Twin Disc Inc Q1 FY2026 Earnings Call

Hello, and welcome to the Twin Disc, Inc. Fiscal First Quarter 2026 Conference Call. We will begin with introductory remarks from Jeff Knutson, Twin Disc's CFO.

Good morning, and thank you for joining us today to discuss our fiscal 2026 first 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 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. 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. Now I'll turn the call over to John.

Good morning, everyone, and welcome to our fiscal 2026 first quarter conference call. We begin the year with strong momentum, delivering another quarter of profitable growth and meaningful progress on our strategic priorities. Sales and margins improved year-over-year, supported by steady execution across our global operations with healthy demand across all three core product groups, contributing to our robust backlog. Our performance this quarter underscores the strength of our diversified portfolio and the operational discipline that continues to define our success. As we move through fiscal 2026, we are encouraged by the resilience of our end markets and by the growing contribution from areas such as defense and hybrid propulsion. These growth vectors position us well to sustain outperformance and deliver strong profitability amid an evolving macroeconomic environment. That said, we remain mindful of potential tariff developments and expect a 1% to 3% tariff impact on second quarter cost of sales versus roughly 1% previously. This increase is temporary and will not affect the remainder of the year. As such, we expect the tariff impact to return to roughly 1% of cost of sales in the second half of the fiscal year. Now let me take you through the quarter's highlights. Sales grew 9.7% year-over-year to $80 million, marking another quarter of steady top line growth led by our marine and propulsion business, along with the integration of Katsa and Kobelt, which continues to advance ahead of plan and together are broadening our capabilities and expanding global reach while driving meaningful synergies. On an organic basis, net sales increased 1.1%, which excludes the impacts of acquisitions and foreign currency exchange. We continued to streamline operations in the quarter, efforts that effectively helped us deliver 220 basis points of gross margin expansion year-over-year as gross margins increased to 28.7% for the quarter. EBITDA margins remained strong despite the impacts of non-operating and noncash items such as defined benefit pension amortization, stock-based compensation and currency translation loss in addition to costs from recent acquisitions. We also delivered a robust 6-month backlog of $163.3 million, driven by sustained demand across our end markets, illustrating a strong start to fiscal 2026. Defense momentum remains exceptionally strong. Orders continued to accelerate during the quarter, and defense-related projects continue to represent a growing share of total backlog, increasing by $4 million sequentially and up 45% year-over-year, comprising 15% of total backlog. In the U.S. and Europe, we are actively supporting multiyear government initiatives to modernize both marine and land-based platforms, while our recent acquisition of Katsa continues to generate strong demand in Europe. Our work includes contracts tied to NATO vehicle programs and U.S. Navy patrol vessels, where we're serving as a trusted propulsion and systems partner. With a defense-related pipeline that continues to expand, we see significant runway ahead, supported by elevated government budgets and increased focus on marine and hybrid applications. Now let me walk you through product group performance. Our marine and propulsion business continues to perform exceptionally well, and sales increased 14.6% year-over-year to $48.2 million, driven by work boat activity, government programs and demand for Veth Elite thrusters. Record new unit bookings, combined with the growing demand for hybrid and autonomous vessel solutions continue to underscore the strength of our products and market position. In September alone, we booked $20 million in new unit orders, surpassing previous records. Orders supporting the unmanned U.S. Navy platforms class continue to build, and we are excited about our entry into the new class of autonomous patrol vessels, extending our presence on higher-value platforms. Additionally, we are seeing traction with the U.S. vector thruster market with backlogs increasing across workboat and cruise applications. Lastly, aftermarket remains resilient with steady utilization of military and commercial fleets flat compared to a year ago. Within land-based transmission, sales were stable, up 1.6% year-over-year to $17.6 million. Oil and gas shipments were nearly flat as China continued to decline. North American customers also remain cautious with a focus on rebuilds and refurbishments. However, we are seeing an emerging tailwind as the rebuild cycle matures and replacement demand begins to materialize. ARFF demand remains strong, and we continue to advance next-generation e-frac solutions, securing an initial order during the quarter, representing 14 units totaling $2.3 million. Overall, we continue to remain well-positioned to capture emerging opportunities as activity improves. Our industrial business grew 13.2% year-over-year with growth supported by acquisitions and broad-based customer activity. Steady demand for higher content solutions is reinforcing our mix and helping sustain momentum as we extend Katsa's engineering and parts capability across the portfolio. Our backlog of $163.3 million, up 13% year-over-year and 9% sequentially, provides solid visibility for the balance of fiscal 2026. Inventory is up slightly because of our strong demand and pre-buys. As we look at the remainder of the year, we remain focused on further optimizing inventory levels with delivery schedules as we convert our backlog and maintain flexibility across our manufacturing footprint to support demand while protecting margins. As we look to the balance of the year and beyond, I want to reaffirm our strategy centered on global footprint optimization, operational excellence and disciplined capital allocation. Our near-term priority remains reducing debt and strengthening our balance sheet while continuing to invest in targeted organic initiatives that enhance productivity and margin expansion. We have made great progress streamlining our business into a more agile and globally integrated operating model, one that breaks down silos, drives collaboration across our business units and goes to market as one consolidated company, which leverages our scale and shows the power of our consolidated platform. This starts with the business units and their leadership, which is now reporting through Tim Batten, our Executive Vice President. These efforts are improving execution speed, driving margin improvement and laying the foundation for sustainable growth. With these ongoing efficiency and integration initiatives, Twin Disc is well-positioned to deliver strong results through the remainder of the year and to achieve our long-term targets, driving sustained profitability and lasting value for our shareholders. With that, I'll now turn the call over to Jeff to discuss our financial results in greater detail.

