Good day, and welcome to the Twin Disc Fiscal Second Quarter 2020 Financial Results Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Stan Berger. Please go ahead, sir.

Thank you, Christine. On behalf of the management 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 2020 second quarter and six-month financial results and business outlook. Before I introduce 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. Additional 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 a copy of the news release which was issued this morning before the market opened. If you have not received a copy, please call Annette Mianecki at 262-638-4000 and she will send a copy to you. Hosting the call today are John Batten, Twin Disc Chief Executive Officer; and Jeff Knutson, the company's Vice President of Finance, Chief Financial Officer, Treasurer and Secretary. At this time, I will turn the call over to John.

Thank you, Stan, and good morning, everyone. Welcome to our fiscal 2020 second quarter conference call. As usual, we will begin with a short summary statement and then Jeff and I will be happy to take your questions. Before Jeff goes over the quarter results, I'll touch on some of the operational highlights from the quarter. As we mentioned in prior calls, we've been addressing cost issues on some of our marine and transmission models due to four supplier changes during the oil and gas run-up in fiscal 2018 and 2019. In order to meet demand on other products, we had to move supply to other vendors and not always at a lower cost. We made significant progress in the quarter in bringing out many new parts from new suppliers and actually had a few go into production. To date, we have identified over $1 million in savings for fiscal 2020 spread out over just three models, and we expect to continue to add to this as more components are approved. Assuming a static mix and volume going forward, an example, we expect margins to continue to improve over the next four to eight quarters, as we bring many new supply sources online. We've also begun to work with a key outside partner to help us identify and validate more suppliers in the Asia region. In the quarter, we also offered an early retirement package to our employees in our domestic operations, and we've reduced our domestic headcount by about 10% for about another $1.8 million in savings in the second half of the year. As demand in our market improved, some of this lost capacity will be added to our Lufkin facility as it comes online this summer. We continue to address other cost drivers on a global basis, such as nonessential overhead and to make the necessary adjustments. One bullet that probably stood out in the release was the partner's cancellation of a marine propulsion program. We wish the outcome were different, but it isn't the end of the story. This is an accounting moment in time and also the end of any charges or write-offs. This program may continue in another form. Now, I'll turn to a couple of our strategic objectives for a moment. The Veth acquisition continues to surpass expectations and to be the focal point for our diversification effort. Veth orders and active projects in Asia and North America continue to grow. One of our more recent applications, the Maid of the Mist at Niagara Falls, is an all-electric ferry boat that is getting a lot of attention and you should see more coming in the near future with the integrated L-drive from Veth Propulsion. The cross-pollinization between Veth and Twin Disc continues to drive our hybrid strategy in our other markets as we develop both component and system solutions as our market continues to evolve. In terms of capacity planning for the full cycle, including the ups in oil and gas, we told you that we have moved our North American aftermarket business to a stand-alone facility along the I-94 Corridor between Milwaukee and Chicago. That facility has been up and running since last summer, and we are running more efficiently in terms of man-hours per shipment than we were when we were in the factory. Vertical lift modules and a layout dedicated to parts are making the operation much more efficient. Currently, we are using the facility as a depot location for our marine transmissions coming in from our European operations. Our facility in Lufkin, Texas is nearing completion and we should take occupancy in our fiscal fourth quarter with the first shipments in the first quarter of fiscal 2021. We have begun a limited hiring program in Texas and identified key personnel from Racine who will move to help get the plant operational. Access to a growing talented North American labor force is critical for our growth objective. Shipments from the plant should grow throughout fiscal 2021 as we ramp up different models for production. Finally, at our main facility in Wisconsin, we've begun a new sales and operations planning program to retool our processes and how we run our business. With the downturn of 2015, recent retirements, and all of our new hires in the past two years, it is the perfect time to reset and to best utilize our new capital expenditure spending and freed up floor space. This is an 18- to 24-month journey that we kicked off earlier this month. With that, I'll turn it over to Jeff for some comments on the financials.

