TWIN - NASDAQ

Good day, and welcome to the Twin Disc Fiscal Fourth Quarter 2023 Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Jeff Knutson, Vice President of Finance, CFO, Treasurer and Secretary. Please go ahead.

Good morning, and thank you for joining us today to discuss our fiscal 2023 fourth quarter and full year 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. By now, you should have received a 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 a release to you. Now I'll turn the call over to John.

Good morning, everyone, and thank you for joining us today. Let's begin today's call with some highlights. Throughout the quarter, we experienced strong demand for our products across end markets, coupled with easing supply chain constraints and higher shipments. This translated to a 10.5% increase in sales year-over-year for the fourth quarter and a 14% increase year-over-year sales for fiscal 2023. Gross margin was 29.5% for the quarter, which was 236 basis point decrease from last year's historically high margins and a 340 basis point improvement sequentially. We generated $22.9 million of operating cash flow and $14.9 million in free cash flow for the year, which compares favorably to the cash outflow in fiscal 2022. Earlier in the year, we took a number of actions to respond to headwinds stemming from supply chain constraints and higher costs. Our team has continued to work with strategic vendors to source components that are in short supply or that are currently sourced from a single supplier. We also made significant progress with our global footprint rationalization and expect to realize further benefits in fiscal 2024 as we enter the next phase of our plans. The Veth business ended fiscal 2023 with a record-high six-month backlog, primarily a result of its continued expansion beyond its core Northern European markets to North America and Asia Pacific. Shifting to our product groups. Marine and Propulsion Systems continues to be our strongest product group and experienced a very healthy demand. Sales for the quarter increased 22% year-over-year. We are seeing elevated inquiries from the US and Canada and production in our Belgium plant is at capacity with solid projects in the pipeline, and we are now booking projects into August of 2024 and beyond. Propulsion continues to be a driver with the partnership between Veth and Rolla making considerable progress on improved product performance and project design. A great example is our Elite Drive offering, which combines Rolla's in-house CFD capability and Veth's hybrid experience to design and produce state-of-the-art hydrodynamic propellers and the most efficient azimuth thruster and deliver a complete hybrid system for the mega yacht market. This partnership continues to give Twin Disc a competitive advantage and unlocks new possibilities and open doors to previously untapped markets. On the Land-Based Transmissions side of our business, the lack of oil and gas investment over the past few years has increased utilization and the need to rebuild and/or replace fleets. Customers continue to face constraints on new engine availability from third parties which has led to delayed orders for new transmissions. Instead, we've seen sustained demand at elevated levels to rebuild existing transmissions. While part of our normal offering, what has changed is the number of times we have been asked to rebuild a given transmission. Typically, we'd see a transmission rebuild two or three times before it is replaced. With these third-party engine manufacturing delays, we've seen some transmissions come into our facilities for fifth or sixth rebuild. Our e-frac testing continues to progress, and the feedback to date remains positive. We anticipate orders to begin in the United States starting in fiscal 2024. Within the Industrial group, we continue to experience stable demand across end markets and have been able to maintain volumes. During the fourth quarter, we faced some sourcing headwinds that our team worked to address as quickly as possible. We've already sourced a new vendor for the supply-constrained component, and we expect to resolve any remaining past due backlog in the first quarter of fiscal '24. Our team continues to make headway in several hybrid and electrification projects with various OEMs. These projects have a much longer development time line with a year or more spend on field tests and trials. We'll continue to provide updates as we achieve milestones. Looking ahead, we are evaluating opportunities to drive further innovation, improve execution and accelerate our growth. While challenging at the start of the year, supply chain headwinds eased sequentially and operational execution enabled us to significantly improve shipments. This improvement has allowed us to clear a significant portion of our past due orders from backlog. Inventory as a percentage of backlog ticked up slightly from the third quarter through overall -- though the overall trend toward historical levels continues. We have seen shortages of certain components and materials continue. The steps taken to incorporate alternatives as a means of mitigating these constraints have paid off and will benefit Twin Disc over the long term. To be clear, the bulk of the supply chain headwinds faced in prior quarters by key treatment capacity constraints have subsided and we believe that these trends will continue. However, we operate in uncertain times and are ready to address future challenges head on. As we evaluate each opportunity, we need to explore the puts and takes from multiple vantage points, including how our actions align with our commitments and our long-term strategy. Through fiscal 2023, our team has done a great job making progress on both fronts. We continue to rationalize and modernize our legacy facilities, equipment, processes and geographic footprint. This work has and is expected to continue to deliver improved shipments, lower inventory, reduce lead times and lower cost, all of which will contribute better results for Twin Disc and enhance value for all of our shareholders. As we transition to fiscal 2024, I'm especially excited to bring our e-frac offering to market. I'm also encouraged by the Veth and Rolla partnership, opportunities in the Marine and Propulsion systems area and the progress our Industrial group is having with OEMs on several electrification and hybrid systems projects. With that, I'll now turn it over to Jeff to discuss the financials. Jeff?

