Twin Disc, Inc. — Fiscal 2014 Second-Quarter 10-Q
Reporting period: Quarter and six months ended December 27, 2013. Figures are unaudited; dollar amounts are in millions unless stated otherwise. Twin Disc manufactures and sells marine and heavy-duty off-highway power transmission equipment through manufacturing and distribution segments.
Financial performance
| Metric | Q2 FY2014 | Q2 FY2013 | Six months FY2014 | Six months FY2013 |
|---|---|---|---|---|
| Net sales | $63.2 | $72.3 | $129.6 | $141.1 |
| Gross profit | $18.5 | $22.3 | $39.2 | $41.7 |
| Gross margin | 29.3% | 30.8% | 30.2% | 29.6% |
| Operating earnings | $1.4 | $5.5 | $5.4 | $8.3 |
| Net earnings attributable to Twin Disc | $0.5 | $3.4 | $1.8 | $4.6 |
| Diluted EPS | $0.05 | $0.29 | $0.16 | $0.40 |
- Q2 operating margin was 2.1%, versus 7.7% a year earlier; six-month operating margin was 4.2%, versus 5.9%.
- Six-month operating cash flow was $19.6 million, compared with $12.1 million. Capital expenditures were $3.0 million; the company-defined free cash flow was $16.6 million.
- Cash at December 27 was $27.1 million. Total debt was $21.1 million, yielding reported net cash of approximately $6.1 million. Cash increased $6.4 million from June 30.
- Net working capital was $123.4 million, down $1.6 million from June 30. Current assets were $181.1 million and current liabilities $57.7 million.
- Total equity was $145.9 million. The quarterly and six-month dividend was $0.09 and $0.18 per share, respectively.
Changes and operating drivers
- Q2 sales fell 12.6% year over year; six-month sales fell 8.1%. Management attributed the declines mainly to weaker North American and European demand, including pressure-pumping transmissions and marine products. Foreign currency translation reduced revenue by about $1.0 million in Q2 and $1.9 million for the half, before eliminations.
- Q2 gross margin declined 150 basis points, primarily because of lower volume; improved product mix and lower warranty expense partly offset the impact. Six-month gross margin rose 60 basis points, with mix and lower warranty costs partly offsetting the adverse volume effect.
- Manufacturing segment sales fell 14.8% in Q2 and 11.9% for the half. Distribution sales declined just over 9% and nearly 5%, respectively. Asia-Pacific demand was comparatively strong; Singapore distribution sales rose more than 7% for the first half.
- Six-month marketing, engineering and administrative expenses declined $0.7 million, but rose as a share of sales to 25.2% from 23.7%. Q2 expense increased $0.4 million and reached 27.2% of sales.
- Six-month backlog for shipment over the next six months was $56.2 million, versus $66.8 million at June 30, 2013 and $68.2 million a year earlier. Management said commercial marine transmission orders strengthened in Q2 and backlog for that product increased, despite the overall decline.
Liquidity, outlook, risks and unusual items
- Debt declined $6.1 million in the first half, primarily reflecting operating cash generation. The company had $29.75 million available on its $40 million BMO revolver and a separate $15 million Wells Fargo facility with no borrowings. It was in compliance with debt covenants; funded debt to trailing four-quarter EBITDA was 1.15, against a maximum of 3.0.
- Management expected sufficient operating cash flow for operating and investing needs and did not expect covenant violations in fiscal 2014, while cautioning that results depend on uncertain markets. Planned FY2014 capital spending was $10–$15 million; pension contributions were estimated at $2.6 million, of which $1.3 million had been made by quarter-end.
- No specific revenue or earnings forecast was provided. Management cited depressed North American oil-and-gas demand, weak mega-yacht markets, European softness and foreign-exchange exposure. It also noted the potential for currency, commodity-price and floating-rate debt risks.
- The first half included a $1.094 million Belgian workforce-restructuring charge; $0.788 million was paid, leaving a $0.900 million accrual. A brief Belgian facility strike in Q1 also affected shipments.
- First-quarter FY2014 results included out-of-period corrections for prior-year closing errors: earnings before tax increased $0.437 million and earnings attributable to Twin Disc increased $0.069 million after tax. Management deemed the errors and correction immaterial to prior periods and the current six-month results.
- The six-month effective tax rate was 62.1%, versus 38.3%, reflecting valuation allowances and other tax effects. Management estimated the rate excluding specified nondeductible foreign losses at 37.0%, versus 33.1%.
- The company continued negotiations to exit its Italian distribution agreement and sell inventory back to the supplier. Litigation outcomes were not determinable, but management did not expect material effects; product-liability claims were described as insured or not material. The filing reported no material change to previously disclosed risk factors.
Important facts for investors to verify
- Whether commercial marine order strength converts into shipments and offsets continued weakness in North American oil-and-gas and European markets.
- Whether overall backlog continues to decline and how inventory compares with demand; inventory was 183% of six-month backlog at December 27.
- Whether margins and earnings recover from lower volume, elevated overhead as a percentage of sales, and the unusually high reported tax rate.
- Progress and financial consequences of the Belgian restructuring and the proposed exit from the Italian distribution arrangement.
- Future cash generation, planned capital spending and pension contributions, covenant headroom, and the availability and tax implications of overseas cash.
- Resolution of tax audits and approximately $1.9 million of unrecognized tax benefits, plus developments in litigation and warranty obligations.