SEC Filing - Twin Disc, Inc.

View:

Download DOC

Download PDF

Download XLS

Download XBRL

twin20161231_10q.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

Form 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarter ended December 30, 2016

Commission File Number 1-7635

TWIN DISC, INCORPORATED

(Exact name of registrant as specified in its charter)

Wisconsin	39-0667110
(State or other jurisdiction of	(I.R.S. Employer
Incorporation or organization)	Identification No.)

1328 Racine Street, Racine, Wisconsin 53403

(Address of principal executive offices)

(262) 638-4000

(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.

Yes √ No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes √ No__

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated Filer	Accelerated Filer √
Non-accelerated filer	Smaller reporting company__

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes No √

At January 30, 2017, the registrant had 11,519,133 shares of its common stock outstanding.

Part I. FINANCIAL INFORMATION

Item 1. Financial Statements

TWIN DISC, INCORPORATED

CONDENSED CONSOLIDATED BALANCE SHEETS

(IN THOUSANDS, EXCEPT SHARE AMOUNTS)

(UNAUDITED)

	December 30, 2016			June 30, 2016

ASSETS
Current assets:
Cash	$	12,991		$	18,273
Trade accounts receivable, net		22,727			25,363
Inventories		64,529			66,569
Prepaid expenses		7,182			7,353
Other		7,272			7,477
Total current assets		114,701			125,035

Property, plant and equipment, net		48,590			51,665
Deferred income taxes		28,003			25,870
Goodwill, net		4,999			5,120
Intangible assets, net		2,006			2,164
Other assets		4,123			4,068

Total assets	$	202,422		$	213,922

LIABILITIES AND EQUITY
Current liabilities:
Accounts payable	$	13,865		$	14,716
Accrued liabilities		20,353			21,415
Total current liabilities		34,218			36,131

Long-term debt		7,782			8,501
Accrued retirement benefits		47,888			48,705
Deferred income taxes		784			827
Other long-term liabilities		2,029			2,705

Total liabilities		92,701			96,869

Commitments and contingencies (Note D)

Equity:
Twin Disc shareholders' equity:
Preferred shares authorized: 200,000; issued: none; no par value		-			-
Common shares authorized: 30,000,000; issued: 13,099,468; no par value		9,609			11,761
Retained earnings		170,054			175,662
Accumulated other comprehensive loss		(46,302	)		(44,143	)
		133,361			143,280
Less treasury stock, at cost (1,580,335 and 1,749,294 shares, respectively)		24,205			26,790

Total Twin Disc shareholders' equity		109,156			116,490

Noncontrolling interest		565			563

Total equity		109,721			117,053

Total liabilities and equity	$	202,422		$	213,922

The notes to condensed consolidated financial statements are an integral part of these statements.

TWIN DISC, INCORPORATED

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(IN THOUSANDS, EXCEPT PER SHARE DATA)

(UNAUDITED)

	For the Quarter Ended						For the Two Quarters Ended
	December 30, 2016			December 25, 2015			December 30, 2016			December 25, 2015

Net sales	$	33,672		$	44,829		$	69,507		$	82,201
Cost of goods sold		24,723			33,223			51,385			62,406
Gross profit		8,949			11,606			18,122			19,795

Marketing, engineering and administrative expenses		12,560			14,592			25,035			29,833
Restructuring expenses		816			515			1,074			515
Other operating expense (income)		-			56			-			(445	)
Loss from operations		(4,427	)		(3,557	)		(7,987	)		(10,108	)

Interest expense		122			109			175			200
Other expense (income), net		(456	)		231			(346	)		73
		(334	)		340			(171	)		273

Loss before income taxes and noncontrolling interest		(4,093	)		(3,897	)		(7,816	)		(10,381	)
Income tax benefit		(1,201	)		(1,608	)		(2,253	)		(3,817	)

Net loss		(2,892	)		(2,289	)		(5,563	)		(6,564	)
Less: Net earnings attributable to noncontrolling interest, net of tax		(20	)		(12	)		(45	)		(60	)

Net loss attributable to Twin Disc	$	(2,912	)	$	(2,301	)	$	(5,608	)	$	(6,624	)

Dividends per share	$	-		$	0.09		$	-		$	0.18

Loss per share data:
Basic loss per share attributable to Twin Disc common shareholders	$	(0.26	)	$	(0.21	)	$	(0.50	)	$	(0.59	)
Diluted loss per share attributable to Twin Disc common shareholders	$	(0.26	)	$	(0.21	)	$	(0.50	)	$	(0.59	)

Weighted average shares outstanding data:
Basic shares outstanding		11,242			11,197			11,231			11,196
Dilutive stock awards		-			-			-			-

Diluted shares outstanding		11,242			11,197			11,231			11,196

Comprehensive loss:
Net loss	$	(2,892	)	$	(2,289	)	$	(5,563	)	$	(6,564	)
Benefit plan adjustments, net of income taxes of $399, $465, $798 and $891, respectively		750			805			1,422			1,544
Foreign currency translation adjustment		(4,198	)		(2,316	)		(3,515	)		(4,128	)
Comprehensive loss		(6,340	)		(3,800	)		(7,656	)		(9,148	)
Less: Comprehensive income attributable to noncontrolling interest		(31	)		(19	)		(112	)		(48	)

Comprehensive loss attributable to Twin Disc	$	(6,371	)	$	(3,819	)	$	(7,768	)	$	(9,196	)

The notes to condensed consolidated financial statements are an integral part of these statements.

TWIN DISC, INCORPORATED

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(IN THOUSANDS)

(UNAUDITED)

	For the Two Quarters Ended
	December 30, 2016			December 25, 2015

Cash flows from operating activities:
Net loss	$	(5,563	)	$	(6,564	)
Adjustments to reconcile net loss to net cash used by operating activities:
Depreciation and amortization		3,680			4,423
Restructuring expenses		174			442
Provision for deferred income taxes		(2,580	)		(3,866	)
Stock compensation expense and other non-cash changes, net		720			720
Net change in operating assets and liabilities		1,130			396

Net cash used by operating activities		(2,439	)		(4,449	)

Cash flows from investing activities:
Proceeds from sale of business (see Note L)		-			3,500
Proceeds from life insurance policy		-			1,907
Acquisitions of fixed assets		(1,094	)		(2,876	)
Proceeds from sale of fixed assets		9			80
Other, net		(129	)		(271	)

Net cash (used) provided by investing activities		(1,214	)		2,340

Cash flows from financing activities:
Borrowings under revolving loan agreement		26,948			42,012
Repayments under revolving loan agreement		(27,666	)		(38,455	)
Proceeds from exercise of stock options		-			12
Dividends paid to shareholders		-			(2,041	)
Dividends paid to noncontrolling interest		(109	)		(192	)
Tax shortfall from stock compensation		(153	)		(267	)
Payments of withholding taxes on stock compensation		(140	)		(190	)

Net cash (used) provided by financing activities		(1,120	)		879

Effect of exchange rate changes on cash		(509	)		(1,075	)

Net change in cash		(5,282	)		(2,305	)

Cash:
Beginning of period		18,273			22,936

End of period	$	12,991		$	20,631

The notes to condensed consolidated financial statements are an integral part of these statements.

TWIN DISC, INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)

(UNAUDITED)

A.	Basis of Presentation

The unaudited condensed consolidated financial statements have been prepared by Twin Disc, Incorporated (the “Company”) pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) and, in the opinion of the Company, include all adjustments, consisting only of normal recurring items, necessary for a fair statement of results for each period. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such SEC rules and regulations. The Company believes that the disclosures made are adequate to make the information presented not misleading. It is suggested that these financial statements be read in conjunction with the consolidated financial statements and the notes thereto included in the Company’s Annual Report filed on Form 10-K for June 30, 2016. The year-end condensed balance sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States.