Thanks, John, and good morning, everyone. I'll briefly run through the fiscal 2020 second quarter numbers. Sales of $59.5 million for the quarter were flat with the previous quarter and down $18.6 million or just under 24% from the prior year second quarter. The quarter decline is primarily the result of a significant reduction in new build and aftermarket activity in the North American fracking market along with the softening in the global marine and industrial markets. The oil and gas decline accounted for $16.5 million in the second quarter reduction in sales and is the continuation of the slowdown we saw in the fourth quarter of fiscal 2019. Through the first half, sales are now down $34 million or 22.2% compared to the prior year with foreign currency exchange contributing $2.6 million to that decrease. Second quarter margin percent was 26.4% compared to 33.4% in the prior year second quarter. Our gross margin performance for the quarter was again severely impacted by a continuation of the unfavorable product mix, which began in the fiscal 2019 fourth quarter with lower fracking demand for new rig construction and reduced aftermarket demand being the primary drivers. Gross profit percent for the second quarter has improved over the first quarter of 16.3% in the fourth quarter of fiscal 2019, which was 22.7%. This improving trend is a result of targeted cost reduction actions on key products and an overall focus on cost containment and production efficiency. As we discussed in the year-end 2019 earnings call, we anticipated a continuation of this difficult sales mix and have been focusing on cost reduction and pricing actions to drive margin improvement. We expect to see a continuation of this positive trend through fiscal 2020. Spending on marketing, engineering, and administrative costs for fiscal 2020, second quarter decreased $2.5 million or just over 13% compared to fiscal 2019. The decrease is a result of reduced bonus marketing spending, stock-based compensation, and professional fees, along with the impact of the Mill Log sale which happened in the third fiscal quarter of last year. With the oil and gas market struggling over the past three quarters, we've aggressively pursued cost reduction opportunities to compensate for the decline in gross profit. A restructuring charge of $4.2 million was reported in the second quarter. This charge included $3.2 million related to the partner-driven termination of a marine propulsion program for which we had provided development and production services. This $3.2 million charge was comprised of $2.2 million in non-cash write-offs of assets and a $1 million cash accrual to settle the supplier commitments associated with the program. In addition, we recorded about $1 million in restructuring charges related to headcount reductions at our domestic and European operations. As John noted, those reductions will generate just over $1 million of savings in the second half and a little over $2 million on an annualized basis. With reduced second quarter volume, challenging product mix, and the significant restructuring charge we reported an operating loss of $5 million in the quarter compared to a $6.7 million operating profit in the fiscal 2019 second quarter. Through the first half, operating profit has declined by $23.4 million to a loss of $11.8 million compared to an operating profit of $11.6 million in the prior year. The fiscal 2020 first half includes the $4.4 million of restructuring charges and the $3.9 million product performance charge we recorded in the first quarter. The effective tax rate for the fiscal 2020 first half was just 4.2%, significantly lower than the prior year rate of 25.1%. The current year rate was significantly impacted by the GILTI provisions of the Tax Cuts and Jobs Act, which requires the inclusion of foreign income but prohibits certain foreign deductions and credits in a domestic loss position. The GILTI inclusion decreased the first half tax rate by 18.6%. The net loss for the second quarter of fiscal 2020 was $6.5 million or $0.49 per diluted share compared to a net profit of $4.1 million or $0.31 per diluted share in the prior year second quarter. Year-to-date, the net loss was $12.8 million or $0.98 per share compared to a net profit of $6.9 million or $0.56 per share in the fiscal 2019 first half. Negative EBITDA of $2 million for the quarter is down from a positive EBITDA of $9 million in the prior year second quarter. For the first half, EBITDA is now negative $6.6 million compared to $17.1 million positive EBITDA in the fiscal 2019 first half. This recent decline in EBITDA results in a slight increase in debt levels, and we're anticipating a likely issue in maintaining compliance with the debt-to-EBITDA covenant in our credit agreement. We began discussions with BMO during the quarter and were able to close the third amendment to the credit agreement on January 28. This amendment provides temporary covenant relief as we work through the current market challenges. Under this amendment, we finished the quarter with a debt-to-EBITDA ratio of 3.11, which was well within the revised covenant requirement of 4.0. Inventory was up $7.4 million in the quarter, as reduction efforts were hampered by the reduced volume and vendor commitments. $2.3 million of this increase was related to the termination of the propulsion program, as percentage of completion accounting resulted in a $2.3 million cumulative credit balance in the inventory at the time the program was canceled. With no inventory improvement and significant capital spending, free cash flow was negative $4.2 million in the quarter driving a $3 million increase in debt. Six-month backlog finished the quarter at $94.7 million, which is down just slightly from the $100 million at the end of fiscal 2019. Operating cash flow was slightly positive for the first half, $3.9 million better than the prior year first half despite significantly reduced earnings and an increase in inventory. Capital expenditure levels remained relatively high as we execute on some key investments in machinery and equipment. We expect to spend between $11 million and $13 million this year as we invest in modern machining and quality technology to drive productivity and cost improvement. And now, I'll turn it back to John for some final comments.

