Twin Disc, Inc. — Form 10-Q Summary
Reporting period: Fiscal third quarter and first three quarters ended March 29, 2019. The request labels the period “2018 Q3,” but the filing reports fiscal Q3 2019. Unaudited; amounts below are in U.S. dollars. Financial statement amounts are in millions unless stated otherwise.
Business context and reporting period
Twin Disc manufactures and distributes marine and heavy-duty off-highway power transmission equipment. Its two reportable segments are manufacturing and distribution. Results include Veth Propulsion from its July 2, 2018 acquisition; prior-year reported results do not include Veth, so comparisons are not fully like-for-like.
Financial performance and position
| Metric | Q3 FY2019 | Q3 FY2018 | First 9 months FY2019 | First 9 months FY2018 |
|---|---|---|---|---|
| Net sales | $77.4 | $65.3 | $230.2 | $167.0 |
| Gross profit / margin | $23.1 / 29.9% | $20.8 / 31.9% | $73.2 / 31.8% | $53.0 / 31.8% |
| Income from operations / margin | $7.0 / 9.0% | $5.8 / 8.9% | $18.5 / 8.1% | $7.5 / 4.5% |
| Net income attributable to Twin Disc | $4.6 | $4.3 | $11.5 | $3.6 |
| Diluted EPS | $0.34 | $0.37 | $0.90 | $0.31 |
| Operating cash flow | Not presented quarterly | $(12.2) | $1.0 |
Q3 sales rose 18.5%, primarily reflecting $15.5 million of Veth sales; excluding the acquisition, Twin Disc reported lower shipments amid production and delivery delays and weaker North American aftermarket demand. Nine-month sales rose 37.9%, with Veth contributing $42.9 million. Nine-month net income improved despite higher interest expense and acquisition-related costs. Q3 diluted EPS declined as the weighted-average diluted share count increased following the equity offering.
At March 29, 2019, cash was $15.8 million; total debt was $49.3 million, leaving net debt of approximately $33.5 million. The company reported $21.1 million of available revolving capacity, net working capital of $139.0 million and a current ratio of 3.0. Inventories were $128.2 million, up $44.2 million from June 30, 2018. Total assets were $344.8 million and total equity was $186.6 million.
For the first nine months, investing cash outflow was $64.0 million, including $60.2 million net cash used to acquire Veth and $8.9 million of capital expenditures. Financing provided $76.2 million, including $32.2 million of net equity proceeds. Management-defined free cash flow (operating cash flow less fixed-asset acquisitions) was negative $21.1 million.
Material changes versus comparable periods
- Gross margin fell 2.0 percentage points in Q3, partly due to a $1.1 million nonrecurring inventory fair-value step-up charge from the Veth acquisition, which reduced Q3 gross margin by about 1.36 percentage points. Nine-month gross margin was unchanged at 31.8%.
- Veth added sales but also acquisition-related amortization, inventory step-up expense and debt costs. Veth reported nine-month operating income of $0.2 million and a net loss attributable to Twin Disc of $0.6 million, including acquisition-related and purchase-accounting charges.
- Debt increased substantially following the acquisition, partly offset by the September 2018 stock offering. The March 2019 credit amendment extended the $20 million term loan maturity to March 2026, lowered its applicable margin and established quarterly principal payments of $0.5 million beginning June 2019.
- Mill Log was sold on March 4, 2019. The sale generated $5.2 million cash and a $2.5 million note receivable due March 2020, and a reported gain of $0.9 million.
Outlook, management commentary and risks
- Management expects fiscal 2019 capital expenditures of approximately $14 million and pension contributions of approximately $2.4 million; $2.3 million of pension contributions had been made by March 29.
- Management stated that cash, the BMO credit facility and potential debt-market access should cover foreseeable capital requirements. The six-month shipment backlog was $113.7 million, versus $115.0 million at June 30, 2018; this included $21.2 million of Veth backlog.
- Management cited supply-chain constraints, production and delivery delays, weaker North American oil-and-gas aftermarket demand, and foreign-exchange movements. It also noted improving industrial demand and strength in certain oil-and-gas and commercial marine markets.
- The company is exposed to floating-rate debt, foreign-exchange and steel/aluminum price risks. It entered a $20 million interest-rate swap on April 22, 2019, after quarter-end. Litigation outcomes are not presently determinable, though management does not expect the disclosed litigation to have a material effect. Product liability claims are described as insured or immaterial.
- Veth purchase accounting remains preliminary; final valuations could change goodwill, acquired asset values and future depreciation or amortization. The Mill Log gain may also be adjusted as the entity is wound down. The Veth earn-out was determined at the maximum amount, approximately $3.7 million payable in company shares, with settlement expected in May 2019.
- The filing reports no material change to previously disclosed risk factors. Management stated disclosure controls were effective and that no material change in internal control over financial reporting occurred during the quarter.
Important facts for investors to verify
- Whether Veth delivers sustained operating profit after purchase-accounting charges and whether its final acquisition valuation materially changes reported assets or future earnings.
- Whether inventory growth converts to shipments and cash, given inventory of $128.2 million, backlog of $113.7 million and negative nine-month operating cash flow.
- Debt covenant headroom and the effect of the amended credit terms, floating interest rates and the post-quarter $20 million interest-rate swap.
- Collection of the $2.5 million Mill Log note and any adjustment to the reported sale gain; confirm issuance and dilution from the Veth earn-out shares.
- Whether reported earnings growth persists after excluding acquisition-related charges, the Mill Log gain and the contingent-consideration fair-value gain.