New Accounting Releases

In January 2017, the Financial Accounting Standards Board (“FASB”) issued guidance (ASU 2017-04) to simplify the accounting for goodwill impairment. The guidance removes Step 2 of the goodwill impairment test, which requires a hypothetical purchase price allocation. The amendments in this guidance are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019 (the Company’s fiscal 2021), with early adoption permitted. The Company is currently evaluating the potential impact of this guidance on the Company’s financial statements and disclosures.

In October 2016, the FASB issued updated guidance to the Accounting Standards Codification (ASU 2016-16) that changes the recognition of income tax consequences of an intra-entity transfer of an asset other than inventory. The amendments in this guidance are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017 (the Company’s fiscal 2019), with early adoption permitted. The Company is currently evaluating the potential impact of this guidance on the Company’s financial statements and disclosures.

In August 2016, the FASB issued updated guidance (ASU 2016-15) that addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice. The amendments in this guidance are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017 (the Company’s fiscal 2019), with early adoption permitted. The Company is currently evaluating the potential impact of this guidance on the Company’s financial statements and disclosures.

In March 2016, the FASB issued updated guidance (ASU 2016-09), intended to simplify several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The amendments in this guidance are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016 (the Company’s fiscal 2018), with early adoption permitted. The Company is currently evaluating the potential impact of this guidance on the Company’s financial statements and disclosures.

In February 2016, the FASB issued guidance (ASU 2016-02) which replaces the existing guidance for leases. The new standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The guidance is effective for fiscal years beginning after December 15, 2018 (the Company’s fiscal 2020), including interim periods within those fiscal years and requires retrospective application. The Company is currently evaluating the potential impact of this guidance on the Company’s financial statements and disclosures.

In July 2015, the FASB issued guidance (ASU 2015-11) intended to simplify the measurement of inventory and to closely align with International Financial Reporting Standards. Current guidance requires inventories to be measured at the lower of cost or market. Under this new guidance, inventories other than those measured under LIFO are to be measured at the lower of cost and net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. This guidance is to be applied prospectively, and is effective for fiscal years beginning after December 15, 2016 (the Company’s fiscal 2018). The adoption of this guidance is not expected to have a material impact on the Company’s financial statements and disclosures.

In August 2014, the FASB issued updated guidance (ASU 2014-15) intended to define management’s responsibility to evaluate whether there is substantial doubt about an organization’s ability to continue as a going concern. The amendments in this guidance are effective for annual periods ending after December 15, 2016 (the Company’s fiscal 2017), and for annual periods and interim periods thereafter. The adoption of this guidance is not expected to have a material impact on the Company’s financial statements and disclosures.

In May 2014, the FASB issued updated guidance (ASU 2014-09) on revenue from contracts with customers. This revenue recognition guidance supersedes existing U.S. GAAP guidance, including most industry-specific guidance. The core principle is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance identifies steps to apply in achieving this principle. This updated guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017 (the Company’s fiscal 2019). The Company is currently evaluating the potential impact of this guidance on the Company’s financial statements and disclosures.

B.	Inventories

The major classes of inventories were as follows:

	December 30, 2016		June 30, 2016
Inventories:
Finished parts	$	44,398	$	45,622
Work in process		7,944		8,020
Raw materials		12,187		12,927
	$	64,529	$	66,569

C. Warranty

The Company engages in extensive product quality programs and processes, including actively monitoring and evaluating the quality of its suppliers. However, its warranty obligation is affected by product failure rates, the number of units affected by the failure and the expense involved in satisfactorily addressing the situation. The warranty reserve is established based on our best estimate of the amounts necessary to settle future and existing claims on products sold as of the balance sheet date. When evaluating the adequacy of the reserve for warranty costs, management takes into consideration the term of the warranty coverage, historical claim rates and costs of repair, knowledge of the type and volume of new products and economic trends. While we believe the warranty reserve is adequate and that the judgment applied is appropriate, such amounts estimated to be due and payable in the future could differ materially from what actually transpires. The following is a listing of the activity in the warranty reserve for the quarter and two quarters ended December 30, 2016 and December 25, 2015:

	For the Quarter Ended						For the Two Quarters Ended
	December 30, 2016			December 25, 2015			December 30, 2016			December 25, 2015
Reserve balance, beginning of period	$	3,036		$	4,220		$	3,607		$	5,245
Current period expense		61			402			243			99
Payments or credits to customers		(506	)		(540	)		(1,268	)		(1,261	)
Translation		(49	)		(33	)		(40	)		(34	)
Reserve balance, end of period	$	2,542		$	4,049		$	2,542		$	4,049

The current portion of the warranty accrual ($2,063 and $2,888 as of December 30, 2016 and December 25, 2015, respectively) is reflected in accrued liabilities, while the long-term portion ($479 and $1,161 as of December 30, 2016 and December 25, 2015, respectively) is included in other long-term liabilities on the consolidated balance sheets.

D.	Contingencies

The Company is involved in litigation of which the ultimate outcome and liability to the Company, if any, is not presently determinable. Management believes that final disposition of such litigation will not have a material impact on the Company’s results of operations, financial position or cash flows.

E.	Business Segments

The Company and its subsidiaries are engaged in the manufacture and sale of marine and heavy-duty off-highway power transmission equipment. Principal products include marine transmissions, surface drives, propellers and boat management systems, as well as power-shift transmissions, hydraulic torque converters, power take-offs, industrial clutches and controls systems. The Company sells to both domestic and foreign customers in a variety of market areas, principally pleasure craft, commercial and military marine markets, as well as in the energy and natural resources, government and industrial markets.

The Company has two reportable segments: manufacturing and distribution. Its segment structure reflects the way management makes operating decisions and manages the growth and profitability of the business. It also corresponds with management’s approach of allocating resources and assessing the performance of its segments. The accounting practices of the segments are the same as those described in the summary of significant accounting policies. Transfers among segments are at established inter-company selling prices. Management evaluates the performance of its segments based on net earnings.

Information about the Company’s segments is summarized as follows:

	For the Quarter Ended						For the Two Quarters Ended
	December 30, 2016			December 25, 2015			December 30, 2016			December 25, 2015
Net sales
Manufacturing segment sales	$	29,472		$	38,518		$	59,971		$	67,575
Distribution segment sales		14,291			17,544			29,686			38,268
Inter/Intra segment elimination - manufacturing		(8,229	)		(9,401	)		(16,355	)		(17,879	)
Inter/Intra segment elimination – distribution		(1,862	)		(1,832	)		(3,795	)		(5,763	)
	$	33,672		$	44,829		$	69,507		$	82,201
Net loss attributable to Twin Disc
Manufacturing segment net loss	$	(1,459	)	$	(1,317	)	$	(2,879	)	$	(4,164	)
Distribution segment net earnings		496			95			767			648
Corporate and eliminations		(1,949	)		(1,079	)		(3,496	)		(3,108	)
	$	(2,912	)	$	(2,301	)	$	(5,608	)	$	(6,624	)

	December 30, 2016			June 30, 2016
Assets
Manufacturing segment assets	$	211,930		$	221,590
Distribution segment assets		47,613			52,719
Corporate assets and elimination of intercompany assets		(57,121	)		(60,387	)
	$	202,422		$	213,922

F.	Stock-Based Compensation

Performance Stock Awards (“PSA”)

During the first half of fiscal 2017 and 2016, the Company granted a target number of 109.6 and 60.5 PSAs, respectively, to various employees of the Company, including executive officers. The fiscal 2017 PSAs will vest if the Company achieves performance-based target objectives relating to average return on invested capital, average annual sales and average annual Earnings Per Share (“EPS”) (as defined in the PSA Grant Agreement), in the cumulative three fiscal year period ending June 30, 2019. These PSAs are subject to adjustment if the Company’s return on invested capital, net sales, and EPS for the period falls below or exceeds the specified target objective, and the maximum number of performance shares that can be awarded if the target objective is exceeded is 164.4. Based upon actual results to date and the low probability of achieving the threshold performance levels, the Company is currently not accruing compensation expense for these PSAs.