Thanks, John. Good morning, everyone. During the quarter, we delivered $80 million in sales, up 9.7% from $73 million in the prior year period, which was primarily driven by strength in the marine and industrial product groups and supported by the addition of Kobelt. On an organic basis, adjusted for M&A and FX, revenue increased approximately 1.1% in the first quarter. First quarter gross profit rose 18.7% to $22.9 million and gross margin increased 220 basis points to 28.7%, reflecting the benefit of incremental volume and successful margin improvement initiatives in addition to improved mix in the marine propulsion product groups, specifically within Vet products. ME&A expenses were $20.7 million in the first quarter compared to $19.5 million last year. The increase reflects the addition of Kobelt as well as ongoing wage and professional services inflation. We continue to focus on cost discipline and operational efficiencies to support long-term margin expansion. Net loss attributable to Twin Disc for the quarter was $518,000 or $0.04 per diluted share compared to a loss of $2.8 million or $0.20 last year. The year-over-year improvement reflects higher operating income and lower expenses, driven by reduced currency losses, partially offset by higher pension-related amortization. EBITDA was $4.7 million for the first quarter, representing a 172% increase versus the prior year as expanded sales and profitability together drove strong results. From a geographic standpoint, sales growth was driven primarily by North America, where continued demand for Veth products and contributions from our recent acquisitions supported a higher share of quarterly revenue. The overall mix shifted toward North America, while Asia-Pacific and the Middle East accounted for a smaller portion of total sales, reflecting the impact of order and shipment timing of our customers. Net debt increased slightly in the first quarter, primarily reflecting seasonal usage of our revolver. We ended the quarter with a cash balance of $14.2 million, down 14.8% from the prior year. As expected, cash flows during Q1 are seasonally lower due to net working capital dynamics and slightly elevated inventory levels, as John described, heading into the year to satisfy robust demand. We continue to maintain a conservative net leverage ratio of 1.3x. Our strong financial position provides flexibility to navigate the current macroeconomic environment with discipline while continuing to evaluate targeted bolt-on acquisitions that align with our innovation strategy and broaden our product portfolio. As noted earlier, gross margin expanded by roughly 220 basis points year-over-year to 28.7% in the first quarter, reflecting the ongoing benefits of our cost reduction initiatives, improved operational execution and higher sales volumes. We continue to build on this momentum by sharpening our cost discipline and pursuing margin-accretive growth opportunities across our portfolio. Enhancing profitability remains central to our strategic priorities. Our capital allocation strategy remains focused on balancing growth investments with disciplined financial management. We maintain a focus on prudent capital deployment, pursuing targeted M&A that strengthens our marine and industrial technology platforms alongside organic investments in R&D, geographic expansion and hybrid and electrification innovation. Supported by a healthy balance sheet and clear strategic priorities, we're positioned to deliver sustainable growth and long-term value creation. I'll now turn the call back to John for his closing remarks.