Sure. Thanks, Jeff. I'll now spend a quick moment on the outlook. The second half of fiscal 2020 still faces some of the same domestic oil and gas challenges of the first half. We are seeing aftermarket signals of life across a broad range of markets including oil and gas. We are seeing increased rebuild activity and hope that this continues throughout the remainder of the fiscal year. A disappointment in the second quarter was the rapid drop in industrial demand. Speaking with suppliers, this happened across the market; early starts in January are positive backed up by increased aftermarket orders. We have the backlog to make our third quarter a better quarter in terms of revenue and margins, provided the recent coronavirus outbreak doesn't dramatically affect our customers in Asia. The fourth quarter should also see that improvement trend continue. We don't see any domestic new unit demand in oil and gas until this summer. That concludes my prepared remarks. And now Jeff and I will be happy to take your questions. Christina, could you please open the line for questions?

Yes. Thank you. [Operator Instructions] And we'll take our first question from Noah Kaye with Oppenheimer.

Thanks, and good morning. So stripping out year-over-year restructuring, it looks like EBITDA decrementals got back to what we consider normal levels, and you improved the gross margin. Sequentially clearly, you mentioned some of the actions to take out costs. I'm just trying to understand how your further cost reduction efforts vis-à-vis your commentary around potential improvement in the back half in activity? Which levers are you going to continue pressing on? Are any costs likely to come back with the improvement that you foresee in some markets? Just kind of help us get through how you're kind of balancing those factors that you mentioned for the rest of this.

Sure. So Noah, it's John. We've got two parts -- well, three parts. We're going to continue the material variable cost coming in, finding new suppliers. The second one is operational improvements in our domestic operations, getting industrial out and down to Texas, reorganizing the plant here, being more efficient with our processes. But then there's still a component outside of North America that I would say is fixed cost rationalization, and we're actively working on all three of those.

Okay. That's helpful. And then to be clear, you said it at the end of your prepared remarks, you're not expecting North America oil and gas transmission, certainly not the OE market, to come back anytime soon, correct?

I think we could see some orders in this fiscal year, but my gut tells me there won't be any shipments this fiscal year -- there won't be any significant shipments this fiscal year. But they're putting it into use.

Okay. Right. If I could ask on the termination of that marine propulsion program, can you just give us essentially a little bit of color on that? Was that a legacy Twin program? Was that a Veth program? How do we understand that it was...

Sure. That's a -- yeah, it's John again. It's a program that we announced close to eight years ago maybe more with an engine OEM here in North America. And their strategy has changed, and still, the program was canceled. We never got into production. So part of the charge is if there's a continuation, we will continue on. A lot of this has to -- it will have to have our name on it. So there's a pause here, and a lot of the charges reflect it. We can't continue on with another name on it. So it's not the end of the story, Noah. I hope to have certainly, there's a chance that there's a release before the third quarter conference call, but certainly by the third quarter conference call, I hope to have the rest of the story here for you.

I’ll check that. I’ll jump back in the queue.

We'll take our next question from Tim Wojs with Baird.

Hey, good morning, guys. Close enough.

Hi, Tim.

Maybe just to in the back half as you're thinking about just some of the Asian orders that you've got, and maybe some of the improvements you've seen in marine, how big of a revenue ramp can you -- do you think we can see in the back half of the year if we maybe use this kind of like $59 million to $60 million run rate in the first half as a base?