The fiscal 2016 PSAs will vest if the Company achieves (a) performance-based target objectives relating to average annual sales and consolidated economic profit, and (b) relative Total Shareholder Return (“TSR”) (as defined in the PSA Grant Agreement), in the cumulative three fiscal year period ending June 30, 2018. These PSAs are subject to adjustment if the Company’s net sales, economic profit and relative TSR for the period falls below or exceeds the specified target objective, and the maximum number of performance shares that can be awarded if the target objective is exceeded is 90.7. Based upon actual results to date and the low probability of achieving the threshold performance levels, the Company is currently not accruing as compensation expense for the portion of the PSAs relating to the average annual sales and economic profit measures. The Company is currently accruing compensation expense for the TSR measure. Compensation expense relating to the relative TSR portion is recognized based on the grant date fair value over the vesting period.

There were 181.8 and 86.4 unvested PSAs outstanding at December 30, 2016 and December 25, 2015, respectively. The fair value of the PSAs (on the date of grant) is expensed over the performance period for the shares that are expected to ultimately vest. Compensation expense of $15 was recognized for the quarter ended December 30, 2016, related to PSAs. Compensation expense of $30 was recognized for the two quarters ended December 30, 2016, related to PSAs. There was no compensation expense for the one and two quarters ended December 25, 2015, related to PSAs. The weighted average grant date fair value of the unvested awards at December 30, 2016 was $13.44. At December 30, 2016, the Company had $2,360 of unrecognized compensation expense related to the unvested shares that would vest if the specified target objective was achieved for the fiscal 2017, 2016 and 2015 awards. The total fair value of PSAs vested as of December 30, 2016 and December 25, 2015 was $0.

Performance Stock Unit Awards (“PSU”)

There were no grants of PSUs during the first half of fiscal 2017 and 2016.

There were 11.4 and 29.9 unvested PSUs outstanding at December 30, 2016 and December 25, 2015, respectively. The weighted average grant date fair value of the unvested awards at December 30, 2016 was $30.16. PSUs are remeasured at fair-value based upon the Company’s stock price at the end of each reporting period. The fair-value of the PSUs is expensed over the performance period for the shares that are expected to ultimately vest. There was no compensation expense for the quarters ended December 30, 2016 and December 25, 2015, and, there was no compensation expense for the two quarters ended December 30, 2016 and December 25, 2015, related to PSUs. At December 30, 2016, the Company had $166 of unrecognized compensation expense related to the unvested shares that would vest if the specified target objective was achieved for the fiscal 2015 awards. The total fair value of PSU awards vested as of December 30, 2016 and December 25, 2015 were $0. The PSU awards are cash based, and would therefore be recorded as a liability on the Company’s consolidated balance sheets. As of December 30, 2016 and June 30, 2016, there were no awards included in liabilities in our consolidated balance sheets due to actual results to date and the low probability of achieving any of the threshold performance levels.

Restricted Stock Awards (“RS”)

The Company has unvested RS awards outstanding that will vest if certain service conditions are fulfilled. The fair value of the RS grants is recorded as compensation expense over the vesting period, which is generally 1 to 3 years. During the first half of fiscal 2017 and 2016, the Company granted 181.8 and 95.7 service based restricted shares, respectively, to employees and non-employee directors in each year. There were 269.6 and 143.0 unvested shares outstanding at December 30, 2016 and December 25, 2015, respectively. Compensation expense of $370 and $288 was recognized for the quarters ended December 30, 2016 and December 25, 2015, respectively. Compensation expense of $696 and $643 was recognized for the two quarters ended December 30, 2016 and December 25, 2015, respectively. The total fair value of restricted stock grants vested as of December 30, 2016 and December 25, 2015 was $587 and $681, respectively. As of December 30, 2016, the Company had $2,428 of unrecognized compensation expense related to restricted stock which will be recognized over the next three years.

G. Pension and Other Postretirement Benefit Plans

The Company has non-contributory, qualified defined benefit plans covering substantially all domestic employees hired prior to October 1, 2003 and certain foreign employees. Additionally, the Company provides health care and life insurance benefits for certain domestic retirees. Components of net periodic benefit cost for the defined benefit pension plans and the other postretirement benefit plan are as follows:

	For the Quarter Ended						For the Two Quarters Ended
	December 30, 2016			December 25, 2015			December 30, 2016			December 25, 2015
Pension Benefits:
Service cost	$	259		$	128		$	480		$	258
Interest cost		1,118			1,225			2,243			2,450
Expected return on plan assets		(1,457	)		(1,691	)		(2,899	)		(3,383	)
Amortization of transition obligation		9			8			18			17
Amortization of prior service cost		1			-			2			-
Amortization of actuarial net loss		899			898			1,798			1,806
Net periodic benefit cost	$	829		$	568		$	1,642		$	1,148

Postretirement Benefits:
Service cost	$	6		$	7		$	12		$	14
Interest cost		122			151			244			302
Amortization of actuarial net loss		182			182			364			364
Net periodic benefit cost	$	310		$	340		$	620		$	680

The Company expects to contribute approximately $1,467 to its pension plans in fiscal 2017. As of December 30, 2016, the amount of $352 in contributions has been made.

The Company has reclassified $750 (net of $399 in taxes) of benefit plan adjustments from accumulated other comprehensive loss during the quarter ended December 30, 2016. The Company has reclassified $805 (net of $465 in taxes) of benefit plan adjustments from accumulated other comprehensive loss during the quarter ended December 25, 2015. The Company has reclassified $1,422 (net of $798 in taxes) of benefit plan adjustments from accumulated other comprehensive loss during the two quarters ended December 30, 2016. The Company has reclassified $1,544 (net of $891 in taxes) of benefit plan adjustments from accumulated other comprehensive loss during the two quarters ended December 25, 2015. These reclassifications are included in the computation of net periodic benefit cost.

H.	Income Taxes

For the two quarters ended December 30, 2016 and 2015, the Company’s effective income tax rate was 28.8% and 36.8%, respectively. As a result of a change in prior year estimates of foreign tax credits and research and development credits, the Company recognized a net expense of $490 which decreased the rate by 4.8%. Continued low global earnings and a similar mix of earnings by jurisdiction during fiscal 2017 had minimal impact to the effective rate.

The Company maintains valuation allowances when it is more likely than not that all or a portion of a deferred tax asset will not be realized. Changes in valuation allowances from period to period are included in the tax provision in the period of change. In determining whether a valuation allowance is required, the Company takes into account such factors as prior earnings history, expected future earnings, carry-back and carry-forward periods, and tax strategies that could potentially enhance the likelihood of realization of a deferred tax asset. Due to recent operating income in a certain foreign jurisdiction with a history of generating operating losses, the Company has evaluated the realizability of the net deferred tax assets related to this jurisdiction. This evaluation concluded that, based primarily upon recent losses in this jurisdiction and failure to achieve targeted levels of improvement, a full valuation allowance continues to be necessary.

The Company has not provided for additional U.S. income taxes on cumulative earnings of certain consolidated foreign subsidiaries that are considered to be reinvested indefinitely. The Company reaffirms its position that these earnings remain permanently invested. Such earnings could become taxable upon the sale or liquidation of these foreign subsidiaries or upon dividend repatriation.

Accounting policies for interim reporting require the Company to adjust its effective tax rate each quarter to be consistent with the estimated annual effective tax rate. Under this effective tax rate methodology, the Company applies an estimated annual income tax rate to its year-to-date ordinary earnings to derive its income tax provision each quarter.

The Company has approximately $963 of unrecognized tax benefits, including related interest and penalties, as of December 30, 2016, which, if recognized, would favorably impact the effective tax rate. There was no significant change in the total unrecognized tax benefits due to the settlement of audits, the expiration of statutes of limitations or for other items during the quarter ended December 30, 2016. It appears possible that the amount of unrecognized tax benefits could change in the next twelve months due to on-going audit activity.

