Twin Disc, Inc. — Form 10-Q Summary
Reporting period: Fiscal second quarter and first half ended December 28, 2018; comparisons are with the periods ended December 29, 2017. Financial amounts below are in millions of dollars unless stated otherwise. The quarter includes Veth Propulsion results from its July 2, 2018 acquisition.
Financial performance
| Metric | Q2 FY2019 | Q2 FY2018 | First half FY2019 | First half FY2018 |
|---|---|---|---|---|
| Net sales | $78.1 | $56.5 | $152.8 | $101.6 |
| Gross profit | $26.1 | $18.2 | $50.1 | $32.2 |
| Gross margin | 33.4% | 32.2% | 32.8% | 31.7% |
| Operating income | $6.7 | $2.3 | $11.6 | $1.7 |
| Net income (loss) attributable to Twin Disc | $4.1 | $(4.1) | $6.9 | $(0.7) |
| Diluted EPS | $0.31 | $(0.36) | $0.56 | $(0.06) |
For the quarter, sales rose 38.1%; management attributed $14.1 million of the $21.6 million increase to Veth. First-half sales increased 50.4%, including $27.4 million from Veth. Management cited improving North American oil-and-gas demand, stronger industrial sales, and improving commercial marine demand. Foreign currency translation reduced sales by approximately $0.9 million in the quarter and $1.4 million in the first half.
Gross margin improved year over year, supported by volume and mix. Q2 margin included a 129-basis-point adverse effect from $1.0 million of acquired-inventory fair-value step-up amortization. ME&A expenses increased in dollars but declined as a share of sales: 24.2% versus 26.7% in Q2 and 24.8% versus 28.0% for the first half. Restructuring expense was $0.4 million in Q2 and $0.6 million year to date, below prior-year levels.
First-half operating cash flow was negative $3.8 million, versus positive $3.8 million in the prior-year period. The $21.5 million net change in operating assets and liabilities was the main cash use. Investing cash flow was negative $66.4 million, including $59.7 million for Veth net of cash acquired and $6.7 million in fixed-asset purchases. Financing cash flow was positive $73.3 million, including stock offering proceeds and borrowings. Cash ended at $18.5 million, up $3.4 million from June 30, 2018. First-half free cash flow, defined by the company as operating cash flow less fixed-asset purchases, was negative $10.5 million.
Balance sheet, debt, and liquidity
At December 28, 2018, cash was $18.5 million, current assets $212.3 million, current liabilities $77.4 million, and net working capital $134.9 million. The current ratio was 2.7, compared with 2.6 at June 30, 2018. Inventory increased to $130.2 million from $84.0 million, reflecting the acquisition and higher production needs, particularly for North American oil-and-gas demand. Six-month shipment backlog was $137.8 million, versus $115.0 million at June 30, 2018 and $85.1 million a year earlier; inventory equaled 95% of backlog, up from 73% at fiscal year-end.
Long-term debt rose to $46.7 million from $4.8 million at June 30, 2018. The company reported $35.8 million of revolver borrowings and $10.8 million on the term loan, with approximately $14.2 million of available borrowing capacity under its $50 million revolver. Net debt was $28.1 million. Debt is secured by substantially all personal property and specified subsidiary equity interests. The company states it expects available cash, credit facilities, and potential debt-market access to meet foreseeable capital requirements.
Total assets were $350.8 million and total equity was $181.8 million. Goodwill was $27.8 million and net intangible assets were $22.4 million, primarily reflecting Veth. The company completed a public offering of 1.533 million shares at $22.50 per share, receiving $32.2 million net; proceeds were applied to repay term and revolving debt.
Acquisition, outlook, and risks
Twin Disc paid approximately $60.7 million in cash for all of Veth Propulsion, a Netherlands-based marine propulsion manufacturer. Preliminary acquisition accounting records $25.7 million of goodwill and $22.0 million of intangible assets. The valuation and purchase-price adjustments remain subject to review and could change materially, affecting goodwill and future depreciation and amortization. A contingent earn-out has a preliminary fair value of $2.9 million and a maximum of approximately $3.8 million, subject to Veth’s results and determination in April 2019.
Management expects fiscal 2019 capital expenditures of approximately $14–$16 million and pension contributions of approximately $2.4 million; $1.4 million had been contributed by December 28. No specific revenue or earnings forecast is provided. Management cited continued cost management, investment in facilities and products, and an expectation that operating cash generation and credit facilities will support operating and investing needs.
Risks and unusual items include floating-rate debt exposure, foreign-currency movements, steel and aluminum price changes, warranty-estimate uncertainty, and the possibility that final Veth purchase accounting will change. Approximately 33% of quarterly revenue was denominated in currencies other than the U.S. dollar; the company had no outstanding forward exchange contracts at quarter-end and does not hedge translation exposure. A 10% change in applicable interest rates would change annual pretax interest expense by approximately $124,000. Litigation outcomes were not determinable, but management did not expect material effects; product-liability claims were described as insured or immaterial. The company reported no material changes to previously disclosed risk factors and no material changes to internal financial controls during the quarter.
Prior-year comparisons are affected by significant tax items: the first half of FY2018 included a $3.8 million valuation-allowance release and noncash tax charges associated with U.S. tax reform and a Belgian tax-rate change. The first-half effective tax rate was 25.1% in FY2019 versus 204.0% in FY2018.
Key facts for investors to verify
- Final Veth purchase price, working-capital adjustment, earn-out outcome, and valuation of acquired assets and liabilities.
- Whether backlog converts to shipments and cash as expected, and how inventory growth and the 95% inventory-to-backlog ratio develop.
- Operating cash flow, free cash flow, debt reduction, and available revolver capacity in coming periods.
- Veth’s contribution to sales and profitability after inventory step-up amortization, transaction costs, and acquired-asset amortization.
- Delivery of the $14–$16 million capital-spending plan and expected $2.4 million pension contribution, alongside demand, currency, and input-cost risks.