Yeah. Yeah, it's Jeff. John and I just side-barred. We're thinking 10% to 15% is what is anticipated.

From the first half?

Yeah.

Okay. Okay. Got you. Okay. And then what was the -- how big was the -- I think in the press release you had mentioned some production delays that impacted the shipments. How big was that? Is that material?

Yeah. So the way we quantify that it's about $6 million that could have gone out had we been able to get the materials that we needed to do the assembly and enable to ramp up our assembly to where we expect we should be. So it's about a $6 million impact in the quarter.

Okay. And that would be kind of included in the -- so that would really shift, you think, in the third quarter?

Yeah.

Okay. Got you. Okay. And then I guess just on some of the restructuring and the voluntary retirement comments that you made, John. Is there going to be some shifting in the workforce structurally from Racine down to Texas? Because I guess from what we've kind of seen over the last couple of years, it's been hard for you to find people in Racine. And so I'm just kind of curious to kind of the -- maybe some color on the background of just the voluntary retirement?

Yeah. I mean, the timing is right on two fronts. We had excess capacity in terms of people in Racine who are near retirement or at retirement age, and we have a plant coming online down in Texas. So you're absolutely right. We take the early retirement. We've got a lot of people, a lot of knowledge leaving. And we can handle the production that we have right here. But as Lufkin comes online, you're absolutely right, the hiring and replacing of those bodies, a lot of that is going to happen in Texas.

Okay.

Again, we're very optimistic. One of the reasons we chose Lufkin was specifically because of their labor pools down there.

Okay. Okay. And then, Jeff, what type of gross margin level do you think we can kind of exit the year at? And then as you look at 2021, as Lufkin comes up. Is there any sort of underabsorption or anything like that that we should be aware of?

Yes. So, I think we've been targeting, and I think we said last quarter as well, to get to the high 20s as we exit the year, assuming no significant change in mix. Any change in mix would probably be a good guide. And I think we will, as we wind down maybe some activities that are being moved to Lufkin and ramp up Lufkin, I think we might have some slippage in absorption in the first quarter.

We're just going to have to increase expense in moving -- but I think it will improve. Yes. Well, it will definitely take a little bit of -- it will be a drag for the first few quarters, because we can't just -- in Q1 of whenever -- in the first quarter, we won't be shipping 100%. We'll be bringing it up slowly. We want to do it right.

Okay. Okay. That makes sense. And then, I guess, just from an SG&A perspective, if you're kind of at this level of revenue, do you expect kind of the $16 million to $17 million kind of level for SG&A to be pretty consistent or sustainable?

Yes, I think so. I mean, within that range, plus or minus a couple of percent? Yes.

Okay. All right. And then last one, do you think just with inventory, you'll be able to generate positive free cash flow for the rest of the year?

So I'm glad you asked that, Tim, because I was going to interject there. I'm glad you asked that. Despite like -- the jump was a bit of a shock for me. And again, I didn't foresee the negative inventory reversal from the marine propulsion program. But inventories at our factory, primarily here in Racine, actually went down in the quarter. We had a lot of stuff shipped from factories in December that did not make the quarter cutoff. So they're either in transit or they got to our distributors, our company-owned distributors, and we don't -- and they haven't gotten to the customer yet. So, I think the trend that you will see during the remainder of the second half of the year will be an improving trend.

Okay. I mean, it sounds like --

First, in this factory. Yes. We had to see it go down at the factory, and it's getting to the customer.

Right. I mean, it kind of marries with what you're seeing on some of the production delays, that $6 million you called out, that's probably in transit and that's probably pretty decent inventory that's going to push out. So --

There's a big chunk of it in transit right now.

Okay. Okay. Great. Appreciate the time. Good luck on the rest of the year, guys. Thanks.

Thanks, Tim.

And we'll go to our next question from Rand Gesing with Neuberger Berman.

Hey, guys.

Hi, Rand.

On that last question, could you be a little bit more specific? I mean, can we generate $10 million in operating cash flow for the second half? Given your rising gross margins and inventory coming out? I mean, I was supposed to see some push?

