Twin Disc, Inc. — Fiscal 2014 First-Quarter 10-Q
Reporting period: Three months ended September 27, 2013; comparable period ended September 28, 2012. Amounts are in U.S. dollars. Financial statement figures below are in millions except per-share data.
Business context and results
Twin Disc manufactures and distributes marine and heavy-duty off-highway power transmission equipment. Its markets include pleasure craft, commercial and military marine, energy and natural resources, government, and industrial applications.
| Metric | Q1 FY2014 | Q1 FY2013 | Change / note |
|---|---|---|---|
| Net sales | $66.4 | $68.8 | Down 3.4% |
| Gross profit | $20.7 | $19.4 | Gross margin 31.1%, up from 28.2% |
| Operating earnings | $4.1 | $2.8 | Includes $1.1 restructuring charge in current quarter |
| Net earnings attributable to Twin Disc | $1.3 | $1.2 | Up modestly |
| Basic and diluted EPS | $0.11 | $0.11 | Unchanged |
| Effective tax rate | 64.4% | 46.4% | Higher, principally due to foreign tax effects and limited tax credits |
| Operating cash flow | $9.7 | $2.1 | Improved; working-capital changes were favorable year over year |
Financial position and liquidity
- At September 27, 2013, cash was $24.1 million, total debt was $24.8 million, and net debt was approximately $0.8 million. Debt declined $2.3 million from June 30, 2013.
- Net working capital was $127.5 million, up $2.5 million from fiscal year-end. Cash increased $3.3 million and receivables declined $8.9 million; inventory was approximately flat at $103.1 million.
- Management reported $8.9 million of free cash flow for the quarter. Capital expenditures were $0.9 million; cash dividends paid to shareholders were $1.0 million.
- The company reported $26 million available under its $40 million BMO revolver and an additional $15 million commitment under its Wells Fargo facility, which had no borrowings. Cash was concentrated overseas, and management noted that repatriation may involve restrictions and tax implications.
- The company was in compliance with debt covenants. Four-quarter EBITDA was $22.5 million and funded debt to EBITDA was 1.10; management stated it expected to remain compliant in fiscal 2014.
Material changes and management commentary
- Sales fell mainly because of lower demand in North America and Europe, partly offset by record growth in Asia Pacific. Foreign currency translation reduced consolidated revenue by approximately $0.9 million before eliminations.
- Manufacturing segment sales declined 8.6% to $53.3 million; distribution sales were essentially flat at $31.0 million. Manufacturing segment net earnings decreased to $2.0 million from $2.8 million, while distribution segment net earnings increased to $1.9 million from $1.2 million.
- Gross margin improved with a more profitable product mix, including stronger oil-and-gas transmission sales, and lower warranty expense; lower sales volume partly offset those benefits. Marketing, engineering and administrative expense fell $1.1 million to $15.5 million.
- Six-month order backlog was $58.1 million, down from $66.8 million at June 30, 2013 and $82.4 million a year earlier. Management attributed much of the decline to weaker North American pressure-pumping and commercial marine demand. Inventory was 178% of six-month backlog, versus 154% at fiscal year-end.
- Management planned fiscal 2014 capital investment of $10–$15 million and expected approximately $2.6 million in pension contributions; $0.6 million had been contributed by quarter-end. It expected cash from operations to fund operating and investing needs. No specific revenue or earnings forecast is stated in the filing.
Risks, contingencies and unusual items
- A $1.094 million restructuring charge followed finalization of a targeted workforce reduction at the Belgian operation. The company paid $0.775 million during the quarter and reported a $0.898 million remaining accrual.
- Current-quarter results included out-of-period corrections of prior-period errors: the net effect was to increase pretax earnings by $437,000 and Twin Disc net earnings by $69,000. The company considered the errors and corrections immaterial to the periods affected. Corrections included payroll, warranty, work-in-process inventory and deferred-tax items.
- Product liability claims and other litigation were disclosed. Management did not expect litigation to materially affect results, financial position or cash flows; certain product claims were described as insured or immaterial.
- Warranty costs depend on failure rates and repair costs; management considered the reserve adequate but acknowledged actual costs could differ materially from estimates. The quarter’s warranty expense was $371,000, versus $881,000 a year earlier.
- The company disclosed approximately $1.9 million of unrecognized tax benefits, with possible changes as audits proceed, and a full valuation allowance on deferred tax assets in a foreign jurisdiction with recent operating losses.
- Key exposures include foreign exchange, interest rates and steel and aluminum prices. The company did not hedge translation exposure or commodity prices; no forward exchange contracts were outstanding at quarter-end. Management reported no material changes to previously disclosed risk factors.
Important facts for investors to verify
- Whether the declining backlog—especially in North American pressure pumping and marine markets—translates into further sales or utilization pressure.
- Whether improved gross margin and lower operating expenses are sustainable if sales remain weak, and how much reported earnings benefited from the $69,000 out-of-period correction.
- Whether inventory levels remain appropriate relative to backlog and demand, and whether warranty claims support management’s reserve estimates.
- Whether the company maintains covenant compliance and liquidity if EBITDA declines; also consider the overseas location and potential repatriation costs of much of its cash.
- Progress on the Belgian restructuring, the contemplated exit from the Italian distribution agreement, pension funding, and resolution of tax audits and litigation.