Good day everyone, and welcome to the Twin Disc, Inc. Fiscal Third Quarter 2018 Conference Call. Today's call is being recorded. And now your host for today’s conference Mr. Stan Berger of SM Berger. Please go ahead. Mr. Burger, please go-ahead sir.

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 2018 third quarter and nine-month 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 a copy to you. Hosting the call today are John Batten, Twin Disc's 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 2018 third 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'd touch on some of the operational highlights from the quarter. Sales for the quarter rose 45% year-over-year, compared to third quarter sales a year ago demand was top in most of our markets. Obviously the most dramatic increase year-over-year was in our land-based oil and gas transmission sector, but we also saw rising tides in many of our other markets as well. Demand was strong across our marine markets and we have seen a nice industrial demand increase across both our forward and after-market businesses. As we mentioned in prior calls, this is putting a lot of pressure on the supply chain. A lot of our management time has been spent on securing the parts and processes needed to meet this ramp up. The overall situation improved throughout the quarter but we still had work to do. Many of our key suppliers are at full capacity and we are adding additional capacity through new suppliers and new internal CapEx. Sales for the quarter could easily have been 7 million higher before we’re able to get all of the components necessary to meet the demand. Currently we have about 6 million in CapEx on order which will increase our internal capacity primarily in gear production and anticipation of the assembly and test expansion. As part of our cost rationalization process, capacity years we have moved some of our distribution deeper function factor seeing when we divested our distribution entity in the South-eastern part of the US. To improve our manufacturing throughput, we will be moving this activity over the shop area to a new location and using this free space for new machines. Our productivity slipped a bit during the quarter due to a lot of new hires coming online after January 1st, but the trends should reverse as the productivity of the new employees improves and the new CapEx is installed. Our gross margin for the quarter could have been 130 basis points higher except for the one-off warranty expense related to the marine transmission in fast supply vessels. While the marine gears were well past the standard warranty times, there were 20 that we felt were not meeting our internal threshold and we decided to update them in this low activity period. With that, I’ll turn it over to Jeff for some comments on the financials and then I’ll be back for the outlook at the end.

Thanks John and good morning everyone. I’ll briefly run through the third quarter numbers in a little more detail. Sales of 65.3 million for the quarter were up 20.3 million or nearly 45% from the prior year third quarter, this represents the fifth consecutive quarter of year-over-year growth demonstrating a sustained and accelerating growth trend. The primary driver as John mentioned improved revenue in the quarter remains in the improved shipment of oil and gas, transmission units into North America along with improved North American aftermarket demand which is also led by oilfield activity. In addition, we’ve seen increase in size of growth to varying degrees in nearly all of our markets including European and North American commercial marine, global petrol craft, pleasure craft, global industrial and agent commercial marine. The global offshore supply vessel market, however, remains depressed. For the first nine months, sales are now up 52.4 million or 46% to 167 million. Our gross margin percent for the quarter improved by 220 basis points to 31.7% compared to 29.5% in the prior year third quarter. This improvement is primarily volume driven but also reflects improved operating efficiencies and a global reduction in fixed cost. As John mentioned, market performance for the quarter was somewhat hampered by an isolated warranty issue resulting in an $800,000 charge in the quarter. Year-to-date gross margin through March at 31.6% compared to 27.4% for the fiscal 2017 nine months. Spending and marketing, engineering and administrative cost for the fiscal 2018 third quarter increased $1 million or roughly 7% compared to fiscal 2017, a decrease as a percent of sales from 30.5% in the fiscal 2017 third quarter to 22.6% in the current quarter. The increase in spending was primarily related to a $600,000 increase in the global bonus expense as well as…

Thanks, Jeff. And I’ll just spend a quick moment on outlook. Our six months backlog increased as Jeff mentioned 37% in the last three months and is a 130% higher than a year ago and I would say that the biggest change since our last call is the market improvements in areas outside of North American pressure pumping, particularly Asia. In short, it’s a better mix of backlog. We have seen a lot of new order activity in Asia, both in marine and oil and gas and continued after-market demand across all of our product lines signals that the market is coming to life. Our industrial marine shipments are up almost 10% year-over-year. And with respect to land-based oil and gas submarket, it’s very active and we expect it to be for some time to come. The attendance at last week’s OTC show in Houston was extremely busy and many of our customers had a very positive outlook through 2019 and into 2020. We share that optimism. But it is our goal to use this opportunity to invest in new products and technologies to diversify our business. That concludes our prepared remarks. And now Jeff and I will be happy to take your question. Lucas, please open the line for discussion.

[Operator Instructions]. And for our first question we go to Josh Chan with Baird.

Yes, if I can start on North American oil and gas. I mean obviously that drove the quarter for you guys. Could you talk about just kind of the conversations that you’re having with the customers and sort of the lead times and whether you think the market is undersupplied and will be for some time or whether you think it’s sort of balanced with the capacity that’s coming on?

My sense Josh is, well they’re very positive conversations done in Houston. I’d say we’re in that phase where a lot of orders that we currently -- a lot of our production builds for our customers are kind of in midstream and we are already in discussions for the follow-on orders. And my sense and I think sense of our entire team that was done there is that we are still in a state of undersupply. And I think there’s more investment to come. I don’t know how long it’s going to last but it certainly seems that there’s a lot of runway. And we’re talking multiple quarters. So, I think the overall sense is that the market is healthy. There’s still a lot of rebuild activity going on, a lot of new equipment being added. And so, we are looking out delivering for us eight to nine months out. So, everything that we would be scheduling now is probably at the very end -- not very end but it would be in the first calendar quarter of 2019 through our third quarter -- third fiscal quarter of fiscal ‘19. So overall the best OTC in many years for many reasons.

