Greetings, and welcome to Twin Disc, Incorporated fiscal first quarter 2023 earnings conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Andrew Berger, in Investor Relations. Thank you. You may begin.
Thanks, Latonya. On behalf of the management team of Twin Disc, we are extremely pleased that you have taken the time to participate in our call, and thank you for joining us to discuss the company's fiscal 2023 first quarter financial results and business outlook. Before introducing management, I would like to remind everyone that certain statements made during this conference call, especially those that state management's intentions, hopes, beliefs, expectations, or predictions for the future are forward-looking statements. It is important to remember that the company's actual results could differ materially from those projected in such forward-looking statements. Information concerning factors that could cause actual results to differ materially from those in the forward-looking statements are contained in the company's annual report on Form 10-K, copies of which may be obtained by contacting either the company or the SEC.
By now, you should have received the news release, which was issued this morning before the market opened. If you have not received a copy, please call our office at (262) 638-4000, and we will send a copy to you. Hosting the call today are John Batten, Twin Disc's Chief Executive Officer, and Jeff Knutson, the company's Vice President of Finance, Chief Financial Officer, Treasurer, and Secretary. At this time, I'll turn the call over to John Batten. John, go ahead.
Thank you, Andy, and good morning, everyone. Welcome to our fiscal 2023 first quarter conference call. As usual, we begin with a short summary statement, and then we'll be happy to take your questions. As much as went right in the fiscal 2022 fourth quarter, we'd hoped that more of that momentum would carry over into the first quarter of this year. Our global operations team did as much as they could with the supply chain getting out as much as we did. We faced several shortages and delays in the quarter, whether it was chips, wiring harnesses, gears, forgings, castings, and we faced a new challenge with heat treat capacity. Reshoring to North America is very real and causing considerable delays due to capacity constraints and continued elevated pricing, even with scrap falling for 6 months.
The European supply chain continued to have its own struggles with high utility costs, significant cost of living increases on wages and salaries, and a shortage of labor in general. It's disappointing not to have a much higher revenue line in the quarter because the demand was there and continues to be there. In our European operations, we are gonna address the cost structure in very short order based on the inflation we are seeing continuing to rise and our delayed ability to capture that in real-time pricing. While European governments can raise salaries effective immediately, manufacturers have to honor price at the time of quote. Additionally, those cost of living increases were much higher than anyone had expected, that we saw issued this summer and fall.
At this revenue level in the quarter, we would have expected to see gross margins at least 300-400 basis points higher, and we will focus on making that a reality in the second and third quarter going forward. Part of the expectation of lower margins can be explained by the Veth Propulsion products we quoted over 12-18 months ago before the rapid inflation of 2021 and 2022. Those shipped late in the fourth quarter and into the fiscal first quarter. While we were able to mitigate some of the margin erosion due to inflation, we could not recapture all of it. Margins on projects going forward are better, and they will continue to get better as the fiscal year progresses. The issue that we're also facing with the
Just on shipments in general, we are facing with these larger propulsion projects in Europe, continues to be the shipyards challenge with supply chain, whether that's diesel engines, electric motors, and hulls and other prefab components that are built in China and shipped to Europe. Veth's backlog has never been higher since the acquisition in 2018, and we are very confident that we will see margin improvement and revenue improvement throughout the year. We continue to see strong demand in Asia for oil and gas. We see improving demand in our global marine markets, steady industrial demand in both Europe and North America, and growing demand in our domestic oil and gas markets. In the quarter, we received more new unit orders for the domestic pressure pumping fleet and parts demand continues at a very high level.
We have orders for both the 7600 and 8500 transmissions built in Racine, and the team here has a huge backlog in front of them and is doing everything they can to deal with suppliers, internal capacity, and other delays to meet this demand. In Lufkin, our team did a great job managing supply chain issues from India and is operating very efficiently, and, our hydraulic PTOs have moved into production as we speak and should be shipping this quarter and into, you know, the remaining quarters of the fiscal year. Last quarter, we mentioned the hybrid application with Hinckley Yachts. That vessel and technology is being very well-received at the fall boat shows, and we are working with many more customers in marine projects in the hybrid electric space and several other types of markets.