Thanks, Jeff. In closing, I'm encouraged by the strong start to fiscal 2026 and the consistent execution across our global organization. Our teams continue to demonstrate focus, adaptability and discipline in navigating complex market conditions while delivering measurable progress on our strategic priorities. With a robust backlog, a solid balance sheet and a clear road map toward our long-term objectives, Twin Disc is well-positioned to drive profitable growth and strengthen its leadership across core and emerging markets. I remain confident in our ability to sustain this momentum and deliver lasting value for our customers, employees and shareholders. These conclude our prepared remarks, and we're now prepared to take questions.

We will take our first question from David MacGregor from Longbow Research.

Congratulations on the results, strong quarter. Let's start off with military just because you really called that out, and I appreciate the detail behind the strength and kind of how that is evolving. Can you just help us with the timing of shipment acceleration here as well as the expected margin impact?

Yes, it's John. I'll begin with the expected shipment. In Finland for the NATO vehicles, we are still in the early stages. I anticipate that our business will be around 150 units this year, and in a year, that should double and continue to grow from there. In the U.S., the main driver is the autonomous vessels. I expect whatever volume we achieve this year will also double by 2027. While I don't want to state that both main programs will double every year, it seems that we can expect, on average, at least 50% growth in each program over the next couple of years.

And do you have sort of the capacity to support that kind of a ramp right now? Or would that require a pickup in incremental CapEx spending?

We need to reevaluate our capital expenditures. We certainly have the capability in the U.S. to meet the demand for the U.S. Navy by making some adjustments. We're developing plans for this. In Europe, we should be fine with our current setup for the next 18 to 24 months. However, we're exploring ways to optimize our facilities in Europe to capture the demand and possibly increase volume at some of our other sites instead of just in Finland. So, the answer is yes. Our capital expenditures will focus more on test stands and assembly fixtures, which thankfully do not involve longer lead time equipment for machining capabilities, but rather on assembly and testing needs.

Well, that's all very encouraging. Let me turn to the oil and gas business. I know you're less dependent on oil and gas now than you've been in the past. But can you just talk about what you may be seeing in the way of changes in business conditions and order activity? And given what you've been working on in the way of costs and productivity and pricing, do you need a volume recovery in 2026 in order to see year-over-year upside in profitability?

The answer is no, but it would make things much better. It's a significant part of our business. Thankfully, it goes back to the last major downturn for us in oil and gas following the highs of 2018 and 2019 going into COVID. It was a deliberate choice to accelerate our shift, not to diversify from oil and gas since it's still a strong business. The tariffs came at a time when China tends to overbuild, and they have to manage their excess volume. There was a slowdown as they didn't require as much equipment, which primarily comes from the U.S. This contributed to their reduced purchasing. We see that demand picking up soon. The rebuild activity in the U.S. remains quite good, and while it was down in 2025, I don't think it will be difficult to surpass that in 2026. Additionally, we have e-frac orders coming in, which should support us throughout this year, with more follow-on orders expected for 2027. I'm cautiously optimistic about opportunities in natural gas. The overall market still shows that most of our units in the U.S. and North America are heavily focused on gas, whether it's wet gas or dry gas. The demand for gas is substantial, especially with everything being discussed regarding data centers and their power sources; natural gas plants are among the top options. I believe we are still years away from the deployment of nuclear energy, and I doubt renewables can keep pace with the concentrated demand required by AI data centers. Therefore, I'm quite positive about the macro situation and feel we are well-positioned to take advantage of the growing demand.

Interesting. I wanted to ask you about land-based transmissions because the double-digit growth in marine and propulsion and industrial, but relatively flat in the land-based transmissions. Can you just talk about the puts and takes within that business that led to the relatively flat top line?

Yes. I would say it's steady. The demand in ARFF is full, and our customers are operating at their capacity, which has remained consistent year-over-year. The minor fluctuations involve small projects outside of ARFF, such as railway maintenance. We're also integrating some products at Katsa into the transmission business. In the oil and gas sector, we've exchanged some unit volume in China for unit volume in North America. Jeff, do you have anything to add?

Yes. No, I think that's right, David. Oil and gas in general was down a couple of percent from last year's Q1. And then there's just timing of our shipments. It's a steady demand that we have for several months and even years in front of us, but there's some shift between quarters depending on the customer schedule, et cetera. So yes, pretty steady demand, I would say.