Annually, the Company files income tax returns in various taxing jurisdictions inside and outside the United States. In general, the tax years that remain subject to examination are 2011 through 2016 for the major operations in Italy, Canada, Belgium, and Japan. The tax years open to examination in the U.S. are for years subsequent to fiscal 2012. The state of Wisconsin income tax audit remains ongoing for the fiscal years 2010 through 2015. The company has been notified of a future U.S. Federal income tax audit for the fiscal year 2015. It is reasonably possible that other audit cycles will be completed during fiscal 2017.

I. Goodwill and Other Intangibles

The Company reviews goodwill for impairment on a reporting unit basis annually as of the end of the fiscal year, and whenever events or circumstances (“triggering events”) indicate that the carrying value of goodwill may not be recoverable. The Company monitors for interim triggering events on an ongoing basis. Such triggering events include unfavorable operating results and macroeconomic trends, and market capitalization of the Company below its book value.

The fair value of reporting units is primarily driven by projected growth rates and operating results under the income approach using a discounted cash flow model, which applies an appropriate market-participant discount rate, and consideration of other market approach data from guideline public companies. If declining actual operating results or future operating results become indicative that the fair value of the Company’s reporting units has declined below their carrying values, an interim goodwill impairment test may need to be performed and may result in a non-cash goodwill impairment charge. If the Company’s market capitalization falls below the Company’s carrying value for a sustained period of time or if such a decline becomes indicative that the fair value of the Company’s reporting units has declined to below their carrying values, an interim goodwill impairment test may need to be performed and may result in a non-cash goodwill impairment charge.

For the quarter ended December 30, 2016, the Company performed a review of potential triggering events, such as the continued market softness and operating losses experienced during the quarter, as well as its market capitalization levels, and concluded that these events were not indicative that the fair values of its reporting units had more likely than not declined to below their carrying values at December 30, 2016.

As of December 30, 2016, goodwill is carried in the following reporting units:

Reporting Unit
U.S. Industrial	$	2,449
European Industrial		2,550
Total	$	4,999

The changes in the carrying amount of goodwill, all of which is allocated to the manufacturing segment, for the quarters ended December 30, 2016 were as follows:

	Gross Carrying Amount			Accumulated Impairment			Net Book Value
Balance at June 30, 2016	$	16,392		$	(11,272	)	$	5,120
Translation adjustment		(121	)		-			(121	)
Balance at December 30, 2016	$	16,271		$	(11,272	)	$	4,999

The gross carrying amount and accumulated amortization of the Company’s intangible assets that have definite useful lives and are subject to amortization as of December 30, 2016 and June 30, 2016 were as follows:

	December 30, 2016
	Gross Carrying Amount		Accumulated Amortization			Accumulated Impairment			Net Book Value
Licensing agreements	$	3,015	$	(2,595	)	$	-		$	420
Non-compete agreements		2,128		(2,045	)		(83	)		-
Trade name		1,604		(316	)		-			1,288
Other		6,610		(5,315	)		(1,194	)		101
	$	13,357	$	(10,271	)	$	(1,277	)	$	1,809

	June 30, 2016
	Gross Carrying Amount		Accumulated Amortization			Accumulated Impairment			Net Book Value
Licensing agreements	$	3,015	$	(2,565	)	$	-		$	450
Non-compete agreements		2,128		(2,045	)		(83	)		-
Trade name		1,668		(275	)		-			1,393
Other		6,615		(5,301	)		(1,194	)		120
	$	13,426	$	(10,186	)	$	(1,277	)	$	1,963

The weighted average remaining useful life of the intangible assets included in the table above is approximately 14 years.

Intangible amortization expense was $42 and $37 for the quarters ended December 30, 2016, and December 25, 2015, respectively. Intangible amortization expense was $85 and $74 for the two quarters ended December 30, 2016, and December 25, 2015, respectively. Estimated intangible amortization expense for the remainder of fiscal 2017 and each of the next five fiscal years is as follows:

Fiscal Year
2017	$	92
2018		173
2019		162
2020		149
2021		145
2022		139

The gross carrying amount of the Company’s intangible assets that have indefinite lives and are not subject to amortization as of December 30, 2016 and June 30, 2016 was $197 and $201, respectively. These assets are comprised of acquired trade names.

J.	Long-term Debt

Long-term debt at December 30, 2016 and June 30, 2016 consisted of the following:

	December 30, 2016		June 30, 2016
Revolving loan	$	7,760	$	8,478
Other		22		23
Subtotal		7,782		8,501
Less: current maturities and short-term borrowings		-		-
Total long-term debt	$	7,782	$	8,501

The revolving loan agreement as of December 30, 2016 pertains to the revolving loan facility which the Company entered into on April 22, 2016 with Bank of Montreal (the “BMO Agreement”). The BMO Agreement is secured by substantially all of the Company’s personal property, including accounts receivable, inventory, and certain machinery and equipment of its primary manufacturing facility in Racine, Wisconsin, and the personal property of Mill-Log Equipment Co., Inc., a wholly-owned domestic subsidiary of the Company. The BMO Agreement provides for a borrowing base calculation to determine borrowing capacity. This capacity will be based upon eligible domestic inventory, eligible accounts receivable and machinery and equipment, subject to certain adjustments. As of December 30, 2016, the Company’s borrowing capacity under the terms of the BMO Agreement was approximately $24,833, and the Company had approximately $16,101 of available borrowings. As of December 30, 2016, the interest rate under this agreement was 2.37%.

The Company’s revolving loan agreement approximates fair value at December 30, 2016 and June 30, 2016. If measured at fair value in the financial statements, long-term debt (including the current portion) would be classified as Level 2 in the fair value hierarchy.

K.	Shareholders’ Equity

The Company from time to time makes open market purchases of its common stock under authorizations given to it by the Board of Directors, of which 315 shares as of December 30, 2016 remain authorized for purchase. The Company did not make any open market purchases of its shares during the quarter and two quarters ended December 30, 2016 and December 25, 2015.

The following is a reconciliation of the Company’s equity balances for the first two fiscal quarters of 2017 and 2016:

	Twin Disc, Inc. Shareholders’ Equity
							Accumulated
							Other						Non-
	Common			Retained			Comprehensive			Treasury			Controlling			Total
	Stock			Earnings			Income (Loss)			Stock			Interest			Equity
Balance, June 30, 2016	$	11,761		$	175,662		$	(44,143	)	$	(26,790	)	$	563		$	117,053
Net (loss) income					(5,608	)								45			(5,563	)
Translation adjustments								(3,581	)					66			(3,515	)
Benefit plan adjustments, net of tax								1,422									1,422
Cash dividends														(109	)		(109	)
Compensation expense and tax shortfall		573															573
Shares (acquired) issued, net		(2,725	)								2,585						(140	)
Balance, December 30, 2016	$	9,609		$	170,054		$	(46,302	)	$	(24,205	)	$	565		$	109,721

	Twin Disc, Inc. Shareholders’ Equity
							Accumulated
							Other						Non-
	Common			Retained			Comprehensive			Treasury			Controlling			Total
	Stock			Earnings			Income (Loss)			Stock			Interest			Equity
Balance, June 30, 2015	$	12,259		$	190,807		$	(35,481	)	$	(28,057	)	$	639		$	140,167
Net (loss) income					(6,624	)								60			(6,564	)
Translation adjustments								(4,118	)					(10	)		(4,128	)
Benefit plan adjustments, net of tax								1,544									1,544
Cash dividends					(2,041	)								(192	)		(2,233	)
Compensation expense and tax shortfall		376															376
Shares (acquired) issued, net		(1,444	)								1,267						(177	)
Balance, December 25, 2015	$	11,191		$	182,142		$	(38,055	)	$	(26,790	)	$	497		$	128,985

Reconciliations for the changes in accumulated other comprehensive income (loss), net of tax, by component for the quarters ended September 30, and December 30, 2016, and September 25, and December 25, 2015 are as follows:

