Greetings. Welcome to the Twin Disc, Inc. Fiscal Third Quarter 2022 Earnings Conference. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note, this conference is being recorded. I'll now turn the conference over to your host, Stan Berger. You may begin.

Thank you. 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 2022 third quarter and nine-month 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 states 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 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's Chief Executive Officer; Jeff Knutson, the company's Vice President of Finance, Chief Financial Officer, Treasurer and Secretary. At this time, I will now turn the call over to John Batten. John?

Thank you, Stan and good morning everyone. Welcome to our fiscal 2022 third quarter conference call. As usual, we will begin with a short summary statement and I will be happy to take your questions. Before we go over the quarter results, I'll touch on some of the operational highlights from the quarter. As we mentioned in the last call, we headed into the third quarter with a nice backlog and our orders continue to improve in the quarter. Supply chain issues from a few key vendors really hampered our shipments, especially for our transmission and marine transmission product lines at our Racine, Wisconsin and Nivelles, Belgium facilities. While all components and raw material lead times have shot up over the past year, we have particular problems with some large casting deliveries and electronic components. Connectors and wiring harnesses were also in incredible short supply. Our team has been working hard to reschedule incoming inventory to meet the cadence of components that are in short supply. While lead times are not improving, predictability is improving and that gives us confidence that we'll be able to improve on our shipments in coming quarters. Obviously, supply chain issues caused some inventory issues, as we had several $50,000 and $150,000 transmissions waiting for $200 harnesses before shipment. We also had several million dollars of inventory on the water headed to both China and Australia that did not leave in time to be shipped on to customers in the quarter. Oil and gas demand for our pressure pumping transmissions continued at a strong pace for China and for our aftermarket parts for the North American fleet. Besides orders for our 7600 transmission, we also have orders for 8500 transmissions for China. 8500 rebuild activity for the North American fleet has almost doubled in the past six months and we are receiving requests for quotes for new spreads. One of the bright spots in production was our facility in Lufkin, where we produce all of our North American industrial PTOs and clutches. With the least amount of reliance on electrical components and a very resilient supply base, their run rate has increased over 40% since they went into production over a year ago. We will be moving our hydraulic PTO product line there this spring and summer. Jeff has specific numbers in his comments, but this quarter's results were really driven by improved industrial sales, modest growth in transmission shipments, and strong shipments into North America in general, but particularly of the aftermarket parts for oil and gas. This mix drove both sales and the improved gross margins. The outlier, my comments right there were strong marine and other shipments into our Australian market. Twin Pack handles the entire market in Australia and has strong demand for our marine product line, but they also handle the Seakeeper gyro for the Australian market and those sales have grown significantly in the past quarters than in the past years. During the quarter, we continued to work extensively with our customers who are designing hybrid and electric prototype equipment, and a few have moved into their prove-out phase. Once we can share the details, we will, but so far, we are very pleased with the results and our team is working hard on this day-in and day-out. Hopefully, this will be the last call we discuss COVID specifically, but late December and January were not good months for either Twin Disc internally or our supply chain. Internally, we have several lost days due to quarantine, the same can be said for our suppliers. Staffing shortages and the cost of goods sold area is a global problem. Many of our electronics and connector shortages can be traced back to China, and we're hopeful that lockdown and bottlenecks of their ports will improve this spring and summer. And now, I'll turn it back to Jeff for some financial.

