Twin Disc, Inc. — Form 10-Q Summary
Business context and period. Twin Disc manufactures and distributes marine and heavy-duty off-highway power-transmission equipment. This unaudited report covers the quarter and six months ended December 25, 2015, the second quarter and first half of fiscal 2016. Amounts below are in U.S. dollars; financial statement amounts are converted from thousands to millions where indicated.
Financial performance
| Metric | Q2 FY2016 | Q2 FY2015 | First half FY2016 | First half FY2015 |
|---|---|---|---|---|
| Net sales | $44.8m | $72.7m | $82.2m | $137.5m |
| Gross profit | $11.6m | $22.1m | $19.8m | $44.5m |
| Gross margin | 25.9% | 30.4% | 24.1% | 32.4% |
| Operating income (loss) | ($3.6m) | $5.6m | ($10.1m) | $12.1m |
| Net income (loss) attributable to Twin Disc | ($2.3m) | $3.7m | ($6.6m) | $7.8m |
| Diluted EPS | ($0.21) | $0.33 | ($0.59) | $0.69 |
- Sales fell 38.3% in Q2 and 40.2% in the first half. Management attributed the decline to weaker oil-and-gas demand, particularly for pressure-pumping products, softer Asian commercial marine demand, weak European markets, and unfavorable currency translation. Constant-currency sales declined 34.4% for Q2 and 35.3% for the first half.
- Lower volume and less favorable product mix weighed on gross margin; cost savings and improved efficiencies partly offset the pressure. Q2 ME&A expense declined 11.6% year over year to $14.6m, but rose to 32.6% of sales as revenue contracted.
- First-half operating cash flow was negative $4.4m, versus positive $9.4m a year earlier. Capital expenditures were $2.9m, making management-defined free cash flow (operating cash flow less fixed-asset acquisitions) negative $7.3m. Cash declined $2.3m to $20.6m.
- At December 25, 2015, current assets were $143.0m and current liabilities $57.4m; the current ratio was 2.5, down from 3.0 at June 30, 2015. Net working capital was $85.6m, down $27.2m. Total debt was $17.4m, compared with cash of $20.6m, or net cash of approximately $3.3m. Equity was $129.0m.
- Dividends were $0.09 per share for Q2 and $0.18 per share for the first half, unchanged from the comparable periods.
Material changes and notable items
- Manufacturing-segment sales declined 37.7% in Q2 and 44.2% in the first half; distribution-segment sales declined 42.7% and 30.5%, respectively. The largest reported pressures included U.S. manufacturing, Singapore distribution, and the Northwest U.S./Southwest Canada distribution operation.
- Backlog scheduled for shipment within six months was $34.6m, broadly level with $34.4m at June 30, 2015, but 41% below the prior-year December level of $58.3m.
- The company recorded $0.5m of restructuring expense in Q2, including severance associated with workforce and compensation reductions. The announced actions are expected to generate approximately $4.3m of annualized savings. A prior-year restructuring plan had recorded $3.3m of expense in Q4 FY2015.
- The sale of southeastern U.S. distribution rights and related assets generated $4.1m of proceeds; $0.6m of proceeds was deferred and will be recognized through June 2016. A $0.056m post-closing adjustment reduced the first-half operating gain to $0.445m.
- Foreign-currency translation reduced first-half sales by $6.8m and contributed to a $4.1m unfavorable translation adjustment in equity. The company reported no goodwill impairment at quarter-end, but said it would continue monitoring market capitalization and industry conditions.
Debt, liquidity, outlook and risks
- Covenant breach and subsequent amendment: At December 25, 2015, the company failed the prior minimum four-quarter EBITDA covenant of $11m; reported covenant EBITDA was $7.7m. Other reported tests were met, including a 2.25 total-funded-debt-to-EBITDA ratio and adjusted net worth of $162.5m versus a $124.7m minimum. The revolving facility and Prudential note agreements were amended on February 1, 2016, after quarter-end, and prior events of default were waived.
- The amended revolving facility uses a borrowing base, has a maximum commitment of $40m, and provided approximately $30m of borrowing capacity and $12.6m of availability at amendment. It is secured by substantially all of the company’s and Mill-Log’s personal property, with a pledge of 65% of certain foreign-subsidiary equity. Pricing increases while EBITDA is below the specified threshold. The company said it was pursuing longer-term financing and expected a solution before fiscal 2016 year-end; there is no assurance it will obtain one.
- The $13.765m revolver balance was classified as current because management anticipated that the company might not meet a covenant at a measurement date within the next 12 months. The $3.571m senior-note balance was also current and due April 10, 2016.
- Management said cash, credit availability, and operating cash generation should fund near-term operating and investing needs, while noting that overseas cash may involve restrictions or tax consequences if repatriated. Expected FY2016 capital spending was $5m–$7m. Expected pension contributions were approximately $2.2m, of which $1.2m had been made by quarter-end.
- Principal business risks include continued weakness in oil and gas, Asian commercial marine and other markets; foreign-exchange movements; covenant compliance and access to financing; and possible goodwill impairment if market or operating conditions deteriorate. Warranty estimates, litigation outcomes, pension obligations and tax audits also involve uncertainty. Management said pending litigation was not expected to materially affect results, financial position or cash flows.
Important facts for investors to verify
- Whether Twin Disc meets the amended debt covenants and secures longer-term financing, including the status and terms of the February 1, 2016 amendments.
- Whether demand, orders and backlog recover in oil and gas, Asian commercial marine, and other weak end markets, and whether the announced cost reductions offset lower production volumes.
- Whether cash generation, borrowing availability and the planned capital expenditure range remain adequate, particularly given the current classification of the revolver and the senior-note maturity.
- Whether market-capitalization and operating trends trigger a goodwill impairment test or other material charges, and whether warranty, pension, tax or litigation exposures change materially.