The next few quarters will be very exciting on projects that are coming to fruition. Just in the past few weeks, our distributor, Stewart & Stevenson, and their partner, Grizzly, released an E-Frac solution that uses our 7600 frac transmission. The reception has been very positive. It was just at the hybrid show down in Texas. We see lots of opportunity here on new unit construction and also the possibility of refits in the older Tier 2 applications. The number of hybrid and electrification projects continues to grow, and that growth will be constrained by the supply chain as well. Motors, inverters, all have their challenges. Nothing is straightforward at the moment, but we are bullishly optimistic in our hybrid and electric future. Now I'll turn it over to Jeff to talk about the financials.
Thanks, John, and good morning, everyone. I'll briefly run through the fiscal 2023 first quarter results. Sales of just under $56 million for the quarter were up $8.2 million or 17% from the prior year first quarter. The sales increase reflects the improved demand in the company's global oil and gas, industrial, and marine markets. Shipments in the quarter were somewhat limited by ongoing supply chain constraints mentioned in previous quarters. Electronic components remain the most challenging area to find reliable and predictable supply. With help from improving North American demand for pressure pumping equipment compared to the prior year first quarter, our transmission product sales improved by 30%. Sales of industrial products increased by 15%, while marine and propulsion product sales grew by 10%.
By region, sales into North America were up 33%, Asia Pacific up 8%, while sales into Europe were up just 2%. The strengthening of the U.S. dollar has begun to impact our competitiveness when selling U.S. produced goods into the European market. Foreign currency exchange was a net - $4.8 million impact to sales in the quarter. On a constant currency basis, first quarter sales increased 27.2% from the prior year. The first quarter margin percent was 23.8% compared to 28.2% in the prior year first quarter. The prior year result included several one-off benefits, including a domestic ERC credit, a Dutch COVID subsidy, and a favorable adjustment to the warranty reserve. Adjusting for these non-recurring items, the prior year gross profit would have been 22.9%.
The small increase in the current year is a function of improved volume and a favorable product mix, partially offset by the negative impact of inflation, primarily at our European operations. Spending on marketing, engineering, and administrative costs for the fiscal 2023 first quarter increased $2 million or 15.2% compared to fiscal 2022. The increase in the quarter is primarily due to the impact of prior year COVID subsidies in the U.S. and the Netherlands totaling $800,000, along with inflationary impacts and a return to more normal spending activities in areas such as marketing, travel, salaries, professional fees, and the global bonus program. Those items totaling $2.1 million. These increases were partially offset by a foreign currency translation impact of $900,000.
As a percent of revenue for the first quarter, M&A expenses were 23.8% compared to 28.2% in the prior year first quarter. During the prior year first quarter, we recorded a $2.9 million non-operating gain related to the sale and leaseback of our Swiss facility. The effective tax rate for the first quarter of fiscal 2023 was 26.3% compared to 16.2% in the prior year first quarter, with a mix of foreign earnings by jurisdiction driving the increase in the effective tax rate. The net loss for the quarter of $2 million or $0.15 per diluted share compares to a net profit of $2 million or $0.14 per diluted share for the fiscal 2022 first quarter.
EBITDA was breakeven for the quarter, down $5.4 million compared to the prior year, driven by the prior year COVID subsidies and the gain on the sale of the Swiss facility in the prior year. Turning to the balance sheet, inventory was up $1 million for the quarter, impacted by a significant currency driven decline of $4.5 million. The significant increase excluding the translation impact is a result of supply chain imbalances, customer delayed shipments, and the timing of shipments through our distribution operations. We anticipate significant improvement in our second fiscal quarter as we continue to focus on and refine inventory planning and sourcing strategies that will drive progress. With the increase in inventory and lower operating results, operating cash was slightly negative for the quarter.
Capital spending at $2.2 million for the quarter was focused on the modernization of our machine tools. We expect a similar quarterly run rate in capital spending for the remainder of the year, totaling between $10 million-$12 million for the year. Now I'll turn it back to John for some final comments.
