Good day, and welcome to the Twin Disc Fiscal Fourth Quarter 2016 Investor Conference Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Mr. Stan Berger of SM Berger. Please go ahead, sir.

Thank you, Brian. On behalf of the management of Twin Disc, we’re 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 2016 fourth quarter and full-year financial results and business outlook. Before I introduce management, I would like to remind everyone that certain statements made during the course of 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 you a copy. Hosting the call today are John Batten, Twin Disc President and 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 Batten. John?

Thank you, Stan, and good morning, everyone. Welcome to our fiscal 2016 fourth quarter and year-end conference call. As usual, we will begin with a short summary statement and then Jeff and I will be happy to take your question. Before I begin, both Jeff and I would like to apologize for the slight delay in announcing our fiscal 2016 fourth quarter and year-end results. We would like to reassure all of you on the call that this was not due on accounting irregularity or anything of that nature, but rather the lengthy second round analysis for goodwill impairment. It should come as no surprise to anyone that the continued sluggish markets and declining comparables to previous years made this years analysis more rigorous, especially with the backlog that continues to bounce around the bottom. Of the $13.2 million of goodwill that we had on the books, it was decided to take a non-cash charge of $7.6 million and to write-down assets with respect to our domestic industrial business and European propulsion business. We can get into more details of this later on the call. Looking at our fourth quarter results, sales for the 2016 fiscal fourth quarter were $42.6 million versus $67.3 million a year ago, a decrease of about 37%. Full-year sales were $166.3 million, which were also 37% lower than a year-ago levels of $265.8 million. FX had a negligible impact in the quarter-over-quarter sales comparison, but a negative $7.8 million impact on the full fiscal 2016 to 2015 comparison. As with previous quarters in fiscal 2016, we saw no recovery in our domestic oil and gas markets or Asian Marine market. European demand for our Marine and industrial products remain weak but stable throughout the year when compared to fiscal 2015. Aftermarket industrial and non-oil and…

Thank you. [Operator Instructions] We will take our first question from Josh Chan with Baird.

Hi. Good morning, John and Jeff. Great job on the cost inflow and the cash flow.

Thanks, Josh.

Hi, Josh.

My first question is on the oil and gas conversations with the customers. I assume they’re not placing orders at this point, but just – what is the tone like? And when are your customers talking about potentially seeing any type of improvement there?

I think we’ve had conversations on rebuild activity. Very small amount of that still going on, but we’re getting into more conversations about replacing some of our competitors transmissions in the field. So whether that’s in the next quarter or two, there’s still a good chunk of the fleet both with our transmissions and others that are working and are doing works. So I think finally, our stories getting out on how long our units are lasting in the field, so we’re getting more interests in replacing maybe someone’s older – competitors older transmission with a new one of ours. So as long as oil is not above $50, I think that’s going to be our opportunity, particularly in North America in the next 12 months.

Okay. Well that’s good that you – go ahead.

And I would just say, yes, if again I used to think it was in the high-50s, closer to 60, but I think if we can sustain oil above 50 for any length of time, I think we’d see that activity might increase a little bit.

Okay. It sounds good. It sounds like you might also have some share opportunity there if that’s all true.

Yes.

Okay. So then in terms of the year-over-year comps, is there still a lot of oil and gas activities to cycle through in fiscal 2016 as we look at 2017 versus 2016?

No. I think we’re going to start fiscal 2017 to fiscal 2016 comparison is pretty clean of oil and gas.

We had a few units shipped in Q2 of last year, but that was about it.

Okay. So then kind of looking at some of the other end markets, do you anticipate those markets potentially growing in fiscal 2017? And I guess, one that I was particularly interested in was Asia Marine, and it seems like weakness there is a little bit more persistent than maybe previously thought?

Yes. It has been a very, very slow year for the Asian Marine markets. So any new activity I think we could say would be some growth. So it’s going to be challenging. I see any growth in Asia or Europe might be offset a little bit by a slight slowdown in North America. Because we have seen the build activity in the Gulf Coast start to slow down. That’s with respect to offshore oil and gas. We’ll see what happens in more the commercial, the river traffic, the barge activity, pushboat. But I just think overall, it’s going to be stable where we’ve been running. I’m just not that optimistic the next two quarters are going to see any significant growth in Marine.

