Greetings. Welcome to the Twin Disc, Inc. Fiscal First Quarter 2023 Earnings Conference. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Andrew Berger of Investor Relations. Thank you. You may begin.

Thanks Latania [ph]. 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 2023 first quarter 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 the news release which was issued this morning before the market opened. If you have not received a copy, please call our office at 262-638-4000 and we'll 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'll now turn the call over to John Batten. John go ahead.

Thank you, Andy and good morning everyone. Welcome to our fiscal 2023 first quarter conference call. As usual, we will begin with a short summary statement and then we'll be happy to take your questions. As much as went right in the fiscal 2022 fourth quarter, we'd hoped that more of that momentum would carry over into the first quarter of this year. Our global operations team did as much as they could with the supply chain, getting out as much as we did. We faced several shortages and delays in the quarter whether it was chips, wiring, harnesses, gears, gears, forgings castings, and we faced a new challenge with heat treat capacity. Reshoring to North America is very real and causing considerable delays due to capacity constraints and continued elevated pricing even with scrap falling for six months. The European supply chain continued to have its own struggles with high utility costs, significant cost of living increases on wages and salaries, and a shortage of labor in general. It's disappointing not to have a much higher revenue line in the quarter because the demand was there and continues to be there. In our European operations, we're going to address the cost structure in very short order based on the inflation we're seeing continuing to rise, and our delayed ability to capture that real-time pricing. While European governments can raise salaries effective immediately, manufacturers have to honor price at the time of quote. Additionally, those cost of living increases were much higher than anyone had expected that we saw issued this summer and fall. At this revenue level in the quarter, we would have expected to see gross margins at least 300 to 400 basis points higher and we will focus on making that a reality in the second and…

Thanks John and good morning, everyone. I'll briefly run through the fiscal 2023 first quarter results. Sales of just under $56 million for the quarter were up $8.2 million or 17% from the prior year first quarter. The sales increase reflects the improved demand in the company's global oil and gas, industrial and marine market. Shipments in the quarter were somewhat limited by ongoing supply chain constraints mentioned in previous quarters. Electronic components remained the most challenging area to find reliable and predictable supply. With help from improving North American demand for pressure pumping equipment compared to the prior year first quarter, our transmission product sales improved by 30%. Sales of industrial products increased by 15%, while marine propulsion product sales grew by 10%. By region sales in North America were up 33%; Asia-Pacific up 8%; while sales into Europe were up just 2%. The strengthening of the US dollar has begun to impact our competitiveness when selling us produced goods into the European market. Foreign currency exchange has a net negative $4.8 million impact to sales in the quarter and on a constant currency basis, first quarter sales increased 27.2% from the prior year. The first quarter margin percent was 23.8% compared to 28.2% in the prior year first quarter. The prior year result included several one-off benefits, including a domestic ERC credit, a Dutch COVID subsidy, and a favorable adjustment to the warranty reserve. Adjusting for these non-recurring items, the prior year gross profit would have been 22.9%. The increase -- the small increase in the current year then is a function of improved volume and a favorable product mix, partially offset by the negative impact of inflation, primarily at our European operations. Spending on marketing, engineering, and administrative costs for the fiscal 2023 first quarter increased $2…

Thanks, Jeff, and I'll spend a quick moment on our outlook. Despite our first quarter results, we still feel very good about fiscal 2023. Like last year, we think the quarters will build through the year. We will have to address some local cost structures due to local conditions, whether that's inflation we can't pass on, supply challenges, et cetera. But in general, our markets are much more optimistic than they were a year ago, and we are, too. The challenges that manufacturers are facing are coming in waves, and we will continue to deal with them. As Jeff mentioned, the additional challenge right now in the past few months has been the strengthening of the US dollar. And while it helps our European operations selling into North American markets, it is a concern going forward on our US-based products, primarily marine transmissions, which are sold into Europe. That concludes our prepared remarks, and now Jeff and I will be happy to take your questions. Latania, please open the line for questions.

Thank you. We will now conduct a question-and-answer session. [Operator Instructions] Our first question comes from Noah Kaye with Oppenheimer. Please proceed.

Thanks for taking the questions. John, I think you mentioned kind of margin expectations 300 bps, 400 bps higher than actual results was really reflecting the lag on price cost. So just help us understand, as you look at the backlog today, how does that look for subsequent quarters, think about 2Q, 3Q? What is that 300 bps, 400 bps drag look like as we look in the next couple of quarters?