	Translation			Benefit Plan
	Adjustment			Adjustment
Balance at June 30, 2016	$	5,158		$	(49,301	)
Translation adjustment during the quarter		627			-
Amounts reclassified from accumulated other comprehensive income		-			672
Net current period other comprehensive income		627			672
Balance at September 30, 2016	$	5,785		$	(48,629	)
Translation adjustment during the quarter		(4,208	)		-
Amounts reclassified from accumulated other comprehensive income		-			750
Net current period other comprehensive (loss) income		(4,208	)		750
Balance at December 30, 2016	$	1,577		$	(47,879	)

	Translation			Benefit Plan
	Adjustment			Adjustment
Balance at June 30, 2015	$	6,740		$	(42,221	)
Translation adjustment during the quarter		(1,787	)		-
Amounts reclassified from accumulated other comprehensive income		-			739
Net current period other comprehensive (loss) income		(1,787	)		739
Balance at September 25, 2015	$	4,953		$	(41,482	)
Translation adjustment during the quarter		(2,331	)		-
Amounts reclassified from accumulated other comprehensive income		-			805
Net current period other comprehensive (loss) income		(2,331	)		805
Balance at December 25, 2015	$	2,622		$	(40,677	)

Reconciliation for the reclassifications out of accumulated other comprehensive income (loss), net of tax for the quarter and two quarters ended December 30, 2016 are as follows:

	Amount Reclassified			Amount Reclassified
	Quarter Ended			Two Quarters Ended
	December 30, 2016			December 30, 2016
Amortization of benefit plan items
Actuarial losses	$	1,139	(a)	$	2,200	(a)
Transition asset and prior service benefit		10	(a)		20	(a)
Total before tax benefit		1,149			2,220
Tax benefit		399			798
Total reclassification net of tax	$	750		$	1,422

(a)

These accumulated other comprehensive income components are included in the computation of net periodic pension cost (see Note G "Pension and Other Postretirement Benefit Plans" for further details).

Reconciliation for the reclassifications out of accumulated other comprehensive income (loss), net of tax for the quarter and two quarters ended December 25, 2015 is as follows:

	Amount Reclassified			Amount Reclassified
	Quarter Ended			Two Quarters Ended
	December 25, 2015			December 25, 2015
Amortization of benefit plan items
Actuarial losses	$	1,262	(a)	$	2,418	(a)
Transition asset and prior service benefit		8	(a)		17	(a)
Total before tax benefit		1,270			2,435
Tax benefit		465			891
Total reclassification net of tax	$	805		$	1,544

(a)

These accumulated other comprehensive income components are included in the computation of net periodic pension cost (see Note G "Pension and Other Postretirement Benefit Plans" for further details).

L.	Restructuring of Operations

In response to challenging global market conditions within the Company’s oil and gas, global pleasure craft and commercial marine markets, the Company undertook a series of restructuring actions starting in late fiscal 2015, and continuing into the current fiscal quarter. It primarily reduced its workforce in its U.S., Belgian, and Italian manufacturing operations under a combination of voluntary and involuntary separation programs. The restructuring charges pertained to the elimination of 141 full-time employees in the manufacturing segment since June 2015.

The restructuring expense for the quarter and for the two quarters ended December 30, 2016 were $816 and $1,074, respectively, and for the quarter and two quarters ended December 25, 2015 was $515. Accumulated costs to date under these programs are $5,156.

The Company continues to evaluate restructuring actions as part of its cost reduction efforts and additional charges are expected to be incurred through the end of December 2017.

The following is a roll-forward of restructuring activity:

Accrued restructuring liability, June 30, 2016	$	801
Additions during the year		1,074
Payments and adjustments		(1,290	)
Accrued restructuring liability, December 30, 2016	$	585

Other operating expense (income) included in the fiscal 2016 results pertain to the gain on sale of one of the Company’s distribution entities. The gain on sale recorded in the first quarter was subject to a post-closing adjustment of $56 which was recorded in the second quarter, resulting in a net gain of $445. The sale of this business was part of the Company’s initiative to focus its resources on core manufacturing and product development aimed at improving profitability.

Item 2. Management Discussion and Analysis

In the financial review that follows, we discuss our results of operations, financial condition and certain other information. This discussion should be read in conjunction with our consolidated financial statements as of December 30, 2016, and related notes, as reported in Item 1 of this Quarterly Report.

Some of the statements in this Quarterly Report on Form 10-Q are “forward-looking statements” as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements include the Company’s description of plans and objectives for future operations and assumptions behind those plans. The words “anticipates,” “believes,” “intends,” “estimates,” and “expects,” or similar anticipatory expressions, usually identify forward-looking statements. In addition, goals established by Twin Disc, Incorporated should not be viewed as guarantees or promises of future performance. There can be no assurance the Company will be successful in achieving its goals.

In addition to the assumptions and information referred to specifically in the forward-looking statements, other factors, including but not limited to those factors discussed under Item 1A, Risk Factors, of the Company’s Annual Report filed on Form 10-K for June 30, 2016 could cause actual results to be materially different from what is expressed or implied in any forward-looking statement.

Results of Operations

(In thousands)
	Quarter Ended												Two Quarters Ended
	December 30, 2016			%			December 25, 2015			%			December 30, 2016			%			December 25, 2015			%
Net sales	$	33,672					$	44,829					$	69,507					$	82,201
Cost of goods sold		24,723						33,223						51,385						62,406
Gross profit		8,949			26.6	%		11,606			25.9	%		18,122			26.1	%		19,795			24.1	%
Marketing, engineering and administrative expenses		12,560			37.3	%		14,592			32.6	%		25,035			36.0	%		29,833			36.3	%
Restructuring of operations		816			2.4	%		515			1.1	%		1,074			1.5	%		515			0.6	%
Other operating expense (income)		-			0.0	%		56			0.1	%		-			0.0	%		(445	)		-0.5	%
Loss from operations	$	(4,427	)		-13.1	%	$	(3,557	)		-7.9	%	$	(7,987	)		-11.5	%	$	(10,108	)		-12.3	%

Comparison of the Second Quarter of FY 2017 with the Second Quarter of FY 2016

Net sales for the second quarter decreased 24.9%, or $11.2 million, to $33.7 million from $44.8 million in the same period a year ago. The decline is primarily the result of softening demand in Asia for the Company’s commercial marine products, an ongoing domestic supplier transition issue delaying shipments, a reduction in global demand for industrial products and a decline in volume related to the Company’s oil and gas products. Demand from customers in Europe also remains weak, while demand in North America for the Company’s industrial and commercial marine products has also declined from prior year levels. Currency translation had a favorable impact on fiscal 2017 sales compared to the prior year totaling $0.2 million primarily due to the strengthening of the Asian currencies against the U.S. dollar.

Sales at our manufacturing segment decreased 23.5%, or $9.0 million, versus the same period last year. In the current fiscal quarter, our U.S. manufacturing operation, the largest, experienced a 27.4%, or $6.5 million, decrease in sales versus the second fiscal quarter of 2016. This decrease is the result of reduced demand for the Company’s oil and gas transmission, a production delay due to supplier transition, weakening Asian demand for the Company’s commercial marine transmissions and a general decline in industrial and aftermarket volume. The Company’s Belgian manufacturing operation also reported a drop in second quarter volume, driven by reduced North American demand for its marine transmissions. The Company’s Italian manufacturing operations continue to be hampered by the softness in the European mega yacht and industrial markets, reporting a 13.1% decrease compared to the second quarter of fiscal 2016. The Company’s Swiss manufacturing operation, which supplies customized propellers for the global mega yacht and patrol boat markets, experienced a 36.0% decrease in sales, primarily due to timing of project shipments.

