Good day. And welcome to the Twin Disc, Inc. Fiscal First Quarter 2019 Investor Conference Call. Today’s conference is being recorded. At this time, I’d like to turn the conference over to Mr. Stan Berger of SM Berger. Please go ahead, sir.

Thank you, Naomi. 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 2019 first quarter 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 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. 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 President and Chief Executive Officer and Jeff Knutson, the Company's Vice President of Finance, Chief Financial Officer, Treasury 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 2019 first 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 will touch on some of the operational results from the quarter. Historically, our first quarters and the most challenging due to facility shutdowns and summer vacations in many of our European market. The fiscal 2019 first quarter exceeded our expectation in a few areas. When backing out of Veth shipments in the quarter, core Twin Disc sales were up 36% compared to last year. Much of that demand was driven by our North American customers, but we also saw increases in our Asian marine customers and from our global ARFF market. Gross margins, while not at fiscal 2018 fourth quarter levels were better than anticipated for Q1. Jeff will have more of an explanation on the effect of the best purchase accounting on our overall gross margins. Operationally, we did bring more people online and we're seeing operations and that did affect our efficiency somewhat, but we expect that to improve going forward. Jeff will also have more color on our MD&A spending for the quarter, which was driven by a lot of one-off and the addition of Veth. But I would like to highlight two of the activities that drove our spending considerably. The first was our centennial anniversary, which included our global distribution meeting and the creation of our Heritage Gallery here in Racine, which highlights the evolution of our technology and strategy since the very first Twin Disc collection of Wallis Tractor, the acquisition of Veth and the push into marine hybrid propulsion. The gallery is open to the public and…

Thanks, John, and good morning everyone. I'll briefly run through the first quarter numbers. Sales of $74.7 million for the quarter were up $29.6 million or 66% from the prior year first quarter. The quarterly results include the impact of Veth Propulsion, the acquisition of Veth Propulsion, which closed on July 2nd. Excluding the impact of Veth, sales were up 36% compared to the prior year first quarter, which represents the seventh consecutive quarter of year-over-year growth, demonstrating the sustained growth trend we've enjoyed since the middle of fiscal 2017. The primary driver, as John mentioned, for the improved revenue in the quarter remains the improved shipments of oil and gas transmission unit into North America, along with the improved North American aftermarket demand, which has also been led by oilfield activity. In addition, we continue to see improving trends in nearly all of our markets, including the global commercial marine and patrol craft market. Marine and propulsion sales increased nearly 13% compared to the prior year first quarter. Our gross margin performance for the quarter was solid with the margin of 32.1, an improvement of 110 basis points for the prior year first quarter. This result also includes the impact of the Veth acquisition and related purchase accounting amortization. Excluding Veth, gross profit was approximately 35.5%. This improvement is primarily volume driven but also continues to reflect the strong oil and gas and aftermarket mix. Spending and marketing, engineering and administrative costs for the fiscal 2018 first quarter increased $5.6 million or roughly 42% compared to the prior year. Approximately half of this increase represents the addition of Veth and related amortization of acquired intangible. We also had roughly $2 million of non-recurring spending related to unique activities during the first quarter. As John mentioned, these included marketing costs…

Thanks, Jeff. Now to spend a quick moment on our outlook. As Jeff mentioned, our six-month backlog was up 27% and 8% on traditional Twin Disc business. We are very pleased to see some nice backorders for the North American market, the strongest three month ever for Veth in this market. We are also experiencing the strongest demand in my history at Twin Disc for RF transmission. Our introduction to Veth to the global distribution network is just beginning and we're very optimistic about our ability to be successful in growing this business. Finally, we are still bullish on our ability to continue our strong shipments in oil and gas, whether it's for new construction, retrofit or rebuild activity. Heading into the balance for 2019, we feel very good about another strong year. That concludes our prepared remarks. And now Jeff and I will be happy to take your question. Naomi, can you please open the line for questions.

[Operator Instructions] We will go ahead and take our first question from Tim Wojs from Baird. Please go ahead.

I have a few question maybe to start off with just maybe the oil and gas business. We have -- there's been some of your suppliers talking about takeaway issues in the Permian. So, I’m just curious if you’re seeing that show in the customer order books at all. And maybe over the next six months, is there any puts and takes to how we should think about backlog conversion to revenue if there is any pause in spending related to that?