Thanks John and good morning everyone. I'll briefly run through the fiscal 22 third quarter and year-to-date numbers. Sales of $59.3 million for the quarter were up $1.6 million or 2.9% from the prior year third quarter, but down $600,000 or 1% from the previous quarter. The sales increase compared to the prior year reflects continuing growth in demand across our markets, although shipment performance has been severely limited by supply chain challenges across our locations. As noted in previous quarters and as John just mentioned, we've experienced a significant increase in lead times from suppliers, unpredictable delivery performance and difficulty in receiving primarily electronic components which are specifically challenging. This has resulted in delayed shipments and increase in backlog and an increase in inventory levels as we await delivery of final components before being able to ship complete units. As the industrial product line has the least exposure to the electrical component shortage, sales of industrial products improved by nearly 45% compared to the prior year third quarter. With greater exposure to that supply chain weakness, off-highway transmission sales grew by just 5.4%, and marine and propulsion sales actually declined by just 1.7%. By region, sales in North America were up 26%, while sales in Asia-Pacific were down 10%, and sales into Europe were down 14%. Foreign currency exchange was a net negative $3 million impact to sales in the third quarter and through the first nine months, we are now 9.6% or $14.6 million ahead of the prior year. The third quarter margin percent was 29.8% compared to 24.2% in the prior year third quarter. The improved margin in the current year is the result of increased revenue, a more profitable mix of product, and the positive impact of pricing actions taken early in the quarter to offset the impact of inflationary costs increases across our supply base. We continue to monitor the inflationary environment and are prepared to react with any additional required pricing actions. Spending on marketing, engineering, and administrative costs for the fiscal 22 third quarter increased $1.2 million or 9% compared to fiscal 2021. The increase in the quarter is primarily due to the return of a global bonus program, spending on professional fees, a return of spending in marketing and travel, and inflationary increases, partially offset by the favorable impact of a Dutch COVID Relief subsidy that was recorded in the quarter. As a percent of revenue for the third quarter, ME&A expenses were $24.3 million compared to $22.9 million in the prior third quarter. And for the nine months, ME&A expenses were 25.6% of revenue for both fiscal 2022 and fiscal 2021. We recorded restructuring charges of $300,000 during the quarter, primarily related to an adjustment to the carrying value of an asset held for sale. Specifically, the corporate headquarters building, with an agreed price that was slightly lower than what we had accounted for earlier. Including the restructuring charge, the operating profit for the quarter was $3.1 million compared to an operating profit of $0.5 million in the prior year third quarter. The first three quarters operating income of $3.3 million, which includes a $2 million gain on the sale of our Swiss facility, is $10.5 million improved from the fiscal 2021 first three quarters. The effective tax rate for the first nine months of fiscal 2022 was 76.5% compared to 28.9% in the prior year comparable period. The current year rate was significantly impacted by the domestic full valuation allowance, resulting in no tax benefits being recognized on current domestic losses. The net profit through the third quarter of fiscal 2022 was $300,000 or $0.02 per diluted share compared to a net loss of $8.2 million or $0.62 per diluted share in the prior year nine months period. EBITDA of $5.8 million for the quarter improved from $3.8 million in the prior year third quarter, and for the first nine months, EBITDA improved by $12.3 million from the prior year from an EBITDA loss of $1.3 million to positive EBITDA of $11 million. Turning briefly to the balance sheet, inventory was up $16.1 million through the first three quarters, driven primarily by the supply chain imbalances John noted. We are focused entirely on inventory planning and sourcing strategies that will balance incoming components with the shortage items currently preventing final assembly and shipment of units. With a significant increase in inventory, operating cash was negative $7.2 million in the quarter. Capital spending at just $2.4 million for the first three quarters remains well behind schedule, impacted by lead times on machine tools. Given the slower start in capital spending, we now anticipate that we'll invest in the $4 million to $6 million range in fiscal 2022. And with that, I'll turn it back to John for some final comments.

Thanks Jeff. Just spend a quick moment on the outlook. Clearly, our backlog is improving and orders continue their improving trend. Supply chain issues continue to concern us, particularly in our European supply area, who rely more heavily on Russian and Ukrainian raw material. So far, we have not seen any huge impacts other than elevated prices and delayed deliveries due to temporary shutdowns. Longer term, we feel that the demand for North American natural gas is going to drive a lot more U.S. and Canadian production. This, however, will be tempered by labor and supply shortages. All in all, we see quarter-over-quarter improvements headed out through the balance of the year provided some solid sanity rules the day with respect to Ukraine and Russia. That concludes our prepared remarks. And now Jeff and I will be happy to take your questions. Please open the line for questions.

Sure. At this time, we will be conducting a question-and-answer session. Our first question comes from the line of Josh Chan with Baird. Please proceed with your question.

Good morning, John and Jeff.

Hi Josh.

Hi Josh.

Hi, good morning. I guess my first question is on your comments on getting some quotes for the new oil and gas spreads. Could you talk about the kind of urgency or the timing behind those requests? Is it next calendar year? Or is there a willingness or ability to kind of pull that spend forward even?

I believe the spending won't impact this fiscal year; it will be in the first half of our fiscal 2023. I'm not certain if the deliveries will be at the end of Q1 or Q2, but they are likely to occur around late fall.

Okay, that's encouraging. And I guess in terms of that trajectory of this recovery, do you expect kind of a rush, like in some of the prior cycles? And if so, are you prepared to kind of service that potentially?

I think what sets this situation apart is the availability of personnel and materials. Whether it's for constructing new rigs, I believe this cycle will be different due to these constraints. This might lead to a longer recovery.

Right, right.

Yes, I believe it is challenging to find people to construct rigs and to obtain all the necessary components. This is likely why we are currently witnessing a significant amount of rebuilding activities. Operators are taking existing rigs and refurbishing the engine, pump, and transmission. However, I do believe that some operators will require new equipment. The lead times for acquiring new equipment are at least six to nine months, so I anticipate that we may see developments around October or November of next year.

Understood. That makes sense. And then on the revenue progression into next quarter, I think you might have made some comments at the end, John, but usually you see like an uptick in the fourth quarter compared to your third, but is it possible with the supply constraints that you're seeing now?

Everything is lining up that the fourth quarter will be the strongest quarter of the year on the top line for sure. It's unless something hits us that we haven't seen yet as far as a supply crunch, but we have the orders, we have most of the inventory here. It's just execution on some last critical components.