Our distribution segment experienced an 18.5%, or $3.3 million, decrease in sales compared to the second quarter of fiscal 2016. The Company’s Asian distribution operations in Singapore and Japan saw a 45.3% decrease in sales compared to the prior fiscal year’s second quarter. This decline reflects the ongoing challenges in the Asian economy hampering demand for the Company’s commercial marine transmissions in the Asian market. The Company’s distribution operation in the Northwest of the United States and Southwest of Canada experienced relatively flat sales, while the Company’s distribution operation in Australia, which provides boat accessories, propulsion and marine transmission systems for the pleasure craft market, saw a 28.3% increase in sales due to improving pleasure craft volume along with a favorable currency impact.

The elimination for net inter/intra segment sales decreased $1.1 million, reflecting the general decline in volume, accounting for the remainder of the net change in sales versus the same period last year.

Although gross profit dollars decreased by $2.7 million, gross profit as a percentage of sales increased 70 basis points to 26.6% of sales, compared to 25.9% of sales for the same period last year. Along with the favorable impact of a Belgian property tax refund ($0.8 million), the Company was able to partially offset an unfavorable volume impact ($5.2 million) with the positive impact of the cost reduction actions taken over the past several quarters. These actions resulted in a reduction in fixed manufacturing costs of $0.7 million compared to the prior fiscal year second quarter, as well as improved manufacturing efficiencies of nearly $0.9 million. The Company continues to focus on eliminating cost and improving efficiencies through the significant downturn in many of its markets.

For the fiscal 2017 second quarter, marketing, engineering and administrative (ME&A) expenses, as a percentage of sales, were 37.3%, compared to 32.6% for the fiscal 2016 second quarter. ME&A expenses decreased $2.0 million versus the same period last fiscal year. The decrease in ME&A expenses for the quarter relates to the Company’s ongoing focus on cost containment, including the positive impact of the restructuring actions taken over the past several quarters, totaling approximately $1.8 million. These savings, combined with a reduction in corporate development costs ($0.6 million), were partially offset by the consulting fee associated with the Belgian property tax refund ($0.3 million).

The Company incurred nearly $0.8 million in restructuring charges during the second quarter of fiscal 2017, generating expected annualized savings of approximately $1.7 million, primarily associated with cost reduction actions at its domestic and European operations. The Company continues to focus on actively managing its cost structure and reducing fixed costs in light of the current challenging business cycle.

During the first quarter of fiscal 2016, the Company sold the distribution rights and assets of its distribution entity covering the southeast U.S. territory for approximately $4.1 million, resulting in a net operating gain of $0.4 million.

Interest expense remains relatively immaterial at approximately $0.1 million for the second quarter of both the current and prior fiscal year. The Company has focused on controlling debt and managing cash flow through this down cycle in many of its markets.

The favorable movement in other expense (income) compared to the prior year is primarily due to transaction gains and losses resulting from currency movements related to the euro and Singapore dollar.

The fiscal 2017 second quarter tax rate was 29.3%, compared to the fiscal 2016 second quarter rate of 41.3%. Both periods were impacted by the exclusion of operating results in a foreign jurisdiction that is subject to a full valuation allowance. Adjusting both periods for these excluded results, the fiscal 2017 second quarter rate would have been 24.6%, compared to 38.8% for the fiscal 2016 second quarter. This decrease was primarily a result of a change in prior year estimates of foreign tax credits and research and development credits.

Comparison of the First Two Quarters of FY 2017 with the First Two Quarters of FY 2016

Net sales for the first two quarters of fiscal 2017 decreased 15.4%, or $12.7 million, to $69.5 million from $82.2 million in the same period a year ago. Currency translation had a favorable impact on fiscal 2017 sales compared to the prior year totaling $0.7 million due to the strengthening of the Asian currencies against the U.S. dollar. The significant volume decline reflects softening across most market segments, led by continued softening demand in Asia for the Company’s commercial marine products, along with reduced demand for the Company’s oil and gas related products in both North America and Asia. Demand from customers in Europe remains weak, while overall demand in North America for the Company’s commercial marine and industrial products has also declined from prior year levels. The sales decline was seen most heavily in Asia, driven by the reduced demand for commercial marine products, as the percentage of sales to this region fell to 18% of total consolidated net sales in the first two quarters of fiscal 2017 compared to nearly 21% for the same period in fiscal 2016.

Sales at our manufacturing segment were down 11.3%, or $7.6 million, versus the same period last year. In the current fiscal year’s first two quarters, our U.S. manufacturing operation, the largest, experienced a 6.1% decrease in sales versus the first two quarters of 2016. This decrease reflects a softening in demand for its industrial and marine products, along with the impact of a supplier transition issue impacting the timing of shipment for certain military transmission orders. The Company’s Belgian manufacturing operation experienced a volume decline of 32.9%, on continued challenges in the European market and reduced North American demand for its marine transmission. The Company’s Italian manufacturing operations, which continue to be hampered by the softness in the European mega yacht and industrial markets, experienced a 5.9% decrease in sales compared to the prior fiscal year’s first two quarters. The Company’s Swiss manufacturing operation, which supplies customized propellers for the global mega yacht and patrol boat markets, experienced a 12.0% decrease in sales, on softening demand for commercial and patrol craft applications.

Our distribution segment experienced a 22.4%, or $8.6 million, decrease in sales compared to the first two quarters of fiscal 2016. The Company’s Asian distribution operations in Singapore and Japan saw a 39.2% decrease in sales compared to the prior fiscal year’s first half. This significant decrease is primarily due to a decline in commercial marine transmissions for the Asian market. The Company’s distribution operation in the Northwest of the United States and Southwest of Canada experienced a decrease in sales of 6.9% on a general decline across the product offering. The Company’s distribution operation in Australia, which provides boat accessories, propulsion and marine transmission systems for the pleasure craft market, saw an increase in sales of nearly 10% from the prior fiscal year’s first two quarters, after adjusting for a favorable currency impact (5.0%). This constant-currency increase was driven by improved shipments in the Australian pleasure craft market compared to the prior year.

The elimination for net inter/intra segment sales decreased $3.5 million, reflecting the general decline in activity, accounting for the remainder of the net change in sales versus the same period last year.

Although gross profit dollars decreased by $1.7 million, gross profit as a percentage of sales increased 200 basis points to 26.1% of sales, compared to 24.1% of sales for the same period last year. Gross profit for fiscal 2017’s first two quarters was unfavorably impacted by the reduced volume ($6.0 million) and a less profitable product mix (approximately $0.4 million) driven by lower sales of the Company’s oil and gas transmission products. These unfavorable items were partially offset by aggressive actions to reduce fixed manufacturing costs ($1.8 million), improved operating efficiencies resulting from a series of restructuring initiatives ($1.6 million), favorable movement in the elimination of intercompany profit in inventory ($0.3 million), and a Belgian property tax refund recorded in the second quarter of fiscal 2017 ($0.8 million).

For the fiscal 2017 first two quarters, marketing, engineering and administrative (ME&A) expenses, as a percentage of sales, were 36.0%, compared to 36.3% for the fiscal 2016 comparable period. ME&A expenses decreased $4.8 million or 16.1% versus the same period last fiscal year. The decrease in ME&A expenses for the first two quarters reflects the Company’s ongoing focus on cost containment, including the positive impact of the restructuring actions taken over the past several quarters, totaling approximately $3.6 million. These savings, combined with a reduction in corporate development costs ($1.1 million), reduced pension expense ($0.3 million) and the impact of the sale of Twin Disc Southeast in the prior year ($0.5 million), were partially offset by the consulting fee associated with the Belgian property tax refund ($0.3 million).

The Company incurred nearly $1.1 million in restructuring charges during the first half of fiscal 2017, generating expected annualized savings of approximately $2.1 million, primarily associated with cost reduction actions at its domestic and European operations. The Company continues to focus on actively managing its cost structure and reducing fixed costs in light of the current challenging business cycle.

Interest expense remains relatively immaterial at approximately $0.2 million for the first half of both the current and prior fiscal year. The Company has focused on controlling debt and managing cash flow through this down cycle in many of its markets.