Thanks, John. Good morning, everyone. Before I jump into our results, I want to make sure you're all aware that Twin Disc's pension accounting method changed to modified mark-to-market during the fourth quarter of fiscal 2023. The change in accounting method has been applied retroactively with fourth quarter and full year results discussed today. The modified mark-to-market adjustment for fiscal year 2022 resulted in a $2.4 million gain. Turning to our financial performance. We delivered sales of $83.9 million for the quarter, up $8 million or 10.5% from the prior year as shipments improved substantially in the quarter. Supply chain headwinds continue to ease as a result of the mitigating actions taken earlier in the year. Our teams are also able to clear much of our past due orders from backlog, an important step to laying the foundation for fiscal 2024. Sales for fiscal 2023 increased 14% to $277 million from fiscal 2022. Net income attributable to Twin Disc for the fourth quarter was $8.6 million or $0.62 per diluted share compared to $10.2 million or $0.75 per diluted share in the fourth quarter of fiscal '22. the year-over-year decrease was primarily the result of higher income tax expense. For the fiscal year 2023, the company generated net income attributable to Twin Disc of $10.4 million or $0.75 per diluted share, a decrease of 0.8% and 3.8%, respectively, from fiscal 2022. Each of our product groups delivered continued growth sequentially with both Marine and Propulsion systems and Land-Based Transmissions reporting another double-digit quarter and the Industrial Product Group delivering another quarter of sales in line with expectations. Across our business, quarterly sales growth remained fairly consistent across geographies, further implying robust global demand. In addition to strong end market demand, our product groups are also benefiting from continued geographic expansion and strategic partnerships. For example, the Veth partnership with our high-end propeller design and manufacturing firm, Rolla, continues to deliver results that demonstrate one plus one can equal more than two. Gross margin decreased approximately 236 basis points from the prior year period, primarily driven by inflation as well as mix. However, we continue to make sequential progress with gross margin of 29.5%, increasing approximately 340 basis points from Q3. The quarter-over-quarter improvement was driven by increased volume, favorable product mix and a full quarter realization of our prior pricing actions as supply chain headwinds continue to ease. Similarly, we continue to see commodity pricing trend down, which has resulted in some improved pricing for our raw material inputs and components as we negotiate supply contracts up for renewal. In fiscal 2024, we expect to implement low single-digit pricing actions to mitigate any remaining headwinds. Over the course of fiscal 2023, we continue to strengthen our balance sheet. Twin Disc has reduced net debt by approximately $19 million and improved EBITDA by 7.6% to $25.8 million. At the end of the fiscal year, we had a cash balance of $13.3 million, 5.9% higher than the prior year, generated positive free cash flow of $14.9 million and achieved a leverage ratio of 0.2x. As John mentioned, we faced geopolitical and macroeconomic uncertainty as we consider how fiscal 2024 may unfold. Our balance sheet is a credit to our team's discipline and effectiveness. We can look at this new fiscal year from an enviable position of strength and opportunity. We continue to pursue bolt-on and transformational M&A opportunities and are making further investments in innovation and improving the operational efficiency of Twin Disc. To best deploy our balance sheet, we need to take a measured approach to capital allocation. This includes establishing a track record of cash flow generation before resuming any dividends as a means to return capital to shareholders. We will continue to make investments within our business to fuel growth through research and development, geographic diversification and expansion and our marketing efforts. We will also continue to evaluate and pursue bolt-on and/or transformational acquisitions that align with our strategic and financial fit characteristics as well as other considerations. As we shift to a new fiscal year, I think it is important to confirm our medium-term targets. Over the next three to five years, we believe the execution of our long-term strategy will deliver revenues of approximately $400 million with gross margins of 30%. We also expect to deliver consistent free cash flow conversion of 60%. In summary, the demand strength and sales momentum we've experienced in Q4 provides a solid foundation as we transition to fiscal 2024. We delivered our strongest free cash flow since 2014 and expect inflation to improve slightly in fiscal 2024. Substantial progress has been made to release supply chain challenges at surface in fiscal 2022 and '23. We will take necessary and prudent steps to mitigate any challenges brought on by the macroeconomic and geopolitical uncertainties that remain. Finally, our balance sheet gives us confidence and enables us to manage the business and evaluate growth opportunities for the long term. That concludes our prepared remarks. John and I will be happy to answer your questions.

