Please standby. Good day, and welcome to the Twin Disc Inc. Fiscal Second Quarter 2021 Earnings Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Stan Berger. Please go ahead, sir.

Thank you, James. 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 2021 second quarter and first half 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 the copy to you. Hosting the call today are John Batten, Twin Disc's 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 2021 second quarter conference call. As usual, we'll begin with a short summary statement and then Jeff and I will be happy to take your questions. Before Jeff goes over the quarterly results, I'll touch on some of the operational highlights or headwinds that we faced in the quarter. Again, in the fall timeframe of our second quarter we faced to get a lot of our distributors and end-customers working down inventory that was in the pipeline. And we've seen that come and the trends start to reverse and orders in the backlog improved in the quarter. I thought our team did an excellent job navigating the continued -- continuing COVID pandemic and ongoing staffing issues due to quarantines. Obviously, having people out in the plant here and we're seeing 15% to 20% of the staff but there are a lot of increased efficiencies and some extra overtime on people who were not on quarantine. Half of the topline miss that we faced in the second quarter was due to aftermarket, and obviously, aftermarket parts come at a higher margin and a lot of that mess was due to a lot of decreased activity, the ability to do rebuild out in the market, and we've seen that trend reverse as of late as far as incoming orders in the quarter and that continued into January. Our facility in Lufkin did come online in late November, early December, and we started producing and shipping our -- some of our mechanical clutch line and all of the mechanical -- the rest of the mechanical clutches and PTOs were transferred there over the holiday shutdown. Orders in the quarter did show some improvement and our backlog as you've seen in the press release did increase during the quarter, we saw strong orders at our Veth subsidiary, we saw good orders in Asia and Australia, and a lot of the U.S. and European core markets. Obviously, activity in North American oil and gas remained extremely low, but we did see some aftermarket demand in orders at the end of the quarter, we are seeing some rebuild activity at some of our customers starting in January. We did have a nice increase, again, in projects for hybrid and electrification, and our application and engineering teams are very busy with projects in most of our core markets, whether it's industrial, marine or oil and gas, and we are expecting to get more orders as these projects come to completion. With that, I'll turn it over to Jeff for some comments on the financials before I come back for an outlook.

Thanks, John and good morning, everyone. I'll briefly run through the fiscal 2021 second quarter numbers. Sales of $48.4 million for the quarter, down $11.1 million or 18.6% from the prior year second quarter. But the quarter declines from the prior year was a result of continuation of the generally weak global economy due to the ongoing effects of the COVID-19 pandemic. Compared to the prior year second quarter transmission sales were down 28.7%, industrial sales down 8.2%, and marine and propulsion down 18.1%. By region, sales in the North America were down 35%, sales in the Europe were down 17%, and sales in the Asia-Pacific were actually up 11% on improving Australian market demand and relatively stable demand for oil and gas transmissions in China. Foreign currency exchange was a net positive $2.1 million impact to sales in the quarter. For the first half sales are down $24.2 million or 20.4% with currency translation contributing a positive impact of $3.6 million compared to the prior year first half. Second quarter margin percent was 19.6% compared to 26.4% in the prior year second quarter. The decline in margin percent was primarily a function of the reduced volume and then very unfavorable product mix with significant decline in aftermarket volume and shipments in the North American oil and gas market. Gross profit for the first half finished at 20.9% compared to 21.3% for the fiscal '20 first half. Spending on marketing, engineering and administrative costs for the fiscal '21 second quarter decreased $2.4 million or 15% compared to fiscal '20. The decrease is primarily the result of reduced payroll cost, bonus expense, corporate travel, amortization expense and marketing activities. Along with the reduction in all, North American wages would continue to aggressively pursue cost reduction opportunities to compensate for this decline…

Thanks, Jeff and I have just a few comments on the outlook. As we've mentioned, orders and backlog improved in the second quarter and we saw that across most markets including oil and gas and some spare parts orders, and we expect our markets -- the core markets to improve throughout the year; obviously, oil and gas may improve a little bit towards the latter half of the year. But we are seeing, as I mentioned, much better demand in our aftermarket spare parts orders. The order rates in January were double of what they were throughout the summer, so that gives us a lot of optimism heading into calendar 2021. Our focus remains diversification through the growth of our other markets outside of oil and gas, primarily industrial with our new products coming out with the HPTOs or the RPTO [ph] line that are going to be produced at the Lufkin facility. And again, our focus on how we participate whether supplying the complete system in hybrid and electrification or how we provide the key components that work in the general systems. We will continue with those product development efforts throughout the year and continue to rationalize our investment in bricks-and-mortars, whether it's in North America or in Europe. That concludes our prepared remarks. And with that, now James, we'll turn it over for questions.