That's great. I have one last question. We saw a very strong gross margin this quarter. Are your pricing actions starting to have an effect? Is this level sustainable moving forward, or did anything unusual contribute to the margins this quarter?

I believe the margin was definitely influenced by the product mix. There was a significant increase in oil and gas transmissions to China. That aspect didn't decrease due to supply chain issues, as we had ample spare parts activity for North American oil and gas, and the mix for North American industrial was larger. Pricing contributed, but the mix played a major role as well.

Okay, that’s good information. Thanks.

In terms of sustainability, I guess, that's the question is what is the mix in Q4? Was it a similar mix? Yes.

And that's what's shaping up for the quarter, is a similar mix.

Okay, great. Thanks for the color and good luck on the rest of the year.

Thanks Josh.

Our next question comes from the line of Noah Kaye with Oppenheimer. Please proceed with your question.

Good morning. Thank you for the questions. I would like to explore the quarter in more detail. First, do you have information on the growth from total price benefits?

Yes, I can provide some insights, Noah. The transition from Q2 to Q3 was particularly noteworthy due to a substantial margin increase. We experienced approximately a 730 basis point improvement in that quarter. I would estimate that just over half of that improvement, around 380 basis points, was driven by the net effects of price inflation. The product mix contributed another 220 to 250 basis points, with the remainder stemming from customer mix within product lines and cost reductions. Overall, price adjustments have helped us return to what we regard as a normal margin range of about 26%, excluding heavy oil and gas. We previously mentioned in last quarter's call that with the pricing changes, we expected to close the year in the mid to upper 26% range, around 26 to 27%, and that is indeed what we've observed.

Well, I would just comment first that to get positive price/cost in this environment is alone a significant accomplishment. So, well done. But to your point around the mix being an uplift, can you just repeat because I didn't quite catch it? What happened with land-based transmissions in the quarter? I think you said industrial sales were up 45% year-over-year. But marine was down slightly and I think you said off-highway was down. Can you just repeat that?

Certainly. Land-based increased by 5.4%, but the main highlight is that the oil and gas segment within land-based grew by more than that percentage, despite some offset from other segments. The military segment also contributed to this offset, leading to the overall net increase of 5.4%. Additionally, both the oil and gas component and the aftermarket aspect of land-based saw increases. These elements are crucial when discussing how the mix drives higher margins.

Yes. If some of the inventory tied up in various supply chain issues and freight, if that actually comes into the quarter, if that had come into this quarter, is that, kind of corporate average contribution margin a little bit better than others? What I'm trying to figure out here is if some of the bottlenecks start to ease a little bit, it seems like margins might actually be able to break 30%, but just let me know what you think?

Yes, I mean, I think that's not out of the question. I mean we finished that 29.8 for the quarter. So, yes, volume alone with a similar mix, just more volume of everything would get us there. So, yes, I think with the continuation of what we did in Q3, which is a pretty healthy mix. That's kind of what we're seeing as we work into Q4. Yes, with some things going our way, it's not out of the question I guess.

Yes. Okay. And then just a last question around the inventories and the working capital management, is it feasible to bring inventory levels down sequentially in 4Q, a goal to bring inventory levels down sequentially in 4Q, is that sort of in your plan? And how should we be thinking on a full year basis about working capital?

We are really focused on managing our inventory wisely as we approach fiscal 2023. We believe that with the right strategies, we can reduce inventory levels by the end of the year. This should lead to some improvement in free cash flow in Q4. While we may not fully offset the negative cash flow from Q2 and Q3, we expect to see a positive shift in Q4. Our goal is to plan effectively to ensure we bring in the right components and move products efficiently.

Okay. And maybe just a little bit longer term question here. But how are some of the electric programs going? I think in the last couple of quarters, there's just been a ton of activity mentioned, nothing hugely material in terms of revenue. At this point, you do that changing, maybe as we look into 2023?

It's still quite early in terms of revenue, but we have done a lot of work on the project side and with prototypes at our customers. We have received an order for the first system from one of our land-based customers, and I'm just waiting for their release. Unfortunately, they want to showcase these at in-person trade shows, so I expect to see that over the summer. Hopefully, by the next call for the fourth quarter, we can share some updates. The potential is significant, as we're looking at a component priced at $130,000 compared to a hybrid system at $200,000 for the same piece of equipment. We're excited to see how the market responds and the growth opportunities that arise. In the second half of this calendar year, we should have more news about the various projects we’re working on as customers begin to release their vessels or construction equipment.

Okay, perfect. Thanks so much for the color.

Thanks Noah.

And we have reached the end of the question-and-answer session. I'll now turn the call back over to John Batten for closing remarks.

Thank you, everyone for joining our conference call today. We truly appreciate your continuing interest in Twin Disc, and hope that we have answered all of your questions. If not, please feel free to call either Jeff or myself and we will get your question answered as quickly as possible. And we look forward to speaking with you again following the close of our fiscal 2022 fourth quarter and year-end conference call. I'll now turn the call back to you.

Thanks John. And this concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.