Well, I'm going to let Jeff help me there, too. But Noah, I can just tell you on the trend, it looks better going forward. What's our backlog, if we look at it today going out the next three quarters, looks better than it did at the end of the fourth quarter. We knew that the Veth projects were at a lower margin than inflation. But just in general, I mean, if you go back, our first quarter is always our most challenging one just with shutdowns in Europe, longer shutdowns in Europe, but we have shutdowns in North America. But Europe, I would just say Europe, in general, was incredibly inefficient. I'm not just talking about our operations. Europe, in general, in the first quarter was incredibly inefficient, and we had cost of living increases. For instance, Belgium is usually 1% to 2%. We thought that given the extraordinary inflation times that would be 2% to maybe 4%, and they always have it delayed a quarter. They did an 8.5% effective immediately. That was one of our European operations. We didn't anticipate that and the effect on the whole quarter. The Dutch cost of living increase was also higher than expected. But in general, we need to -- and the revenue levels in Europe and all over continue to be lower than the demand is by 15% to 20%, meaning that there's 15% to 20% that gets caught because we don't have all the parts. We're taking a serious look on how long is this going to continue. We -- can you be staffed in certain operations when the revenue is going to be significantly lower based on supply chain? So, that's what we're working through right now. The frustrating part, again, is demand is there. I mean, we…

That's helpful. And I guess just listening to that answer, there are a lot of companies in various industries that really had to change how they price, right, because we've been looking at some extraordinarily challenging times with respect to wrangling the inflation bear. So talk to us about how you price and how that may change. You mentioned the cost of living index. What -- how do you price projects now? And what are you changing? And do you think that, that allows you to kind of better manage inflation going forward?

It does. So what is -- besides the sheer frequency of our price increases, which I've never seen anything like it, meaning price increases every quarter. Historically, from North America, we had been priced at the time of shipment, that was very difficult to -- we were able to do it. We also did surcharge last year. I'm not saying we'll never go back to a surcharge, but we are much more now pricing at the time of the order, we're giving you a price. But the price may change next month, meaning you order model XYZ, the price is $100 today if you order it, but in two months, it might be more. So we are pricing at the time of shipment, primarily because we can't, in Europe, it is almost impossible to do price at the time of shipment. It's priced at the time of order. And you go back two years, we did annual price increases. What's changed now is, we're going to do them much more frequently and look at every order. And we're hopeful -- and I do think a lot of the inflation has stabilized. We're at a much higher level. We don't see a lot of the material costs going up, but they're not -- as I mentioned, they're not coming down, even with six months of scrap prices falling, we're not seeing price decreases necessarily from our suppliers. So we feel better about the stability of some of it, but it's -- they're not coming down. So to answer your question, it's -- we're looking almost everything as a case-by-case basis. When we quote, are we confident in that we have the margin at that time? And if it changes, when we -- when someone wants to buy it a month from now, the price may be different.

Okay. And if I could sneak one more in. I don't want to steal thunder from future project announcements, but you did mention that you've got some exciting projects in the hybrid and electric space apart from Hinckley. Can you just maybe give us an idea of what sort of applications or…?

Yes, I would -- more -- there's going to be more work boat commercial related things like that. Hinckley was definitely a huge splash with one of the premier builders in the pleasure craft market. I mean, there are more projects there, a little bit longer-term further off. But there's a lot more, I'd say, not smaller, but one, two, five, 10 vessels coming up in whether it could be a ferry. It could be a taxi system. It could be things like that. So the commercial space is very, very active. Everyone is positioning to find a more fuel efficient green solution and with a vessel that they're using as a revenue generating business. So we're very optimistic. Again, though, it's going to -- it's -- everything is based on getting all the components there. So, electric motor lead times have been pushed way out. So that's one of the things that we're dealing with right now and trying to get some more announcements. And so a lot of what we work on, whether it's on land and an industrial construction type of equipment or a vessel, we do the application. They get it, then they want to they want to test it and do it for six to 12 months and then will be released, but there will be more coming through the year, for sure, that we can talk about.

Great. Well, appreciate all the color. Thanks.

All right. Thanks, Noah.

[Operator Instructions] Our next question comes from Simon Wong with Gabelli Funds. Please proceed.

Hey, John and Jeff.

Hey, Simon.

Hey, Simon.

Just some quick questions on the oil and gas side. How much of your sales this quarter was in oil and gas?

It's a good question, Simon. Let me do a quick calculation, and why don't you jump on your next question, and then I'll come back to you real quick.

Okay. My next question also related to oil and gas. How much of the orders came in related to oil and gas? Because you had really nice order quarter, just wondering how much of that was due to the North American pressure pumping -- pumpers coming back?

I guess, I can tell you it's a big part. I don't have the numbers. I'm not in the same room with Jeff, but it's a combination of equal part about new unit orders as far as units, but also parts continue at a high level. So it was a pretty good quarter for oil and gas North America.

No, are they related to the traditional diesel fleet? Or are we seeing order for the...

So the parts, obviously, are for the traditional diesel fleet, but we do have -- it's a small percentage right now, but I would say that each quarter that we go forward, units for the e-frac fleet will get much higher. I can see a point in the next few quarters where you ask that question, and we're at 15%, 25%, potentially 50%. That's not very far away.

