Twin Disc, Incorporated

Greetings and welcome to Twin Discs Fiscal Third Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Jeff Knutson, Vice President of Finance, Chief Financial Officer, Treasurer, and Secretary. Thank you. You may begin.

Thank you, Doug. Good morning, and thank you for joining us today to discuss our fiscal third quarter 2023 results. On the call with me today is John Batten, TwinDisk CEO. I would like to remind everyone that certain statements made during this conference call, especially statements expressing 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 , copies of which may be obtained by contacting either the company or the SEC. Any forward-looking statements that are made during this call are based on assumptions as of today and the company undertakes no obligation to publicly update or revise these statements to reflect subsequent events or new information. During today's call, management will also discuss certain non-GAAP financial measures. For a definition of non-GAAP financial measures and a reconciliation of GAAP to non-GAAP financial results, please see the earnings release issued earlier today. 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 will send a release to you. Now I'll turn the call over to John.

Good morning, everyone, and thank you for joining us today. I'd like to start today's call with a few highlights from the quarter. Strong demand across our end markets, coupled with an easing supply chain constraints, and in turn higher shipments translated into a 24% increase in sales year over year and double-digit sales growth in our North American markets, and Asia Pacific regions. Margins were adversely impacted by multiple factors, including a non-cash LIFO charge related to a reevaluation of inventory and higher costs that more than offset the pricing actions we implemented mid-quarter. Normalizing for the non-cash impact of margins, the operational accomplishments of our team would have resulted in sequential margin improvement, which has been and will continue to be a top priority. Further, we also generated nearly $7 million of cash from operations and ended the quarter with our highest backlog in more than four years and VETS largest backlog ever. We have already taken a number of actions to respond to headwinds stemming from supply chain constraints and higher costs. And we've been working with other strategic vendors to source components that are in short supply or that are currently sourced from a single supplier. The operational accomplishments of our team lend to a significant improvement in shipments, which will allow us to continue to decrease inventory and further improve lead times. I'm also encouraged by the results we are seeing from our collaboration between VET and ROLA. The VET team has been working with our propeller manufacturer to include more twin disc content in their designs and provide a better overall product to customers. There has been a noticeable increase in the number of applications of our hybrid and electric offerings, and we are seeing a correlated increase in new orders as a result. Our marine and propulsion systems product group continues to experience strong demand across end markets. We are seeing more activity within offshore oil and gas, which is translated into offshore oil supply vessel inquiries, something we haven't seen in several years. As the geopolitical environment in the South Pacific continues to evolve, we've concurrently observed a significant increase in the number of inquiries from U.S. and European governments for small military marine transmissions used in shallow water boats. VET has had a number of wins recently. and has experienced its geographical reach beyond its core northern European markets, booking orders across North America, Asia Pacific, and the rest of Europe, including Italy, which is a key luxury yacht market. We are excited about what those opportunities represent. On the land-based transmission side of our business, the lack of oil and gas investment over the past few years has increased utilization and the need to rebuild or replace fleets. That said, as we continue to see elevated demand with the oil and gas end market, customers continue to face constraints on new engine availability from third parties, which has led to delayed orders for new transmissions. Instead, we've experienced increased orders for rebuilding existing transmissions, work we are uniquely positioned to complete. Our EFRAC testing continues to progress, and the feedback on the results to date remain extremely positive, and we anticipate orders to begin shortly after this fiscal year. Within the industrial product group, we continue to experience stable demand across end markets and have been able to maintain volumes in line with the spike observed last year. While still early days, there has been a noticeable increase in opportunities to work and to partner with key domestic OEMs on a variety of exciting projects. Additionally, we have seen the number of hybrid and electrification system applications continue to grow. The greater twin-disk content in these systems presents an opportunity to accelerate sales growth and expand the margin profile for the industrial product group. Focusing on inventory and backlog for a moment, strong end market demand persisted throughout the quarter, resulting in our highest backlog level in over four years. And easing supply chain headwinds and operational execution enabled Twindes to significantly improve shipments and reduce inventory on a dollar and percentage of backlog basis. We are still experiencing shortage of certain components or materials and are working to find alternatives to mitigate these headwinds. as we experience or are able to find and able to anticipate them. For example, one of our major suppliers hasn't been able to source enough material for a graphite ring that seals the inside of a piston. We've explored alternate suppliers as well as a change in material. Either path requires significant lab testing for extended time periods, which presents its own challenges. That being said, The bulk of the supply chain headwinds faced in prior quarters like heat treatment and capacity constraints started to subside in the third quarter, and we expect those trends to continue. As we navigate and respond to each challenge that our business faces, we evaluate our options based on how they align with our commitments and long-term strategy. We strive to be the leading hybrid and electric solution provider for our marine and off-highway land-based applications. As we look to the future, it is clear that controls and systems integration provides greater sales and margin opportunities than a continued focus on individual components would. We've also noted that the vet business has had a lot of success recently, and we expect that trend to continue as we extend and expand that business across geographies and markets. As with the acquisition of vet, our M&A priorities continue to be focused on industrial and marine technology, especially for the hybrid and electrification solutions where we strive to be the leading provider. Further, we need to modernize and optimize the global footprint of our business to be more efficient and improve customer response and lead times. As we think about capital allocation, and more specifically, returning capital to shareholders, I think it's important to clarify our approach. First, we will continue prioritizing the reduction of net debt, which We've been able to accelerate in recent quarters as we've closed on the sale of various facilities around the world. Second, TwinDisk has historically paid a dividend to shareholders, and we have a strong desire to resume paying a dividend. However, we won't use debt to fund it. We will only resume the dividend after we've established a track record of free cash flow generation and have a positive outlook on the cash generation potential for the business. We continue to make investments within our business to fuel growth, through research and development, geographic diversification and expansion, and our marketing efforts. We will also continue to evaluate and pursue bolt-on and or transformational acquisitions that align with our strategic and financial fit characteristics, as well as other considerations, which we've consolidated on slide nine. As we look forward, I think it is important to provide clarity around our near-term expectations of external factors and the actions we are taking in response. We expect broader manufacturing and supply chain headwinds to continue to moderate while acute components shortages, especially those sourced from European suppliers, are likely to persist or resolve and then reemerge elsewhere in the portfolio over the next several quarters. We are doing what we can to anticipate and to address these headwinds as early as possible. We have not experienced a reduction in raw material costs despite the lowering prices of key commodities. Our pricing actions to restore and protect margins are already in effect And at the moment, we do not expect lower raw material costs to be the material driver of margin improvement in the near term. Our team continues to progress on our plan to modernize our legacy facilities, equipment, processes, and geographic footprint. This work has and is expected to continue to deliver improved shipments, lower inventory, reduced lead times, and lower costs, all of which will contribute to better margins and cash flow for TwinDisk. With that, I will now turn it over to Jeff to discuss the financials.