Thanks, Jeff. I'll spend a quick moment on our outlook. Despite our first quarter results, we still feel very good about fiscal 2023. Like last year, we think the quarters will build through the year. We will have to address some local cost structures due to local conditions, whether that's inflation we can't pass on, supply challenges, et cetera. In general, our markets are much more optimistic than they were a year ago, and we are too. The challenges that manufacturers are facing are coming in waves, and we will continue to deal with them. As Jeff mentioned, the additional challenge right now in the past few months has been the strengthening of the U.S. dollar.
While it helps our European operations selling into North American markets, it is a concern going forward on our U.S.-based propulsion products, primarily marine transmissions, which are sold into Europe. That concludes our prepared remarks. Now Jeff and I'll be happy to take your questions. Latonya, please open the line for questions.
Thank you. We will now conduct a question and answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Once again, that's star one at this time. One moment while we poll for our first question. Our first question comes from Noah Kaye with Oppenheimer. Please proceed.
Thanks for taking the questions. John, I think you mentioned kind of margin expectations, 300-400 basis points.
Yep.
Higher than actual results, just really reflecting kind of the lag on, you know, price costs. So just help us understand-
Yep.
As you look at the backlog today, how does that look for subsequent quarters? Think about 2 Q, 3 Q.
Yeah.
you know, what does that 300-400 basis points drag look like as we look in the next couple quarters?
Well, I'm gonna let Jeff help me there too, but no, I can just tell you on the trend, it looks better going forward. You know, what's our backlog if we look at it today going out the next three quarters, looks better than it did at the end of the fourth quarter. You know, we knew that the Veth projects were at a lower margin than the inflation. But just in general, I mean, if you go back, our first quarter is always our most challenging one, just with shutdowns in Europe, you know, longer shutdowns in Europe, but we have shutdowns in North America. But Europe, I would just say Europe in general was incredibly inefficient. I'm not just talking about our operations. Europe in general in the first quarter was incredibly inefficient. We had cost of living increases.
For instance, Belgium is usually, you know, 1%-2%. We thought that given the extraordinary inflation times, that would be 2%-maybe 4%, and they always have it delayed a quarter. They did 8.5% effective immediately. That was one of our European operations. We didn't anticipate that and the effect on the whole quarter. The Dutch cost of living increase was also higher than expected, but you know, in general, we need to. You know, the revenue levels in Europe and all over continue to be lower than the demand is by 15%-20%, meaning that you know, there's 15%-20% that gets caught because we don't have all the parts.
Hmm.
We're taking a serious look at how long this is gonna continue, you know. We can be staffed in certain operations when the revenue is gonna be significantly lower based on supply chain. That's what we're working through right now. The frustrating part again is the demand is there. I mean, we're optimistic. We have lots of projects. Our sales team, particularly with Veth around the world, is doing a great job converting projects into orders, and our backlog has never been. I would say it's the highest percentage of projects outside of Northern Europe. You know, one of the strategic objectives was to grow the business outside of their home market. Now we're doing that. We just have to get all the parts and be able to ship them.
you know, if you forget looking at the details of the quarter, where we are right now is significantly better than where we were a year ago. you know, just, you know, kind of the frustrating thing is a year ago, we had to deal with the rapid inflation and pricing, and we did, and everything improved through the year, through the quarters. you know, in very many ways, we're faced with some of those same challenges again this year. again, looking at our backlog, and again, not just our backlog that we reported the six months, just a lot of what we have is beyond the six months. you know, we're optimistic that things will improve during the quarter, throughout the year.
You know, I'm much happier this year than I was 12 months ago.
Okay. That's helpful. I guess just listening to that answer, you know, there are a lot of companies in various industries that really had to change how they price, right? 'Cause we've been living-
Yep.
in some extraordinarily challenging times with respect to, you know, wrangling the inflation bear. Talk to us about how you price and how that may change. You mentioned cost of living index.
Yeah.
You know, how do you price projects now and what are you changing and do you think that allows you to?
So it-
Kind of better manage inflation going forward?
