with our expectations. Depending on the product line, it ranges from the high 20s to low 30s. They will be an excellent supplier for us, particularly for gears used in our products manufactured in the US, the Netherlands, and Italy. They initially started as a component supplier and have made significant investments in complex machining centers for gear production. Recently, they have ventured into the gearbox market, focusing on industrial applications and specialized marine gears, as well as transfer cases for all-wheel drive military vehicles. Until recently, their operations were primarily based in Finland, but with Finland joining Mato, they have received orders from Germany and Sweden, indicating good market expansion. The horsepower range of their products is very similar to Twin Disc's, and while they have primarily concentrated on the European and Scandinavian markets, we see strong potential to introduce them to the global market. Our teams across marine, industrial, and transmission sectors are eager to leverage Katsa products and present them to our global customers.

Thank you for that clarification. My final question relates to your earlier comments, John, about innovation, electrification, hybrid technology, and so on. Could you provide us with your perspective on the opportunity in this area? Given your expertise in traditional transmission, how do you see the potential for applying this technology to hybrid and electrification markets? Thank you.

Yes, there is a significant opportunity in our sector, whether it's marine, construction, or RF, as we create packages for OEMs to assist them. When considering our mechanical products, such as a pump drive or transmission, these are essential components for hybrid systems. They facilitate both an internal combustion engine and can integrate input from an electric motor powered by a battery. Our control system acts as the central intelligence. We also incorporate various other elements in the system, like inverters and wiring. For instance, in a crane application, a gearbox might cost around $20,000, while a hybrid system can range from $160,000 to $200,000, demonstrating significant potential for revenue growth. However, this relies on OEMs being able to market hybrid cranes at a substantial premium compared to traditional ones. In marine applications, we are quoting system prices between $500,000 to $1 million, depending on whether it's single or twin crew, whereas just a few years back, that was close to the total cost of an entire vessel. We are demonstrating to ourselves and our clients that we possess the technological solutions needed. Now we are awaiting the results of testing and how these products will perform in the market. There is a willingness to invest more for enhanced performance and reduced emissions. In some instances, such as in California, regulations are pushing for government-funded vessels to be fully electric or hybrid, so we anticipate some quick successes. In other areas like construction, it remains a matter of testing new equipment and assessing market acceptance. To sum up, our potential for growth can increase significantly, from four times to eight times swiftly.

Well, thanks for that elaboration and again congrats on the great quarter and best of luck in your fourth quarter. Thanks so much for the time.

Thanks Will.

That concludes our Q&A session. I will now turn the conference back over to John Batten for closing remarks.

Thanks, Alex. Again, we'd like to thank you for participating in our Q3 call and look forward to speaking with you in August for our Q4 and Fiscal Year End '24 Conference Call. Thank you, everyone.

Ladies and gentlemen, that concludes today's call. Thank you all for joining. You may now disconnect.