I will answer the first question. Certainly, as that’s been a topic of discussion everywhere, I would just say that the mix which what we’ve seen in the mix of our backlog and new orders Tim, I would say, are more units for retrofit and rebuild taking out some older transmissions, primarily from some competitive transmission and putting ours in. I would say though, in general, our customers the ones that we're selling to still are very optimistic about 2019 and heading into 2020. But again, I would just say that the mix of what we see is new rig construction versus what we're selling to replace an existing transmission in a rig. That mix is definitely I would say in the last month or so, shifted higher to rebuild activity, so not necessarily filling to add new horsepower, just replacing existing horse power.

And then just as we think about the overall backlog. Is there a way to think about that core Twin Disc backlog by end market? I’m just curious if all the industries were maybe up sequentially and organic basis marine, industrial and oil and gas? And then secondarily, how does that compare to maybe where we were a few quarters ago. And really why I am asking is just are you seeing a boarding out of the strength in your backlog, or is it still specific to a couple of sub-industries?

Certainly, we’ve seen growth across the product families to varying degrees. I think marine, in particular commercial marine, has shown significant growth not quite in line with oil and gas but significant. As I said, sales were up about 13% backlog probably little bit higher than that in the marine space; industrial up probably high single digits. So yes, I would say broad positive movement across the product line.

And then on Veth, was the first quarter in line with your expectations in terms of the financial contribution? And I guess the revenues are little shy of what we were looking for. I just am curious if there is some seasonality in Europe that might negatively impact that?

I think you're right. I think there was some seasonality and maybe some unfavorable mix, slight unfavorable mix. We’re still really working to understand the details of how their business works quarter-to-quarter, but I would say broadly in line with what we had expected.

And then just two last ones. What should we think about the pro forma diluted share count for the second quarter? And then just free cash generation for fiscal ‘19, will you be able to generate a modest amount of free cash flow for the year?

So the first one, we’re at about 13.1 million shares outstanding. So that average will continue to grow through the course of the year. So probably around -- I think we were at 11.7 roughly Q1 probably 12.1, 12.2 on average for year-to-date Q2. And free cash flow, yes, I think we did probably a little better quite honestly than we expected free cash flow wise in the first quarter, especially considering the ramp up in inventory and the significant payments we had go out. So, we expect to generate cash over the course of the rest of the year to be positive free cash flow full year.

And just to confirm. So, the end of the quarter share count was 13.1?

Right.

Thank you. We’ll move on to our next question from Jim Dowling from Jefferies Capital. Please go ahead.

I have three questions. I know you've addressed the issue of margins, but if you can. Can you give us a little bit more quantification on the margins for the basic business without the Veth acquisition? You had the benefit of various projects you've completed over the last 18 months or so. And you’ve got increasing backlogs, all of which would argue for expanding margins, offset possibly by some headwinds from labor. But as you look at the quarter that just ended and the next two quarters as we look out. Can you give us some quantification at all on those margins on the basic business?

So the margins, excluding the Veth acquisition entirely, margin for the first quarter was 35.5%, which is roughly what we would have expected coming off of a very strong Q4 over 37%. Obviously, volume significantly higher in Q4 compared to Q1 on that base business Q1 always has the summer shutdowns, etc. So performance wise, margin wise, still pretty much in line with the Q4 levels, and I think that’s what we would expect on that base business, going forward.

And the two projects that you just announced that will be completed sometime in the middle of next calendar year…

Yes.

What do they do to margins?

I would say probably in the couple of quarters, so there'll be headwinds. But we expect the overall efficiency in our 21st operation again to expand. So, while the lease expense and the overhead expense, as we’re starting up both facilities, will be a little bit of a drag. But again, within a couple quarters, we expect certainly us to be able expand our capacity and our shipment volume levels in the Racine operation, which should more than make up for the gross margin impact of having those two additional facilities. So, the aftermarket facility will -- I meant to be more specific in my comments. The aftermarket facility 6 miles west of our operation here in Racine, that should be fully operational in February and free up about 30,000 square feet in our Racine operation, which will expand, assembly and test. And then the Lufkin facility, the depot and industrial facility, that will go online probably in July of next year. So, we’re staggering them apart. So, we tackle one then tackle the next one. But we’re looking to increase again our square footage in Racine operation by about 50,000 square feet for new machine tools to allow us to cut bigger gears, reduce costs, so we’re not buying some of these very expensive components on the outside, but then also expand our capacity for assembly and test. So overall, when all are done, you should see this greatly help the gross margins here in the North American operations.