The favorable movement in other expense (income) compared to the prior year is primarily due to the impact of currency movements related to the euro and Singapore dollar.

The fiscal 2017 first half tax rate was 28.8%, compared to the fiscal 2016 first half rate of 36.8%. The decrease in the fiscal 2017 effective tax rate was primarily a result of a change in prior year estimates of foreign tax credits and research and development credits.

Financial Condition, Liquidity and Capital Resources

Comparison between December 30, 2016 and June 30, 2016

As of December 30, 2016, the Company had net working capital of $80.5 million, which represents a decrease of $8.4 million, or 9.5%, from the net working capital of $88.9 million as of June 30, 2016.

Cash decreased $5.3 million to $13.0 million as of December 30, 2016, versus $18.3 million as of June 30, 2016. The reduction reflects the Company’s cash repatriation efforts over the past few quarters. The repatriated cash was used for debt reduction and operating requirements. The majority of the cash as of December 30, 2016 is at the Company’s overseas operations in Europe ($6.0 million) and Asia-Pacific ($5.9 million).

Trade receivables of $22.7 million were down $2.6 million, or approximately 10.4%, when compared to last fiscal year-end. The impact of foreign currency translation was to decrease accounts receivable by $0.6 million versus June 30, 2016. The net remaining decrease is driven by the reduction in sales volume, along with the collection of certain past due balances, in the fiscal 2017 second quarter.

Inventories decreased by $2.0 million, or 3.1%, versus June 30, 2016 to $64.5 million. The impact of foreign currency translation was to decrease inventories by $2.2 million versus June 30, 2016. The Company will continue to search for opportunities to reduce inventory in fiscal 2017 following a very successful effort in fiscal 2016 ($13.7 million or 17%). An ongoing supplier transition issue has hampered inventory performance somewhat during the first half of fiscal 2017, but resolution is expected in the second half of the fiscal year. On a consolidated basis, as of December 30, 2016, the Company’s backlog of orders to be shipped over the next six months approximates $38.0 million, compared to $35.7 million at June 30, 2016 and $34.6 million at December 25, 2015. The increase versus the end of the prior fiscal year is being experienced at the Company’s U.S. manufacturing location, partially due to initial orders for oil and gas transmissions. As a percentage of six month backlog, inventory has decreased from 186% at June 30, 2016 to 170% at December 30, 2016.

Net property, plant and equipment (PP&E) decreased $3.1 million versus June 30, 2016. This includes the addition of $1.1 million in capital expenditures, primarily at the Company’s U.S. and Belgian-based manufacturing operations, which was more than offset by depreciation of $3.7 million. The net remaining decrease is due to foreign currency translation effects. In total, the Company expects to invest between $3 and $5 million in capital assets in fiscal 2017. These anticipated expenditures reflect the Company’s plans to continue investing in modern equipment and facilities, its global sourcing program and new products. The Company continues to review its capital plans based on overall market conditions and availability of capital, and may make changes to its capital plans accordingly. The Company’s capital program is focused on modernizing key core manufacturing, assembly and testing processes, investments in new product development and improving efficiencies at its facilities around the world.

Accounts payable as of December 30, 2016 of $13.9 million were down $0.9 million, or 5.8%, from June 30, 2016. The impact of foreign currency translation was to decrease accounts payable by $0.2 million versus June 30, 2016. The remaining decrease is consistent with the reduced purchasing activity level over the first half of fiscal 2017.

Total borrowings and long-term debt as of December 30, 2016 decreased by $0.7 million, or roughly 8%, to $7.8 million versus June 30, 2016. Cash needs were driven primarily by working capital requirements. During the first two quarters, the Company incurred negative operating cash flow of ($2.4) million and ended the quarter with total debt, net of cash, of ($5.2) million, compared to ($9.8) million at June 30, 2016, for an unfavorable net change of $4.6 million.

Total equity decreased $7.3 million, or 6.3%, to $109.7 million as of December 30, 2016. Retained earnings decreased by $5.6 million, reflecting the net loss for the first half of fiscal 2017. Net unfavorable foreign currency translation of $3.5 million was reported. The net remaining increase in equity of $1.8 million primarily represents the amortization of net actuarial loss and prior service cost on the Company’s defined benefit pension plans.

On April 22, 2016, the Company entered into a revolving Credit Agreement (the “BMO Agreement”) with Bank of Montreal (“BMO”). This agreement permits the Company to enter into loans up to $40 million. This maximum may be increased under the BMO Agreement by an additional $10 million so long as there exists no default and certain other conditions specified in the BMO Agreement are satisfied.

In general, each revolving loan under the BMO Agreement will bear interest at a Eurodollar Rate, as defined. This rate as of December 30, 2016 was 2.37%. In addition to monthly interest payments, the Company will be responsible for paying a quarterly unused fee equal to 0.15% of the average daily unused portion of the revolving credit commitment. The Company may prepay loans subject to certain limitations. Borrowings under the BMO Agreement are secured by substantially all of the Company’s personal property, including accounts receivable, inventory, certain machinery and equipment, and intellectual property, and the personal property of Mill-Log Equipment Co., Inc. (“Mill-Log”), a wholly-owned domestic subsidiary of the Company. The Company has also pledged 100% of its equity interests in certain domestic subsidiaries and 65% of its equity interests in certain foreign subsidiaries. The Company has entered into a security agreement, IP security agreement and pledge agreement with BMO, and Mill-Log has entered into a guaranty agreement, guarantor security agreement and pledge agreement with BMO, which collectively grant BMO a security interest in these assets and holdings as administrative agent for itself and other lenders that may enter into the BMO Agreement. The Company has also entered into a negative pledge agreement with BMO, pursuant to which it has agreed not to sell, lease or otherwise encumber real estate that it owns except as permitted by the BMO Agreement and the negative pledge agreement. Within thirty days upon the occurrence of an event of default (as defined) that is not cured within the prescribed cure period, or if availability under the BMO Agreement is less than the greater of 15% of the aggregate revolving credit commitments and $6.0 million, the Company and Mill-Log will execute and deliver mortgages to BMO on all real estate owned by them at such time to further secure borrowings under the BMO Agreement.

The Company’s balance sheet remains very strong, there are no material off-balance-sheet arrangements, and it continues to have sufficient liquidity for near-term needs. The Company had approximately $16.1 million of available borrowings under the BMO Agreement as of December 30, 2016. The Company expects to generate enough cash from operations, as well as its credit facilities, to meet its operating and investing needs. As of December 30, 2016, the Company also had cash of $13.0 million, primarily at its overseas operations. These funds, with some restrictions and tax implications, are available for repatriation as deemed necessary by the Company. In fiscal 2017, the Company expects to contribute $1.5 million to its defined benefit pension plans, the minimum contribution required.

Net working capital decreased $8.4 million, or 9.5%, during the first half of fiscal 2017, and the current ratio declined slightly to 3.4 at December 30, 2016 compared to 3.5 at June 30, 2016. The decrease in net working capital was primarily the result of volume-driven reductions to accounts receivable and inventory, along with improved receivable collection results.

The Company expects capital expenditures to be approximately $3 million - $5 million in fiscal 2017. These anticipated expenditures reflect the Company’s plans to continue to conserve capital while investing in modern equipment and facilities, its global sourcing program and new products.

Management believes that available cash, the BMO credit facility, and potential access to debt markets will be adequate to fund the Company’s capital requirements for the foreseeable future.

As of December 30, 2016, the Company has obligations under non-cancelable operating lease contracts and loan agreements for certain future payments.

The Company has approximately $1.0 million of unrecognized tax benefits, including related interest and penalties, as of December 30, 2016, which, if recognized, would favorably impact the effective tax rate. See Note H of the Condensed Consolidated Financial Statements for disclosures surrounding uncertain income tax positions.