$10 million might be on the high side. I think – yes, I think, operating cash, we should definitely be positive in the second half. Free cash, I'd like to say we will be positive in the second half. We do have CapEx, which we're about, call it, halfway through what we thought we would spend. So, I think, in that $7 million to $9 million of operating cash and maybe 1% to 3% in free cash in the second half is what I think we might expect.

Okay. And on the Veth side, I know it's impressive to acquire the company, but can you give us a sense for the revenues there at this time?

Rand, you cut out a little bit on the first part of the question.

Yes. On the acquisition Veth, on the new acquisition, the relatively new.

Yes.

What are the revenues? And I'm assuming it's sort of a mid-single digit grower?

Yes. The revenues through the first half were around $23 million, $24 million. I would say their first half; they're very project-oriented, so their shipments come in big chunks. First half was kind of flat compared to the previous year. I think what we have a lot of optimism around is the activity -- order activity in particular in North America that we're seeing right now driving growth in the -- as we get into fiscal 2021.

Okay. So, obviously, we've had a bit of a weakness sort of broaden out throughout the whole revenue base I think. Is that sort of the case that 80% of your end markets are weak or just to characterize that for me?

Yes, I think so. I think there are no end markets right now that are growing beyond 1% or 2%. And there's weakness I would say across most of them. So, yes, there are a few bright spots. Stable is about as good as it gets right now.

So, I would say that the--

Guys, can you hear me?

Yes. Rand I would add this. Okay, with Veth though, we are gaining market share in Asia and North America even in a down market. So, I would expect our growth rate at Veth to continue to outperform the market growth rate.

Okay, great. Looking forward to some better results on -- in the second half and a brighter 2021. Thanks.

Thanks Rand. So are we. Thank you.

[Operator Instructions] And we'll take our next question from Simon Wong with G.research.

Can you quantify how big your energy business is this quarter?

A good question. We kind of -- we know specifically like the units that shipped energy-wise, the aftermarket is a little bit more of a guess. So, I would say it's in the $5 million to $6 million, around $5 million. It would be my best guess when you combine forward and aftermarket.

Okay. So, there is some new builds in there. So, I mean--

In Asia.

Okay, great. And I mean I'm just trying to understand how big is the aftermarket business? That's what I was trying to get back at. Yes. Because I -- aftermarket for the energy business.

This quarter -- I would say this quarter it was roughly half.

Okay. Okay. And then you also have some energy business going to the offshore. Been hearing that offshore been picking up for a few quarters now. Are you seeing that in your order rate incoming orders a pickup in offshore?

We're just starting to see some project quote activity. And fortunately, all of that is being handled by inventory at our existing inventory at our distributors. So, first thing we have to do for us is, to get inventory that's sitting out into the market, and then we'll get replacement orders. So, yes, I would say there's been some signs -- some small signs of life in that market.

Okay. That's encouraging. If I were to look back five or six years ago how big was these offshore initiatives for you?

Five or six in '20. So you're going back to almost our peak. That probably would have been 20 -- I will double check it, but I want to mention $20 million.

Okay. All right. Great. And then -- yes? And then on the covenant side, you mentioned that you've just gotten an amendment that goes to four times leverage. How long is that amendment good for? And what does it go back after the amendment?

Yes. So, there's an 8-K that will be filed. You can see the details. But essentially we've got a 4:1 for the quarter that just ended, goes up to 5:1 in the next quarter, and then it starts backing down over the next two quarters and we get back to the 3:1 in the second quarter of fiscal '21, or the fourth quarter of calendar '20. So, it's a really three, four quarters of relief.

Okay. All right. Great. That's all the questions I had.

I guess the other -- Simon, the other component that maybe is important is we -- it also includes the add-back of the $3.9 million charge in Q1. Remember the product performance charge gets added back to EBITDA, treating that potentially as a restructuring type of charge.

Okay. Great. Thank you.

It appears there are no further questions at this time. Mr. Batten, I'll turn the call back to you for any additional or closing remarks.

All right. Thank you, Christina. Thank you 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 call Jeff or myself. And we look forward to speaking with you again following the close of our fiscal 2020 third quarter. Christina, now I'll turn the call back to you.

Thank you. This concludes today's call. Thank you for your participation. You may now disconnect.