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

Hey, good morning, John and Jeff. Can we start with the transition and ramp up Lufkin. So first I want to understand then you talk a little bit about how the transition is going, how you see kind of revenue capacity ramping at Lufkin in a period of time if you can remind us of the revenue I think that can support and how much of that is incremental. And then just to clarify did you have any sort of production slowdowns or any lost revenue in the quarter from the transition or do you expect any? Thanks. A - John Batten Hi, Noah. It's John. So probably so Lufkin will probably be for the first 12 plus months about 1 million to 1.5 million of shipment a month as we transition the units that were being produced here in Racine. And that facility we easily -- that facility defined -- depending upon what units go there. We have the brick-and-mortar there, phase 1 of 50,000 square feet. We easily could go to 30 million to 50 million depending upon the value of the units that are produced there; so we have considerable room for growth there. So the incremental I wouldn't say there is much incremental business there. It's moving business from Racine, but given -- the extra the room and the capacity there and the team focused. We are determined to grow our industrial business and grow it in a way that we could not have done it in Racine given the constraints here. So part of the plan with Lufkin is to move obviously the industrial production there. We move the inventory, we free up room here in Racine. We have three facilities currently in Racine County. We have corporate headquarters, 21st Street, which is our main manufacturing plant and then we have an aftermarket warehouse out on the Interstate. So the plan is once Lufkin is up and running, we can consolidate some of the facilities that we have in Racine here for further savings. So the long-term plan is growth of our industrial business in Lufkin which will then allow us to consolidate some of our facilities here in Racine.

Yes. And I would say that run rate there's a lot of untapped markets you can play, but can you talk about your strategy for growing industrial sales and market applications, regions where you think you have relatively low partners?

So it's our biggest potential for growth is in the industrial markets and it's with the clutches in the PTO lines. We're doing a lot of projects and a lot of development on being able to plug in play into hybrid and electrification efforts. All many of which require motors I mean which require gearboxes with motors and control systems. So whether it's expanding our hydraulic PTO, which typically a larger horsepower than the mechanical PTOs or remote control activated mechanical PTO lines or pump drives and gearboxes. So a pump drive or a AM line basically in a hybrid application connects behind the diesel engine and provide inputs whether it's a hydraulic pump or an electric motor. So as more and more applications shift to hybrid and electrification, we have pieces that plug in very nicely to that. So it's growing the core, the existing -- just a purely internal combustion engine part of industrial, but then we see a lot of the growth in the hybridization and electrification areas. So it's across all markets, it could be recycling, construction, biomass some oil and gas applications. So we're really looking to grow and have the focus on the capacity of a facility that is not on different cycles; so, Lufkin facility will be solely dedicated to the industrial business.

Great. Thanks so much.

Thanks, Noah.

Next, we'll hear from Josh Chan with Baird.

Hi, good morning, John and Jeff. Just dovetailing on the prior question about the sort of the strategy to grow industrial. I guess will -- that what's kind of required to work with newer OEMs that you haven't worked in the past or are these usually with OEMs that you already have a relationship with and kind of how are you going about those I think that's [indiscernible]?

Yes, it's -- Josh it's both and all of the above. It is working with our existing customers, they venture into hybridization and electrification, and it's working with new OEMs that we haven't worked with before and then a lot of it is working with partners because as I mentioned in previous calls. It's rare that one company can provide all of the components and the solution. So we find ourselves working with electric motor manufacturers, people who do the inverters, other controls companies and so it's -- it is -- it's not a one size fits all solution. What we're trying to do is look at our traditional customer base and other customers that we don't have work with them on solutions that they need and then try to put together the solution for them and we can provide all of that or we can provide part of it or that we have the products that plug into a hybrid solution or an electrification solution that someone else is providing. So it is all of the above; our main effort my effort and the management team is to focus in on the solutions that are going to provide the best return in the near-term. So we can obviously we can focus on everything we have to sharpen our focus and that's what we've been concentrating on the last years is working with key customers that have been long-term customers and then exciting stuff for us working with some new customers.