It does. Besides the sheer frequency of our price increases, which I've never seen anything like it, meaning, you know, price increases every quarter. Historically from North America, we had been priced at the time of shipment. That was very difficult to. We were able to do it. We also did surcharge last year. I'm not saying we'll never go back to a surcharge, but we are much more now pricing, you know, at the time of the order, we're giving you a price. The price may change next month, meaning you order model XYZ, the price is $100 today if you order it, but in two months it might be more. We are pricing at the time of shipment primarily because we can't in Europe.
It is almost impossible to do price at the time of shipment. It's price at the time of order. You know, you go back two years, we did annual price increases. What's changed now is we're gonna do them much more, I mean, much more frequently and look at every order. We're hopeful. I do think a lot of the inflation has stabilized. We're at a much higher level. We don't see a lot of the material costs going up, but they're not, as I mentioned, coming down. Even with six months of scrap prices falling, we're not seeing price decreases necessarily from our suppliers.
Hmm.
We feel better about the stability of some of it, but it's they're not coming down. To answer your question, it's we're looking almost at everything as a case by case basis. When we quote, are we confident in that we have the margin at that time? If it changes when someone wants to buy it a month from now, the price may be different.
Okay. If I could sneak one more in. You know, I don't wanna steal thunder from future project announcements, but you did mention that you've got some exciting projects in the hybrid and electric space.
Yeah.
You know, apart from Hinckley, can you just give us an idea of what sort of applications or, you know, or vertical?
It could be more workboat commercial related, things like that.
Mm-hmm.
Hinckley was definitely a huge splash with one of the premier builders in the pleasure craft market. I mean, there are more projects there, a little bit longer term, farther off. You know, there's a lot more. I'd say small. Not smaller, but you know, one, two, five, 10 vessels coming up, whether it could be a ferry, it could be a taxi system, it could be things like that. The commercial space is very, very, very active. Everyone is positioning to find a more fuel efficient green solution and, you know, with a vessel that they're using as a revenue generating business. We're very optimistic. You know, again, though, it's everything's based on you know, getting all the components there.
Electric motor lead times have been pushed way out. That's one of the things that we're dealing with right now, in trying to get some more announcements. A lot of what we work on, whether it's on land in an industrial construction type of equipment or vessel, we do the application, they get it, then they wanna test it and do it for 6-12 months, and then it'll be released. There'll be more coming through the year for sure that we can talk about.
Great. Well, appreciate all the color and thanks.
All right. Thanks, Noah.
Once again, ladies and gentlemen, to ask a question, please press star one on your telephone keypad. Our next question comes from Simon Wong with Gabelli Funds. Please proceed.
Hey, John and Jeff.
Hey, Simon.
Hey, Simon.
Hi. Just some quick questions on the oil and gas side. How much of your sales this quarter was in oil and gas?
It's always a good question, Simon. Let me do a quick calculation and why don't you jump on your next question, and I'll come back to you real quick.
Okay. My next question also relate to oil and gas. How much of the orders came in related to oil and gas? Because you had a really nice order quarter. Just wondering how much of that was due to the North American pressure pumping pumpers coming back.
I guess, Simon, I can tell you it's a big part. I don't have the numbers. I'm not in the same room with Jeff, but it's a combination. Well, new unit orders as far as units, but also parts continue at a high level. It was a pretty good quarter for oil and gas, North America.
No, are they related to the traditional, diesel fleet, or are we seeing the new order for the E-Frac?
The parts obviously are for the traditional diesel fleet.
Mm-hmm.
We do have. It's a small percentage right now, but I would say that each quarter that we go forward, units for the E-Frac fleet will get much higher. I can see a point in the next few quarters where you ask that question and we're at 15%, 25%, potentially 50%. That's not very far away.
Okay. All right. If a pressure pumper placed an order for a transmission today, what's the lead time for you guys?
We could get you an 8500 for the traditional fleet probably in, I would say, three months, two-three months. The reason I go to three months is 'cause we're dealing with, you know, November and December are shorter months with holidays. Yeah, no. If you ordered them today, we would have them early in the calendar first quarter of next year.
Okay. All right, great. Last question.
Yeah.
Uh, um-
Simon, one of the reasons I think we haven't seen that we potentially could have seen more is what's controlling the refit of the fleet continues to be lead times and availability of engines.
Mm-hmm.
