Twin Disc, Incorporated Q1 FY2026 earnings call

• Began the year with strong momentum, delivering profitable growth and progress on strategic priorities. Sales and margins improved y-o-y. • Defense momentum strong, with defense-related backlog up 45% y-o-y and comprising 15% of total backlog. • Marine and propulsion business performed exceptionally well, with sales up 14.6% y-o-y. • Land-based transmission sales stable, with ARFF demand strong and e-frac solutions securing an order. • Industrial business grew 13.2% y-o-y supported by acquisitions. • Focus on cost discipline and operational efficiencies to support margin expansion.

Marine and propulsion: Sales increased 14.6% year-over-year to $48.2 million, driven by work boat activity, government programs, and Veth Elite thrusters. Record new unit bookings and demand for hybrid/autonomous vessel solutions. Aftermarket resilient. Land-based transmission: Sales up 1.6% year-over-year to $17.6 million. Oil and gas shipments nearly flat, ARFF demand strong, e-frac solutions secured an initial order. Industrial: Grew 13.2% year-over-year with growth supported by acquisitions and broad-based customer activity.

• Tariff impact on second quarter cost of sales expected to be 1%-3% (previously ~1%), temporary and returning to ~1% in H2. • Target 11% EBITDA this year, aiming for 15% EBITDA margin level with additional volume and margin improvements. • Target 60% free cash flow as a percent of EBITDA.

• Potential tariff developments, with a 1%-3% impact on second quarter cost of sales mentioned.

Q: Congratulations on the results, strong quarter. Let's start off with military just because you really called that out, and I appreciate the detail behind the strength and kind of how that is evolving. Can you just help us with the timing of shipment acceleration here as well as the expected margin impact?

A: Yes. It's John, David. I'll start with just the expected shipment. I would say in Finland for the NATO vehicles; it's really very much early in the beginning. I would expect that business for us, let's just say that we're in the 150-unit range right now that in a year from now, that will be double and then it will continue to grow from there. And then in the U.S., primarily the one that's driving it are the autonomous vessels. And I think whatever volume we have this year, again, will be double in '27. So, it's -- and continuing from there. So, I don't want to say it's the 2 main programs are going to be doubling every year, but that's kind of the pace that we're on is that we can expect high, I would say, on average, at least for the next couple of years, 50% growth in each program.

Q: And do you have sort of the capacity to support that kind of a ramp right now? Or would that require a pickup in incremental CapEx spending?

A: It would -- let's just say it reevaluate our CapEx spend -- excuse me, CapEx spending. We certainly have the capability here in the U.S. to meet the demand for the U.S. Navy, shuffling some stuff around. And we're working on the plans. We certainly -- I would say we have -- and in Europe, we're probably good with everything the way it is for the next 18 to 24 months. But yes, we're looking at what we do in the facilities in Europe so that we can capture that demand and maybe do some of that volume in one of our other facilities in Europe and not just all in Finland. But the answer is yes. And the CapEx, it's more focusing on test stands and assembly fixtures. So thankfully, it's not necessarily machining capabilities, longer lead time pieces of equipment. It's more on assembly and test fixtures.

Q: I wanted to ask you about land-based transmissions because the double-digit growth in marine and propulsion and industrial, but relatively flat in the land-based transmissions. Can you just talk about the puts and takes within that business that led to the relatively flat top line?

A: Yes. I would say it's -- again, it's steady. I would say it's fairly steady. In ARFF, the demand, we're full. Our customers are kind of at their capacity. That's been full year-over-year. And really, the puts and takes have been small projects with different outside of ARFF, some are falling in like railway maintenance things. We're folding in some of the products at Katsa, fall into the transmission business. And oil and gas has been -- I would say some of the -- like we've traded some unit volume in China for unit volume in North America. So, Jeff, I don't know if you have any more.

Q: I want to ask about gross margins. We normally see kind of seasonal pressures with European shutdowns. And can you bridge the first quarter gross margins of 28.7%, you were up 220 basis points, I think. Maybe separate seasonal versus kind of the incremental volume versus the margin improvement initiatives that you referenced, Jeff? And also, I guess the investments were a factor and maybe the mix of businesses as well, I guess, because you talked about the strength in call. So just help me kind of proportion-wise, how I should think about those various factors.

A: Yes. So, I think the good news for us, and we've talked about this on previous calls that the Veth business wasn't delivering the kind of margin that we were expecting. And there were some definite drags on the margin coming out of that. The thruster business, right? So, coming out of COVID, they were carrying a backlog that had pretty low margins in it, very competitive project bidding during COVID, where there wasn't a lot of activity. And we worked through that over the course of the few years coming out of COVID and really focused them on driving profitability, operational discipline, et cetera, pricing. And so, they delivered their best margin quarter since we've acquired them. So, it was really 2 things. It was the incremental volume at kind of our normal incremental drop-through. So, we look at around 40% drop-through on incremental volume on a global basis. And then incremental to that, driving the -- probably about another $1.2 million of favorable margin was Veth delivering better margin results than they had in prior years.

Q: And so how much of that 220 basis points do you think is sustainable going forward, John?

A: Yes. I mean if we can -- it's same mix, I think we can do that on a trend line. And as I mentioned in the call, one of the tough things that we're dealing with in this quarter, and thankfully, we've gotten some relief is our first shipments in the Trump 232 tariffs of 50%. We got in containers of marine transmissions from Europe and from Japan, and those were tariffed at 50% after feverish activity and explaining to Department of Commerce and anybody else and our codes, thankfully, those have come down to 15%. So, we're going to have to deal with that like in the second -- that happened in the first month of the second quarter. But I think once we can get through the initial negotiation of tariffs with customers, I think the trend line, I think we can sustain that. I think the second quarter right now, given the massive jump in tariffs that were impacted, passing it on. I'd be happy to maintain that in the second quarter for sure. But the trend line going forward, the team and the mix and what they've done, it's all very positive. And our flexibility of being able to move product and assemble and test in different regions is definitely a competitive advantage for us.

Q: Last question for me is really on free cash flow for this year. And you talked about your plans for inventory, and you made a couple of comments around CapEx. But how are you thinking about kind of conversion, either EBITDA conversion or net income conversion, however you want to look at it?

A: Sorry, I'll answer the question I think you're asking, David, and maybe you can clarify. So, I think the way we look at profitability as we drive growth is delivering our sort of benchmark is 40%, like I said. We expect as volume grows; we're delivering 40%. Right now, we're tracking -- our target is to get double-digit EBITDA. So, say, 11% EBITDA would be, I think, a target for us this year, some improvement from where we've been. But as we grow, I think what we have in our minds is to get to that 15% EBITDA margin level. And that's going to take additional volume and additional margin improvements as we delivered this quarter. So, I think we're on a good trend to get to some of those targets.

Q: Right. And so, can you help us at all in terms of the free cash flow model for this year in terms of what that might ultimately look like?

A: Yes. So free cash flow is -- yes, certainly, it was a difficult Q1 for a variety of reasons. We have a typical step back in Q1 with some payouts that naturally follow our Q4. We had some inventory growth with the demand, the increase in backlog, maybe some prebuys with the anticipation of tariffs. So difficult Q1, but we still -- we're targeting 60% free cash flow as a percent of EBITDA. That's our target. That's our goal. I think that's still deliverable. We would hope to get close to breakeven and recover that Q1 in Q2. So, we're focused on managing that incoming inventory in light of the growing demand. I think what we don't want to do is in any way, hamper our ability to grow and disappoint customers, let's say, as we're delivering this volume growth we have in front of us. So yes, that was sort of the drag on Q1.