Okay, that's good to hear. I guess my next question is on the oil and gas business. Does the backlog improvement or may include some of the improvement that you expect to see over the next couple of quarters and then I guess broadly with respect to the replacement cycle. How do you expect the pace of that to come through. I know that in the past both cycles have been sort of all at once, but the replacement kind of come at a more gradual pace?

Yes. So Josh, the improvement in the backlog I would say there's unit demand improvement for Asia, some spare parts demand improvement here in North America seem a little bit stronger demand on some of our distributors. So they've had some inventory that they're able to get out of their inventory and hopefully we'll soon see the replacement orders on us. Yes, I don't see a new unit demand for new construction like we saw in 2017, 2018 or 2011, 2012, right. We'll see one maybe at the end of second half of this calendar year. But I think you'll see a steady improvements of some rebuild activity. Again, what we're waiting to see is transportation demand to get back to even what it was before the COVID pandemic get demand, demand on oil up and that will drive production and make people more comfortable about investing in rebuild activity.

That makes sense. And then I guess last question is, how should we think about your ability to leverage the ME&A line is if you I guess presumably well next year. Can we expect to see some leverage there or will some new expenses going to come back. How should we think about that?

Yes, this is Jeff, Josh. Yes, I think, as we recovered to sort of more normal market conditions. ME&A expense will come back. We've obviously done a lot of reduction some of those permanent, some of those the wage reduction for instance eliminating the bonus program all that kind of stuff would come back in normal times, but I think we have done a good job of really making sustainable reductions in our cost structure on the ME&A line.

That's great. Thank you both for your time.

We'll move on to Rand Gesing with Neuberger Berman.

Hi, guys. I guess some people have a bit of a feeling here in the next couple of quarters in the top-off perspective voice in the background. Can't avoid them, so I just wanted to sort of the free cash neutrality environment, make sure that the working capital will kick back in. We talked about this maybe a little bit on the graph. What's your position that we can sort of keep out of the cash burn in the second half?

Yes, as we've talked about in the first couple of quarters, that's our focus. We're happy with where we are. I think we have the ability to continue to sort of stay neutral. I think obviously any activity in North American oil and gas is only going to help us and we have inventory to support that demand and that can turn into cash very quickly and as John pointed out we're starting to see some of that aftermarket demand. So we're still, in my mind, we're still focused on staying neutral and not leaving cash in this fiscal year.

Most of the orders you're seeing most recently are those sort of book and ship. They're not going to reprice outside the year, fiscal year?

We have to do book and ship. Book and ship. Yes, essentially booked and shift in the aftermarket.

Okay. Any update on the sale of Racine headquarters?

No. It's been -- I would say, relatively quiet we've had one interested party, but nothing, nothing to report.

Okay. And what listed on the market for?

I think the list price is 4.3.

Okay.

Rand, do you need a clean office?

I do. I also welcome. Execute the late.

Okay, good. Well, obviously that will be a little bit of liquidity that amongst.

Okay, thanks. I just wanted to check on the side. Thanks.

We have a question from Jim Canna with Merrill's Investments [ph].

Good morning. The liabilities that you referred to that our Euro-base the translated negatively dollars; can you give me more details of what that is|?

Sure, we have part of our revolver is euro based a liability was it was debt that we took on when we acquired of that subsidiary a year and a half ago. So to that denominated in Euro. That's the biggest piece of it.

Got it, thanks. And just to remind an application on the land transmission segment; what -- how much of that is oil and gas specifically?

Yes, I mean obviously that's our most cyclical piece. So right now, it's probably 20% oil and gas, all in Asia -- essentially all Asia, right now, but it can be over 50% oil and gas when it's at it's peak.