What's happening is we see customers securing engines, and then we're getting orders, just enough transmissions to satisfy the number of engines that they have. You know, I think it'll as engine supply becomes more reliable and more available, then we'll see our orders go up.
Okay.
The flip side is when they don't have engines, we get more spare parts orders 'cause they rebuild. They're rebuilding.
Right. Okay, great. You mentioned something about hydrogen in your press release. Can you talk more about what you're doing there?
Which part, Simon?
You mentioned a couple.
It's a control system for hydrogen applications. In your press release, you have some. You see demand across global markets for hybrid, hydrogen and electric vehicle applications.
Oh, okay. I thought you said hydrogen. No. Yeah, with the Hinckley and with everything that we're working on, our controls group in engineering, they continue to refine our base hybrid controller. Using our controls logic, being able to control multiple inputs and multiple outputs. Every project that we do, we're getting better and better and better on our controls. I think of our controls technology and the product, that's the brains of the application and our mechanical products, whether it's a marine transmission, a frac transmission, an ARFF transmission, or one of our hydraulic PTOs, that's the heart. That's, you know, what's moving stuff, making things work.
Our controls group is doing an incredible job with our controls technology, creating a very adaptable and cost-effective control system that will work in all of our off-highway markets. You know, some of these production delays mean we can't, you know, it's giving them time, and then also, you know, giving them time to develop it, develop sources, multiple sources. They have done an incredible job in the last 12 months, getting us ready for this transition in all of our markets. They are a very real strength at our company.
Okay, great.
Hey, Simon, just going back to your first question. It was about 20% of the quarter was related to oil and gas market.
Yeah. Do you have a split between new equipment and consumables?
It's pretty balanced, actually. Pretty balanced.
Yeah.
Yeah, Simon, it's balanced right now. It goes back to what I just said. If there were more engines available-
Yeah.
It would tilt to more units, but the engines aren't available, so we're seeing a lot more rebuild activity.
Yes, I'm hearing, engine is a real constraint here.
Yeah.
Okay, great. Thank you, guys.
Yep.
Thanks, Simon.
Our next question comes from James Dowling with Jefferies. Please proceed.
Yeah, good morning, fellows.
Good morning.
Could you give us some color on the inventory breakdown between North America on the one hand and Europe and finished product versus work in progress and how that might skew by end market, energy and marine?
We've got a little over half of our inventory in what we would call saleable. Either a finished part that could be sold as it is or assembled into a new unit or fully assembled units. Say about 20% is work in process and the remainder 30%-ish is raw material. A big component of that inventory, I would say in terms of WIP and finished parts, is in the oil and gas market here in North America. That would be the biggest component. You know, in Europe it's primarily marine.
Europe is probably, I would say just, maybe 40% of our total inventory, 60% would be a little over 50% in the U.S. and the remainder in Asia-Pacific. In the U.S., like I said, it's industrial, it's marine, but the biggest component would be the oil and gas piece. That's what's allowing us, I guess, from John's earlier point, to be able to deliver a very large and complex transmission within potentially eight weeks.
One last inventory-related question. How much of your inventory has already been priced into a final product but can't be delivered because of other delays, and how much are still open where you can charge whatever the market will bear?
That's a good question. I don't think it's a huge percentage of our inventory that's locked in. I would say, and John, you maybe have a better feel. I would say it's more in the 10%-20% maybe range of inventory that's sort of committed to, you know, priced, fixed price orders. I'll admit that isn't something that I've thought through completely.
Yeah, it might be a little bit higher, but it's not the majority, Jim, that's for sure.
Thank you.
At this time, I'll return the call back over to Mr. John Batten for closing comments.
Thank you, Latonya, and thank you everyone for joining our conference call today. We appreciate your continuing interest in Twin Disc and hope that we've answered all of your questions. If not, please feel free to reach out to either Jeff or myself, and we'll get you an answer to your question as quickly as possible. We look forward to speaking with you again at the close of our fiscal 2023 second quarter. Now, Latonya, I'll turn the call back to you.
Thank you. This does conclude today's teleconference. You may disconnect your lines at this time, and thank you for your participation, and have a great day.