Okay. All right. So if a pressure pumper place an order for new equipment today, what's the lead time or actually not pressure -- placing order for transmission today. What's the lead time for you guys?

We could get to an 8,500 for the traditional fleet probably in, I would say, three months, three to three months. And the reason I go to three months is because we're dealing with Jan -- and sorry, November and December are short months with holidays. But yes, if you ordered them today, we would have them early in the calendar first quarter of next year.

Okay. All right. And then last question --

And Simon, let me just go -- so one of the reasons -- just I was going to come back. So one of the reasons I think we haven't seen -- that we potentially could have seen more is what's controlling the refit of the fleet continues to be lead times and availability of engine. So what's happening is we see customers securing engines and then we're getting orders just enough transmissions to satisfy the number of engines that they have. So I think it will -- as engine supply becomes more reliable and more available, then we'll see our orders go up.

Okay.

The flip side is when they don't have engines, we get more spare parts orders because they rebuild, they're rebuilding.

Right, right. Okay. Great. And then you mentioned something about hydrogen in the -- in your press release. Can you talk more about what you're doing there?

Which part, Simon? I --

Yes, some new market leading trend. It's a control system for hydrogen applications among -- in your press release that you had some -- you're looking -- you see demand across global markets for hybrid, hydrogen and electric vehicle applications.

Oh, okay, okay. I thought you said hydrogen. I was like -- no. So yes, with the Hinckley and with everything that we're working on our controls group and engineering, they continue to refine our base hybrid controller. So, using our controls logic being able to control multiple inputs and multiple outputs. So every project that we do, we're getting better and better and better on which our controls, so I think of our controls, technology and the product, that's the brains of the application. In our mechanical products, whether it's a marine transmission to frac transmission, an RF transmission or one of our hydraulic PTOs, that's the heart. So that's what's moving stuff, making things work, but our controls group is doing an incredible job with our controls technology, creating a very adaptable and cost-effective control system that will work in all of our off-highway markets. So it's -- some of these production delays, I mean, we can't -- it's giving them time and then also giving them time to develop it, develop sources, multiple sources. So they have done an incredible job in the last 12 months getting us ready for this transition in all of our markets. They are a very real strength at our company.

Okay. Great.

Hey, Simon, just going back to your first question. It was about 20% of the quarter was related to oil and gas market.

Yes. Do you have a split between new equipment and consumables?

It's pretty balanced actually, pretty balanced.

Yes. It's -- yes, Simon, it's balanced right now. And that goes back to what I just said. If there were more engines available, it would tilt to more units, but the engines aren't available. So we're seeing a lot more rebuild activity.

Yes, I'm hearing engine is a real constraint here. Okay. Great. Thank you, guys.

Thanks, Simon.

Our next question comes from Jim Dowling with Jefferies. Please proceed.

Yes. Good morning, fellows. Could you give us some color on the inventory breakdown between North America on the one hand and Europe and finished product versus work in progress and how that might skew by end market, energy and marine?

Yes. So, we've got, say, a little over half of our inventory is in what we would call a salable, so either a finished part that could be sold as it is or assembled into a new unit or fully assembled units. Say, about 20% is work in process. And the remainder, 30%-ish, is raw material. A big component of that inventory, I would say, in terms of WIP and finished parts is in the oil and gas market here in North America. That would be the biggest component. In Europe, it's primarily marine. Europe is probably I would say just maybe 40% of our total inventory. 60% would be -- a little over 50% in the US and the remainder in Asia, Asia Pacific. In the US, like I said, it's industrial, it's marine, but the biggest component would be the oil and gas piece in that. That's what's allowing us I guess, from John's earlier point, to be able to deliver a very large and complex transmission within potentially eight weeks.

And one last inventory-related question, how much of your inventory has already been priced into a final product but can't be delivered because of other delays? And how much are still open where you can charge whatever the market will bear?

That's a good question. I don't think it's a huge percentage of our inventory that's locked in. I would say -- and John, you maybe have a better feel. I would say, it's more 10% to 20% maybe range of inventory that's sort of committed to price -- fixed price orders, but I'll admit that, isn't something that I've thought through completely.

Yes, it may be a little bit higher, but it's not the majority, Jim. That's for sure.

Thank you.

At this time, I will turn the call back over to Mr. John Batten for closing comments.

Thank you, Latonya, and thank you, everyone, for joining our conference call today. We appreciate your continuing interest in Twin Disc, and hope that we've answered all of your questions. If not, please feel free to reach out to either Jeff or myself. And we'll get you an answer to your question as quickly as possible. We look forward to speaking with you again at the close of our fiscal 2023 second quarter. And now Latonya, I'll turn the call back to you.

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time. And thank you for your participation, and have a great day.