And to what extent do you think progress on gross margin for you going forward relies on North American natural gas recovery, sort of looking around the corner type question a little bit, but your gross margins here kind of sub-pointing. I think you've hit on extension [ph] problem in the quarter. But I'm just curious, is North American natural gas and -- or North American oil and gas at higher gross margin piece of that segment that didn't really is a driver for gross margin or is that not the case?

It is, it is a driver, and I think that's when you go back to some of our best quarters when we were in the mid-30s; that's really high North American oil and gas activity. I think we can get improved margin, certainly, without a significant move in oil and gas but to get to where we all want to be, which is back around 30, is going to require some North American oil and gas, at least in the near-term. We're working on a lot of things to drive improvement, in both, our cost structure and new products, to improve margins. But right now, that North American oil and gas and the aftermarket component of that is a big driver of our mix impact and net margin performance.

Yes. So from a big picture perspective, do you think this oil and gas cycle is any different from prior cycles or are you on the assumption that activity will come back as it always has?

It's is John, Tim. I -- it will come; I do not think the next wave will be as big as the one, five years -- three years ago. I think there people will be more tempered on investment. I think the long-term outlook is still good, we still need to generate electricity and natural gas, as you pointed out is the primary source of electricity; renewables are coming online and increasing the percentage every year, but I still think there is huge role for natural gas in that mix for electricity, and honestly, that plays into our strong suite because that's typically the higher horsepower fracturing rigs and that tends to -- our 8,500 transmission fits in perfectly there. So, long-term optimistic that we still have a very strong market. I think everyone who is in the market, ourselves included, would like it to be more balanced and steady state then binary, if either being all on or all off; so that's our hope. We would take years of lower demand per year over more years than all or nothing in a year and a half of two years, and then the cycle turn off again. But we're optimistic, yes, there will be some new rig construction; we're also some retrofit and rebuild activity. Again, I think we would have seen more of that in calendar 2020 if it were not for the pandemic; that put a lot of capital spending plans on hold as demand plummeted and the price of oil plummeted. So we see a reversal of that trend, and I think a lot of it has to do -- it will be completely -- not completely, but very much tied to the general economy improving post-COVID, post-vaccine. And if I had to guess, if I had…

I wouldn't disagree. But I would say that it's still on the base production. If I take your assumption that North American oil and gas product or North American oil production; it will have a steady state decline. I -- that is certainly -- that is a scenario, that's one of the most likely scenarios. But again, there is still production and the equipment needs to be replaced and pressure pumping is an integral part of that. We see more -- we've seen less investment offshore in deepwater; so more and more of the swing production and demand I think is going to be onshore. So the market may not be as big or growing but the equipment absolutely has to be replaced, rebuilt and maintained. And again, we're not -- Tim, I guess, nothing surprises me in oil and gas, meaning that any little event or hiccup in the Mid-East could change OPEC's plans, and we can't forget that OPEC as nations they need oil prices to be a lot higher just to fund their budgets, which is not the case here in the U.S. As I've said in the past, it's an asymmetrical battle or weighted average rate if you want where U.S. producers and Canadian producers are basically competing with nations. And Russia and OPEC, they need oil -- I mean, realistically for their fiscal budget, they need oil around $100 to pay for all of their social programs; this country doesn't, Canada doesn't. So, all that's doing is driving Canadian and American producers to be more efficient. So, I – again, Tim, nothing surprises me but certainly in our planning and that's one of the reasons we want to diversify. We still want to get everything we can in oil and gas, North America on onshore because we've seen the pressures that have ports offshore. And again, why we want to grow our business outside of that because we'll take the bubble provided our base business is growing other places. Speaker A-Jim Canna Thanks. It's really helpful to hear your thoughts on the planning aspects [ph]. I appreciate that. Operator That will conclude today's question-and-answer session. I will now turn the conference over to Mr. Batten for any additional closing remarks.

Thank you, James. And thank you, everyone, for joining our conference call today. As always, we always appreciate your continuing interest in Twin Disc, and hope that we've answered all of your questions. If not, please feel free to contact Jeff or myself, and we'll try to get back to you as quickly as we can. And we look forward to speaking with you again following the close of our fiscal '21 third quarter. And with that, James, I'll turn the call back to you.

Thank you, sir. That will conclude today's conference. Thank you for your participation. You may now disconnect.