Okay. And then I saw the pension line on the balance sheet kind of moved higher. So is there going to be like a pension expense headwind as we look into fiscal 2017?

There will be a little bit, not as significant as you’d see in the – that’s a result of our valuation exercise. So that has a tendency to move in big amount depending on what the discount rate does and what the dash that returns to during the course of the year. Doesn’t always translate into that significant of an impact on the expense or cash contributions in that next year.

Okay, great. Yes. Those are all my questions. Thanks for the time.

Thanks, Josh.

[Operator Instructions] We’ll go next to Walter Liptak with Seaport Global.

Hi, guys. Good morning. Congratulations on the adjusted profits [related] with the cost down. I want to ask - the comment that you made about the hours worked on some of your O&G transmissions, the frac equipment. And I wonder if you can just provide some color on the equipment that’s out there? How it’s being used? If you’re getting calls on equipment breaking down. And in the past, we talked about kind of that shadow inventory out there and cannibalized equipment. And any update that you might have gotten that kind of led to that 1,600-hour work – hours on the machines would be helpful?

Yes. The 16,000 hours are coming from the Canadian fleet. And clearly, I doubt that those 16,000 hours were in hard shale formations. It was probably more in pure oil and wet gas. So slightly easier on the unit, but 16,000 hours is a lot of hours. And they have been putting off – if they don’t have to do anything to the transmission as far as maintenance. They haven’t been doing it. They have done some of the preventative maintenance, so they’ve gotten a lot more life out of these than I think they thought. So we’ve seen the transmissions – most of our rigs right now are on fleets that are doing pure oil and oil and gas and not a whole lot of pure gas so the application, the demand on the unit has been a little bit less. I’m still looking for the increase in usage in gas, because we’ve just seen – coal has been between up to a point where I don’t know if that is going to recover. And I believe it was April where there was the tipping point where natural gas was the primary fuel for electricity generation for the first time. So that demand is good for gas. And then as export demand builds up, I’m optimistic or I don’t know if I stay optimistic or hopeful, but that could be a trend that will help us – not so much the oil part of oil and gas, but gas and that the demand for gas drilling will increase some activity both on the rebuild side, but on the new unit side. And as far as what fleets are out there and inventory, I don’t have a real update, but it just seems like from our customers, there hasn’t been – other than [Trican] selling their North America fleet a few quarters ago, I haven’t seen a whole lot of movement of our units with our equipment in it moving or changing hand.

Okay. Has there been any you know when you’re talking to the customers about replacing transmission, is there any description of like the sizes, the 7,500 or is it the larger one that are being used in this environment?

Yes. It’s a combination of both. I think primarily just from the size of the actual – the whole rig, it will probably be more applications for the 7,500. And that’s not to say that we can’t modify the 7,500 more to make that transition a lot easier. So you don’t have to do as much work on the rig to make that happen. But there certainly will be some of that demand for the 8,500, but we see more of it on the 7,500 side. And we’re working to address to make that easier, so it’s not as much work on the rig to put in the 7,500 if another transmission is already there.

Okay. Unless you’re having these conversations with customers on the rebuild opportunity, I think a lot of it is their investment is return based and there’s a lot of price focus by the service providers. Are they hitting you guys up for lower prices? Or trying to put it out to bid or something? Or are you able to get a return on what you’re making?

Yes. We’re absolutely still able to get a return.

Okay. Maybe that’s the one way to answer the question. Sorry. I guess, the question is just on pricing pressure, are they trying to work down price?

Yes, there is some pricing pressure for sure. But I mean, there hasn’t been these big contracts or bids for spreads. So a lot of it has been on sharpening your tool on hourly rate, sharpening your pencil, make sure that you’re competitive on what your labor rates are to help with the refit and doing the rebuild activity. Walt, we’re still – you pick a model where we’re less expensive than one of our competitors and they don’t seem to sharpen their pencil that much so that helps.