My second question is just to back track a little bit on your comments on the backlog. I was writing quickly, so I may have missed it. I thought you said that excluding the Veth acquisition that the sequential backlog increased about 8% from the previous quarter…

That’s correct…

Then you gave some numbers, you said that and I don’t know whether this with or without Veth. You said marine was up 15, industrial was up high-single-digit. If that’s true, it would suggest that oil and gas was flat?

But it depends on what period you’re comparing to. So, if we’re comparing to the previous quarter, yes, I would say oil and gas was relatively flat. We shipped significant orders. We took in new orders. So, it was probably up slightly marine in that 10% to 15% range and industrial high single-digits.

And then my third question is, what are the early returns to the degree that you can qualify or quantify them for the cross selling between the basic business and the Veth acquisition?

I would say that I don't really think it's a coincidence that Veth had their strongest three months of North American orders now that they were part of Twin Disc. I think it gave a lot of our customers here, which were joint customers. They had going to Veth for some application and maybe bought some smaller thrusters. But now that they’re part of our team, I think there was a lot of confidence in the customers here to finally order big projects from Veth. So, we’re very happy about that going forward, we think will grow the business here. I would say as far as synergy in cross selling, I think the big thing you’re going to see is invest hybrid and diesel and electrics development whether its software or hardware. And our, the hybrid in diesel electric that we’re working on for our traditional transmission, mostly -- hybrid that you’ll see a lot of cross selling of components where we can use some of the Veth hardware in our system and that can use some of our clutches in there. So, the cross-selling has begun with our customers but also in the joint utilization of components that we’ve already developed.

We’ll move on to our next question from [John Wolfhausen] from [indiscernible]. Please go ahead.

Just a quick question, I don’t think we’ve mentioned steel prices and -- what you’re seeing out there and what you expect the impact of rising steel prices to be?

We’re starting to see that impact. We’ve seen pricing increases on components. We don’t buy, I would say, typically raw steel. We buy raw materials that are coming from bar stocks, forging, castings. And we’ve seen pricing impacts in the mid single-digits, in some cases, closer to 10. On some of the electronic components that we do source from China for our control system, we have seen that 25% increase. Thankfully on that, it’s a very small percentage of our overall product cost structure. But we have had recent pricing actions on a lot of our larger transmission projects to compensate for that. So yes, the answer to your question, we have seen the impacts of the tariffs. On domestic suppliers, we’re buying castings, forging and bar stock from domestic suppliers.

And are you addressing that by price increases yourself or…

Yes, we are instituting price increasing -- price increases to capture those increased costs.

Move on to our next question from Tim Curro from Value Holding. Please go ahead.

I was just hoping, you could clarify an accounting question regarding the gross margin. So, if I exclude the amortization associated with a write-up with inventory, does your gross margin go up or down?

I guess where you're starting from, so from 30.1%, if you -- the amortization was about $1.2 million in the quarter. So, 32.1% becomes a little over 33%. If you are comparing it to our Q4 results, certainly it's down because the overall Veth business not coming in at 37% gross profit. Does that answer your question?

Yes, thank you.

Thank you. We’ll move on to our question Tim Wojs with Baird. Please go ahead.

Just two more model things, guys. I guess the first what’s the expectation for purchase accounting for the year? Just so we can make sure we have in our numbers. And then should there be any more restructuring chargers over the next few quarters?

I think, we'll answer the first one, to begin with. So, what you saw in Q1 was $1.2 million in costs to goods sold and about $600,000 in ME&A related to purchase accounting amortization. That will likely -- right now, we’re projecting that to be at the same. The valuation work is still underway, still preliminary so there is a chance that those intangibles could move around a little bit. But at this point, we don't have any reason to expect that. So, that’s the most logical assumption. What was your second question, Tim?

I was just asking about restructuring, but one that question. So, how much of the inventory write up continues, because that should go away at some point, right?

That’s a fourth quarter phenomenon, so $1.2 million for just this fiscal year, but it's appropriate…

And then just restructuring…

We will continue to see some level of restructuring. We don't anticipate anything significant, at this point. So, plus or minus a reasonable range around what you saw in the first quarter.

Thank you [Operator Instructions]. We have no further questions at this time. I would like to turn it back over to you, Stan.

Thank you. And thank you for joining our conference call today. We appreciate your continuing interest in Twin Disc and hope that we have answered all your questions. If not, please feel free to call Jeff or myself. And we look forward to speaking with you again in February following the close of our fiscal 2019 second quarter. Naomi, I will turn the call back to you.

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