I want to ask about gross margins. We normally see kind of seasonal pressures with European shutdowns. And can you bridge the first quarter gross margins of 28.7%, you were up 220 basis points, I think. Maybe separate seasonal versus kind of the incremental volume versus the margin improvement initiatives that you referenced, Jeff? And also, I guess the investments were a factor and maybe the mix of businesses as well, I guess, because you talked about the strength in call. So just help me kind of proportion-wise, how I should think about those various factors.

Yes. The positive aspect for us is that, as we've mentioned in previous calls, the Veth business was not achieving the margin levels we anticipated. There were significant factors negatively impacting those margins, particularly from the thruster business. After COVID, they had a backlog with low margins and faced intense competition during that period when activity was limited. Over the past few years, we have focused on improving profitability and operational discipline, along with pricing strategies. As a result, they have now reported their best margin quarter since we acquired them. This improvement can be attributed to two main factors: an increase in volume with our usual drop-through rate of around 40% on a global scale, and Veth's enhancement in margin performance, contributing approximately $1.2 million more in favorable margins compared to previous years.

Yes, David, I'll just add a little bit of color on Veth too, is one of the things coming out of COVID and the Russia-Ukraine war was our supplier of permanent magnet motors for L drives. Our supplier had almost all of their supply base for raw material in Ukraine or Russia. And what they couldn't get from Russia was destroyed in Ukraine. So, we had some pretty heavy surcharges and cost increases as they were just scrambling to get us motors that unfortunately, we had contract pricing and couldn't pass that on. The Veth team has worked tirelessly for almost two years to develop different suppliers. And so, we're starting to see those suppliers come online and go back to the pricing when we were quoting these projects. So, they've done a great job on lean principles and finding new suppliers. So yes, if there's one entity that drove the improvement, it's really going to be Veth, then everybody else is just working on their constant continuous improvement projects. And it all came together. It was a very nice bump in the first quarter, which is typically a very hard one for us just on shutdowns and available days of shipping.

And so how much of that 220 basis points do you think is sustainable going forward, John?

Yes, if we maintain the same mix, I believe we can continue on a positive trend. As I noted earlier, one of the challenges we faced this quarter was the initial impact of the 50% tariffs from the Trump 232 actions. We received shipments of marine transmissions from Europe and Japan, which were heavily tariffed. After extensive discussions with the Department of Commerce and others, those tariffs have been reduced to 15%. We will need to manage this situation, particularly since it emerged in the first month of the second quarter. However, I am confident that after we navigate the initial negotiations with our customers, we can sustain a positive trend. The second quarter is looking promising despite the steep tariffs we faced, and I believe we can maintain this momentum. Our team's efforts and the ability to move, assemble, and test our products in various regions give us a significant competitive advantage.

Very encouraging. Last question for me is really on free cash flow for this year. And you talked about your plans for inventory, and you made a couple of comments around CapEx. But how are you thinking about kind of conversion, either EBITDA conversion or net income conversion, however you want to look at it?

Sorry, I'll answer the question I think you're asking, David, and maybe you can clarify. We view profitability in relation to our growth objectives, with a benchmark of 40%. As our volume increases, we aim to maintain that 40%. Currently, our target is to achieve double-digit EBITDA, with around 11% being our goal for this year, which would be an improvement from our previous performance. As we expand, we are focused on reaching a 15% EBITDA margin, which will require both increased volume and margin enhancements, as demonstrated in this quarter. We believe we are progressing well towards these targets.

Right. And so, can you help us at all in terms of the free cash flow model for this year in terms of what that might ultimately look like?

Yes, it was certainly a challenging first quarter for various reasons. We typically see a step back in Q1 with some payouts following our Q4. There was an increase in inventory due to rising demand and a growing backlog, possibly due to pre-buys in anticipation of tariffs. Despite this difficult Q1, we are aiming for 60% free cash flow as a percentage of EBITDA. That is our goal and we believe it is achievable. We hope to approach breakeven and recover the losses from Q1 in Q2. Our focus is on managing incoming inventory to meet the increasing demand without compromising our growth and customer satisfaction as we work to fulfill the volume growth ahead of us.

We have not received any questions from the audience. I’ll now turn the call back over to our CEO, John Batten, for closing remarks.

Thanks, Justin. And thank you for your continued interest in Twin Disc. If you have any follow-on questions, please contact either Jeff or myself, and we look forward to speaking with you in February after our second quarter call. Justin, I'll turn it back to you.

Thank you.