[Operator Instructions] Our first question comes from Simon Wong with Gabelli Funds. Please go ahead.

Good morning, John and Jeff. How are you guys?

Good morning, Simon. Good, thanks.

Hey, quick question on your oil and gas business. In light of the lower rig count this year relative to the beginning of the year, what are you hearing from your frac customers?

Well, the -- not sure what the final horsepower count was at the end of our fiscal year. But I can tell you that the average age of the equipment continues to age and they keep rebuilding it. So I'm expecting that some of this equipment will be replaced in the next few months or at least we'll get the orders for it. But they're still pumping and pumping heavily, even though the rig count is down. So the ones that are still in use are being heavily used. And we continue to ship into China at elevated rates versus a year ago.

Okay. That's great. During the last quarter, how much of your business was related to oil and gas? And then within that, how much is consumable versus new equipment?

So it's -- in the quarter, it's probably around 20% and about a quarter of that being aftermarket activity.

Okay. Thanks. Can you -- a quick question on the Rolla partnership. How big of an opportunity is that for you guys?

It's a huge opportunity. We're just scratching the surface. Rolla has been designing and manufacturing propellers and doing the CFD, the computational fluid dynamics analysis for designing the propeller, selecting the right gear ratio in horsepower and then aiding designers with hull design. And that's pretty much just been in their traditional market, kind of yachts in the 150-foot length and down. This working with Veth, who's the integrated L-drive and their larger thrusters goes into much bigger vessels. So it's a bit of a, I won't say a quantum leap for Rolla, but their technology -- their CFD technology and design capability, working with Veth and designing the mechanical product in the electronics, it's big. I mean it gets Rolla into much bigger vessels. And it also helps Veth with their customers be -- more involved in the design process of the vessel and selecting horsepower and any questions that they have on the hull in predicting handling of the vessels. So it's a big opportunity for us.

Okay. Okay. Great. A couple of housekeeping items. Are you talking a 30% gross margin medium term? It looks like you were almost there in the fourth quarter. Was there something onetime benefit in that? Or -- and how should I think about gross margin for next year?

Yeah. No, the fourth quarter was pretty clean. Nothing really unusual other than it's the fourth quarter, which is usually our strongest quarter. So I think as we go forward into fiscal '24, we expect to have favorable comps to the prior year. But I would say Q1 starts with a favorable comp to Q4. So I think we'll build hopefully, to that 30% and beyond as we work through fiscal '24.

Yes. Simon, for us, just any small trend that could affect as far as demand. But in general, we build on revenue and gross margin through our -- sequentially through our quarters and it's all based on shipping days. We have the fewest -- fewer shipping days in the first quarter primarily due to shutdowns in Europe and then given just holidays and the way it falls, it builds, we have more in the second, then more in the third, then more in the fourth.

Okay. Last question, free cash -- not free cash, our CapEx for next year, what's the outlook there?

Yeah, I think we'll be something a little bit higher than probably what we did this year. We're thinking in the $10 million to $12 million range, limited really by lead times again. We have an appetite for some of the machine tools to drive productivity. Some of them are already on order. But with extended lead times even beyond fiscal '24. So I think that's the limitation for next year, I think. But yeah, we should be higher than this year, again, in the $10 million to $12 million range.

Okay, great. Thank you.

[Operator Instructions] As we have no further questions, this concludes our question-and-answer session. I would like to turn the conference back over to John Batten for any closing remarks.

Thank you, Vaishnavi. I'd like to thank our global teammates for another great year. This would not be possible without them. And please reach out if you have any further questions for Jeff or myself, and have a great day, and we'll look forward to talking to you after the close of our first fiscal quarter in October. Thank you.