twin20170630_10k.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-K

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended June 30, 2017

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 Incorporation or Organization)

(I.R.S. Employer Identification Number)

   

1328 Racine Street, Racine, Wisconsin

53403

(Address of Principal Executive Office)

(Zip Code)

   

Registrant's Telephone Number, including area code:

(262) 638-4000

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Title of each class

Name of each exchange on which registered:

 
 

Common stock, no par

The NASDAQ Stock Market LLC

 
 

Preferred stock purchase rights

The NASDAQ Stock Market LLC

 

 

Securities registered pursuant to Section 12(g) of the Act:

 

None

(Title of Class)

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

YES [  ] NO [ √ ]

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

YES [  ] NO [ √ ]

 

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 Web site, 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K [   ].

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.


Large Accelerated Filer [  ]      Accelerated Filer [ √ ]

Non-accelerated Filer [  ]      Smaller reporting company [  ]      Emerging growth company [  ]

 

 
1

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act [  ].

 

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

YES [  ] NO [ √ ]

 

At December 30, 2016, the last business day of the registrant’s second fiscal quarter, the aggregate market value of the common stock held by non-affiliates of the registrant was $123,053,259. Determination of stock ownership by affiliates was made solely for the purpose of responding to this requirement and registrant is not bound by this determination for any other purpose.

 

At August 24, 2017, the registrant had 11,572,523 shares of its common stock outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE:

 

Portions of the Proxy Statement for the Annual Meeting of Shareholders to be held October 26, 2017, which will be filed pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report, are incorporated by reference into Part III.

 

 
2

 

 

TABLE OF CONTENTS

 

TWIN DISC, INC. - FORM 10-K

FOR THE YEAR ENDED JUNE 30, 2017

 

PART I.

   
     
 

Item 1.

Business.

4

 

Item 1A.

Risk Factors.

5

 

Item 1B.

Unresolved Staff Comments.

8

 

Item 2.

Properties.

9

 

Item 3.

Legal Proceedings.

9

 

Item 4.

Mine Safety Disclosure.

9

   

Executive Officers of the Registrant.

10

PART II.

   
     
 

Item 5.

Market for the Registrant’s Common Stock and Related Stockholder Matters.

11

 

Item 6.

Selected Financial Data.

13

 

Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations.

13

 

Item 7A.

Quantitative and Qualitative Disclosure About Market Risk.

26

 

Item 8.

Financial Statements and Supplementary Data.

28

 

Item 9.

Change In and Disagreements With Accountants on Accounting and Financial Disclosure.

28

 

Item 9A.

Controls and Procedures.

29

 

Item 9B.

Other Information.

29

       

PART III.

   
     
 

Item 10.

Directors and Executive Officers of the Registrant.

30

 

Item 11.

Executive Compensation.

30

 

Item 12.

Security Ownership of Certain Beneficial Owners and Management.

31

 

Item 13.

Certain Relationships and Related Transactions, Director Independence.

31

 

Item 14.

Principal Accounting Fees and Services.

31

       

PART IV.

   
     
 

Item 15.

Exhibits, Financial Statement Schedules.

31

       
   

Signatures.

64

   

Exhibit Index.

65

 

 
3

 

 

PART I

 

Item 1. Business

 

Twin Disc, Incorporated (“Twin Disc”, or the “Company”) was incorporated under the laws of the state of Wisconsin in 1918. Twin Disc designs, manufactures and sells marine and heavy duty off-highway power transmission equipment. Products offered 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 its products to customers primarily in the commercial, pleasure craft, and military marine markets as well as in the energy and natural resources, government and industrial markets. The Company's worldwide sales to both domestic and foreign customers are transacted through a direct sales force and a distributor network. The products described above have accounted for more than 90% of revenues in each of the last three fiscal years.

 

Most of the Company's products are machined from cast iron, forgings, cast aluminum and bar steel which generally are available from multiple sources and which are believed to be in adequate supply.

 

The Company has applied for patents in both the United States and certain foreign countries on inventions made in the course of its development work for which commercial applications are considered probable. The Company regards its patents collectively as important but does not consider its business dependent upon any one of such patents.

 

The business is not considered to be seasonal except to the extent that employee vacations and plant shutdowns, particularly in Europe, occur mainly in the months of July and August, curtailing production during that period.

 

The Company's products receive direct widespread competition, including from divisions of other larger independent manufacturers. The Company also competes for business with parts manufacturing divisions of some of its major customers. The primary competitive factors for the Company’s products are design, technology, performance, price, service and availability. The Company’s top ten customers accounted for approximately 48% of the Company's consolidated net sales during the year ended June 30, 2017. There was one customer, Great Lakes Power Companies, an authorized distributor of the Company, that accounted for 11% of consolidated net sales in fiscal 2017.