The Company maintains defined benefit pension plans for some of its operations in the United States and Europe. The Company has established the Benefits Committee (a non-Board management committee) to oversee the operations and administration of the defined benefit plans. As previously mentioned, the Company estimates that fiscal 2017 contributions to all defined benefit plans will total $1.5 million. As of December 30, 2016, $0.4 million in contributions have been made.

New Accounting Releases

Critical Accounting Policies

The preparation of this Quarterly Report requires management’s judgment to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the dates of the financial statements, and the reported amounts of revenues and expenses during the reporting period. There can be no assurance that actual results will not differ from those estimates.

Twin Disc’s critical accounting policies are described in Item 7 of the Company’s Annual Report filed on Form 10-K for June 30, 2016. There have been no significant changes to those accounting policies subsequent to June 30, 2016.

Item 3. Quantitative and Qualitative Disclosure About Market Risk

The Company is exposed to market risks from changes in interest rates, commodities and foreign exchange. To reduce such risks, the Company selectively uses financial instruments and other pro-active management techniques. All hedging transactions are authorized and executed pursuant to clearly defined policies and procedures, which prohibit the use of financial instruments for trading or speculative purposes.

Interest rate risk - The Company’s earnings exposure related to adverse movements of interest rates is primarily derived from outstanding floating rate debt instruments that are indexed to a Eurodollar Rate. In accordance with BMO Agreement expiring April 22, 2021, the Company has the option of borrowing at a Eurodollar Rate plus an additional “Add-On” of 1.75%. Due to the relative stability of interest rates, the Company did not utilize any financial instruments at December 30, 2016 to manage interest rate risk exposure. A 10 percent increase or decrease in the applicable interest rate would result in a change in pretax interest expense of approximately $18,000.

Commodity price risk - The Company is exposed to fluctuation in market prices for such commodities as steel and aluminum. The Company does not utilize commodity price hedges to manage commodity price risk exposure.

Currency risk - The Company has exposure to foreign currency exchange fluctuations. Approximately 29% of the Company’s revenues in the two quarters ended December 30, 2016 were denominated in currencies other than the U.S. dollar. Of that total, approximately 57% was denominated in euros with the balance composed of Japanese yen, the Swiss franc, Indian rupee and the Australian and Singapore dollars. The Company does not hedge the translation exposure represented by the net assets of its foreign subsidiaries. Foreign currency translation adjustments are recorded as a component of shareholders’ equity. Forward foreign exchange contracts are occasionally used to hedge the currency fluctuations on significant transactions denominated in foreign currencies.

Derivative financial instruments - The Company has written policies and procedures that place all financial instruments under the direction of the Company’s corporate treasury group and restrict derivative transactions to those intended for hedging purposes. The use of financial instruments for trading purposes is prohibited. The Company occasionally uses financial instruments to manage the market risk from changes in foreign exchange rates.

The Company primarily enters into forward exchange contracts to reduce the earnings and cash flow impact of non-functional currency denominated receivables and payables. These contracts are highly effective in hedging the cash flows attributable to changes in currency exchange rates. Gains and losses resulting from these contracts offset the foreign exchange gains or losses on the underlying assets and liabilities being hedged. The maturities of the forward exchange contracts generally coincide with the settlement dates of the related transactions. Gains and losses on these contracts are recorded in Other expense, net in the Condensed Consolidated Statement of Operations as the changes in the fair value of the contracts are recognized and generally offset the gains and losses on the hedged items in the same period. The primary currency to which the Company was exposed in fiscal 2017 and 2016 was the euro. At December 30, 2016, the Company had one outstanding forward exchange contract to purchase U.S. dollars in the notional value of $350,000 with a maturity of 32 days. The fair value of the Company’s contract was a gain of $8,000 at December 30, 2016. The Company had no outstanding forward exchange contracts at June 30, 2016.

Item 4. Controls and Procedures

(a) Evaluation of Disclosure Controls and Procedures

The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, have evaluated the effectiveness of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (“the Exchange Act”)) as of the end of the period covered by this report. Based on such evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Company’s disclosure controls and procedures are effective in recording, processing, summarizing, and reporting, on a timely basis, information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act, and that such information is accumulated and communicated to the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely discussions regarding required disclosure.

(b) Changes in Internal Control Over Financial Reporting

Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f) and 15d-15(f). During the most recent fiscal quarter, no changes were made which have materially affected, or which are reasonably likely to materially affect, our internal control over financial reporting.

Part II. OTHER INFORMATION

Item 1. Legal Proceedings

Twin Disc is a defendant in several product liability or related claims which are considered either adequately covered by appropriate liability insurance or involving amounts not deemed material to the business or financial condition of the Company.

Item 1A. Risk Factors

There have been no material changes to the risk factors previously disclosed in response to Item 1A to Part I of our 2016 Annual Report on Form 10-K.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

(a)

Unregistered Sales of Equity Securities

There were no securities of the Company sold by the Company during the quarter ended December 30, 2016, which were not registered under the Securities Act of 1933, in reliance upon an exemption from registration provided by Section 4 (2) of the Act.

(b)

Use of Proceeds

Not applicable.

(c)

Issuer Purchases of Equity Securities

Issuer Purchases of Equity Securities

Under authorizations granted by the Board of Directors on February 1, 2008 and July 27, 2012, the Company was authorized to purchase 500,000 shares of its common stock. This authorization has no expiration, and as of December 30, 2016, 315,000 may yet be purchased under these authorizations. The Company did not purchase any shares of its common stock during the quarter ended December 30, 2016.

Item 3. Defaults Upon Senior Securities

None.

Item 5. Other Information

None.

Item 6. Exhibits

31a	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31b	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32a	Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32b	Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101.INS	XBRL Instance Document

101.SCH	XBRL Schema

101.CAL	XBRL Calculation Linkbase

101.DEF	XBRL Definition Linkbase

101.LAB	XBRL Label Linkbase

101.PRE	XBRL Presentation Linkbase

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	TWIN DISC, INCORPORATED
	(Registrant)


Date: February 7, 2017	/s/ DEBBIE A. LANGE
	Debbie A. Lange
	Corporate Controller
	Chief Accounting Officer

ex31-a.htm

Exhibit 31a

CERTIFICATION

I, John H. Batten, certify that:

1.	I have reviewed this quarterly report on Form 10-Q of Twin Disc, Incorporated;

2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.	The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):

All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.

Date: February 7, 2017	/s/ JOHN H. BATTEN
	John H. Batten
	President, Chief Executive Officer

ex31-b.htm

Exhibit 31b

CERTIFICATIONS

I, Jeffrey S. Knutson, certify that:

1.	I have reviewed this quarterly report on Form 10-Q of Twin Disc, Incorporated;

2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

5.	The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):

Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.

Date: February 7, 2017	/s/ JEFFREY S. KNUTSON
	Jeffrey S. Knutson
	Vice President – Finance, Chief Financial Officer, Treasurer and Secretary

ex32-a.htm

EXHIBIT 32a

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of Twin Disc, Incorporated (the “Company”) on Form 10-Q for the fiscal quarter ending December 30, 2016, as filed with the Securities and Exchange Commission as of the date hereof (the “Report”), I, John H. Batten, President, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of my knowledge:

(1)

The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, and

(2)

The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: February 7, 2017	/s/ JOHN H. BATTEN
	John H. Batten
	President, Chief Executive Officer

ex32-b.htm

EXHIBIT 32b

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of Twin Disc, Incorporated (the “Company”) on Form 10-Q for the fiscal quarter ending December 30, 2016, as filed with the Securities and Exchange Commission as of the date hereof (the “Report”), I, Jeffrey S. Knutson, Vice President – Finance, Chief Financial Officer, Treasurer and Secretary of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of my knowledge:

(1)

The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, and

(2)

The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: February 7, 2017	/s/ JEFFREY S. KNUTSON
	Jeffrey S. Knutson
	Vice President – Finance, Chief Financial Officer, Treasurer and Secretary