Okay. I hear that. I want to ask about the comments about the – that you made, Jeff, on the annual run rate at gross margin with the 700 – or $7.5 million of costs out. Is this gross margin level? And so is the run rate? So that’s maybe like the average that we would see for 2017? Or do you think the gross margin still has some benefits from cost cutting in 2017?

I think the fourth quarter really saw the full run rate of all the actions we’ve taken to date. So I think movement going forward will be based upon future actions we might take and then further efficiencies that we continue to push for in all of our plants and then mix. So it’s hard to give an expectation. I think we are pretty happy with where Q4 came in.

Walt, I would just caution you and everyone that the first quarter is – now that oil and gas is historically our lowest on both the sales and the margin because of the shutdown. We have a one-week shutdown here in the U.S., but also up to three weeks in one of the plants in Europe. So the first fiscal quarter for us is historically the lowest both on sales and particularly on the margin level.

Okay. We’ll factor that in.

Yes.

Maybe just the last one for me. Just sequentially in the industrial exposure that you have, did you see any changes during the quarter? Anything getting better or worse from month-to-month?

I would say only that we’re making a lot more calls. And so it didn’t really change that much quarter-to-quarter. It’s just that and what you look at the peer numbers, but I would say our opportunity now to grow is a lot better than it was even in the third quarter. We made a lot of more context and a lot of more single unit sales to new customers.

The growth from Q3 to Q4, which is about $1 million on the topline was pretty much all industrial, so some of that’s showing in the [result].

Okay. Great. Thanks, guys.

[Operator Instructions]

Okay, Brian, I think that’s it.

And we do have another question in the queue.

Okay.

We’ll take our next question from Josh Chan with Baird.

Hi. Just a two follow-ups. First one is there going to be an opportunity to generate further working capital reductions in terms of the cash flow basis in next year?

Yes. It becomes more challenging, Josh. Obviously, we’ve done a lot with inventory. We expect volume to – as we’ve been bouncing along the bottom in terms of backlog. So I don’t think we anticipate significant decline, and I think as we hopefully see volumes start to improve there will be some investment working capital. So I think it’s going to be more challenging. I don’t think we’ll see a quarter like we saw in the fourth quarter, which was – had a lot of good movements on our balance sheet. We will obviously continue to manage it as well as we always have.

Okay. And then last one for me. You alluded to some new product development. Could you kind of like elaborate on where you’re focusing your efforts there? And what are you looking at?

Yes. I would say a lot of it has been on the new industrial products, both extending the horsepower range of our hydraulic PTOs, which can go into big rock pressures, wood chippers, but also bringing that hydraulic clutch technology down the horsepower range. Then we also have been releasing – a lot of our PTOs are on the field are mechanical. There’s a lever. They just engage it and disengage it by hand and we’ve been working on both electronic and hydraulic clutches for those so you can retrofit existing PTOs with – so you don’t have to engage it by hand. You can do it either electrically or hydraulically. So those models are starting to roll out. Then we’ve been looking at controls technology and how do we control our products, our components, but other people’s as well and offers systems and capabilities to customers. And then in the oil and gas area with respect to the pressure pumping transmission is seeing that the new fleet activity, newbuilds is – keeps being pushed out a couple quarters, couple quarters. What can we do to make our transmissions and the configuration easier to swap out if someone wants to replace someone else’s transmission with ours. So right now that is kind of where the activity is focused.

Okay. Great. Thanks for the color and update. End of Q&A

And there are no further questions in the queue at this time.

Okay. All right. Thank you, Brian, and thank you all for joining our conference call today. We appreciate your continuing interest in Twin Disc and hope that we have answered all of your questions. If not, please feel free to call Jeff or myself. We look forward to speaking with you again in October following the close of our fiscal 2017 first quarter. Brian, now I’ll turn the call back to you.

And ladies and gentlemen, that concludes today’s conference call. We thank you for your participation.