Great. That’s good to hear that there’s some visibility on that. So, I guess like on the backlog, could you talk about kind of the amount of concentration or diversity in terms of kind of, do you think it’s like one large order that drove the growth or was there a number of orders that kind of contributed to the very strong backlog this quarter?

That should have been -- it was multiple orders from different customers, different region. And I would say the most -- the thing that made us the most optimistic was Asia coming to life and a couple of markets, commercial marine and oil and gas orders that we hadn’t seen with that type of significance in two or three year, that’s why I say its better mix of that while it wasn’t just all driven by North American oil and gas, certainly a big part of it but it wasn’t the only part.

That’s encouraging. And then following up on some of your comments about, sounds like there is a lot going on in terms of hiring, in terms of kind of adding capacity. Could you talk about you know whether you’re having troubles finding people and how are you managing sort of the moving pieces between that and equipment coming in and this.

Sure, it’s a mix of finding additional suppliers, dual and triple sourcing certain components hiring and adding CapEx. Certainly, I would say that the two most challenging and it's just the entire time is additional suppliers and new employees that you can bring in and train and get them up to speed. certainly, the CapEx is going to come in and guys know how to run those machines, guys and gals and that’s going to be rolled out over the next few quarters. But we made a big, a lot of headway was made in the third quarter, a lot more to do but I feel a lot better right now than I did three months ago. But certainly, hiring it's for everybody, but finding people here that want to work in manufacturing has always been a challenge but the guys that are coming out of the trade schools are going to fit nicely with the machines that we have coming in.

Okay. Thanks for the color and I guess the last question I have is on free cash flow, so given the increase in demand and then I guess the working capital investments, should we think of free cash flow as more of an investment year this year in ’18 and how would cash flow will potentially into next year when you take into account working capital and CapEx and all that.

Yeah, I think that’s fair to look at this year’s in investment year. I don’t know how sustainable 45% year-over-year-round the growth is going to be. So, I think we’ll see some leveling off of working capital when we get into next fiscal year but I think we’ll see more CapEx. So, I think those two might balance a little bit but we’re certainly looking to see positive cash flow generation when we turn into fiscal ’19.

Thanks. For our next question we go to Jim Dowling with Jefferies Company.

Yeah, you specifically referenced streamlining the operating and you’re talking about CapEx and getting new equipment and basically make the business more profitable. I didn’t go back and look but if you went back in your history when the last time you were in a very strong uptrend. Where would you categorize the potential for future margins versus your past peak margins?

I would say the potential peak is higher and say that 300 basis points higher, 500 basis points higher but its higher Jim and it's going to be a combination of new CapEx and a lower fixed cost basically. Our last peak just a rough number, we had 250 hourly employees and we’re seeing where the demand was. The trade off this time when we get to those peak levels as we’ll have more CapEx with fewer heads and fewer facilities around the world. So, I would say that if we do everything right at a minimum, I could see 300 basis points higher than end of peak.

[Operator Instructions] And to our next question we go to Simon Wong with Gabelli & Company.

Good morning. Just look at the backlog, can you quantify how much that is related to oil and gas versus the other new businesses that came in during the quarter?

Sure. Simon, it is roughly half is what [we'll] consider land-based oil and gas and the rest is -- I guess the rest is every other market, the rest is the rest. So, that’s why it’s the much better mix of backlog because as you back 12 months, 18 months again that the half of our backlog is significantly better than it was at the bottom just a year or two years ago.

Okay. And then staying on the backlog, are you able to identify how much that do you feel versus reflects that?

Sure. So, if I just look at the unit, I would say, I don’t see my slide 10%, say at least three quarters is new build, a quarter is for replacement. And certainly, the aftermarket component of it all is the 100% replacement. But if it’s significantly different than that we will let you know, but that would be the rough order of magnitude.

When you say new build, you're lumping in a rebuild to it [just as a] new build.

Yeah. So, I’m saying that 75% of what we have on order roughly is for new rig construction ground up, they are building the new trail and new engine probably a quarter of our unit are going into replacement for units that they’re not going to rebuild again, but they’re going to keep the rig going.

Right.

And then obviously a 100% of the aftermarket business is for rebuild.

Okay. Now, in terms of your incremental, is the high working expense the main driver of the more incremental margin for the quarter. And how should I think about that going forward?

Yeah. That’s exactly right Simon. So, without that we would have been about 130 basis points higher in the quarter. And that was onetime, that issue is very discrete that now look forward in the quarter. So, we would expect the margin performance to sort of follow what the Q3 performer would have been without that.

Okay. And just a rough calculation, I’m looking at 45% incremental without the higher warranty expense. Is that what I should be looking for going forward?

In that 40% to 45%, I think as the comps go forward we’re comparing to very favorable mixed quarters over the past say two quarters or three quarters. So, we won’t necessarily see the 45% maybe it’s drifting more towards 40%.

Okay. And then finally, [BSL.] Is there anything driving the jump in the quarter?

Yes, there is. We -- as John noted, we had a lot of sort of operational suppliers issues that caused shipments to be more heavily weighted right towards the end of the quarter. So obviously those last three weeks of the quarter were not collectible within the quarter which drove days up significantly.

And with that, ladies and gentlemen, we have no further questions on our roster. Therefore, I will turn the conference over to you Mr. Batten for any closing remarks.

Thank you, Lucas. And thank you 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 August following the close of our fiscal 2018 fourth quarter and year end. Lucas, I will now turn the call back to you.

Thank you, sir. Ladies and gentlemen, this will conclude today’s conference. Thank you for your participation. You may now disconnect.