 

Unfilled open orders for the next six months of $46.4 million at June 30, 2017 compares to $35.7 million at June 30, 2016. Since orders are subject to cancellation and rescheduling by the customer, the six-month order backlog is considered more representative of operating conditions than total backlog. However, as procurement and manufacturing "lead times" change, the backlog will increase or decrease, and thus it does not necessarily provide a valid indicator of the shipping rate. Cancellations are generally the result of rescheduling activity and do not represent a material change in backlog.

 

Management recognizes that there are attendant risks that foreign governments may place restrictions on dividend payments and other movements of money, but these risks are considered minimal due to the political relations the United States maintains with the countries in which the Company operates or the relatively low investment within individual countries. No material portion of the Company’s business is subject to renegotiation of profits or termination of contracts at the election of the U.S. government.

 

Engineering and development costs include research and development expenses for new product development and major improvements to existing products, and other costs for ongoing efforts to refine existing products. Research and development costs charged to operations totaled $1.5 million, $1.8 million and $2.3 million in fiscal 2017, 2016 and 2015, respectively. Total engineering and development costs were $8.9 million, $9.5 million and $11.1 million in fiscal 2017, 2016 and 2015, respectively.

 

Compliance with federal, state and local provisions regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, is not anticipated to have a material effect on capital expenditures, earnings or the competitive position of the Company.

 

 
4

 

 

The number of persons employed by the Company at June 30, 2017 was 672.

  

A summary of financial data by segment and geographic area for the years ended June 30, 2017, 2016 and 2015 appears in Note J to the consolidated financial statements.

 

The Company’s internet website address is www.twindisc.com. The Company makes available free of charge (other than an investor’s own internet access charges) through its website the Company’s Annual Report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and amendments to those reports, as soon as reasonably practicable after it electronically files such material with, or furnishes such material to, the United States Securities and Exchange Commission. In addition, the Company makes available, through its website, important corporate governance materials. This information is also available from the Company upon request. The Company is not including the information contained on or available through its website as a part of, or incorporating such information by reference into, this Annual Report on Form 10-K.

 

Item 1A. Risk Factors

 

The Company’s business involves risk. The following information about these risks should be considered carefully together with other information contained in this report. The risks described below are not the only risks the Company faces. Additional risks not currently known, deemed immaterial or that could apply to any issuer may also result in adverse results for the Company’s business.

 

As a global company, the Company is subject to currency fluctuations and any significant movement between the U.S. dollar and the euro, in particular, could have an adverse effect on its profitability. Although the Company’s financial results are reported in U.S. dollars, a significant portion of its sales and operating costs are realized in euros and other foreign currencies. The Company’s profitability is affected by movements of the U.S. dollar against the euro and the other currencies in which it generates revenues and incurs expenses. Significant long-term fluctuations in relative currency values, in particular a significant change in the relative values of the U.S. dollar or euro, could have an adverse effect on the Company’s profitability and financial condition. While the long-term impacts of the United Kingdom’s vote to exit the European Union (commonly known as “Brexit”) are currently unknown, any resulting unfavorable currency impact to the euro could have an adverse effect on the Company’s profitability and financial condition.

 

Certain of the Company’s products are directly or indirectly used in oil exploration and oil drilling, and are thus dependent upon the strength of those markets and oil prices. In recent years, the Company has seen significant variations in the sales of its products that are used in oil and energy related markets. The variability in these markets has been defined by the change in oil prices and the global demand for oil. Significant decreases in oil prices and reduced demand for oil and capital investment in the oil and energy markets adversely affect the sales of these products and the Company’s profitability. The cyclical nature of the global oil and gas market presents the ongoing possibility of a severe cutback in demand, which would create a significant adverse effect on the sales of these products and ultimately on the Company’s profitability.

 

Many of the Company’s product markets are cyclical in nature or are otherwise sensitive to volatile or variable factors. A downturn or weakness in overall economic activity or fluctuations in those other factors could have a material adverse effect on the Company’s overall financial performance. Historically, sales of many of the products that the Company manufactures and sells have been subject to cyclical variations caused by changes in general economic conditions and other factors. In particular, the Company sells its products to customers primarily in the pleasure craft, commercial and military marine markets, as well as in the energy and natural resources, government and industrial markets. The demand for the products may be impacted by the strength of the economy generally, governmental spending and appropriations, including security and defense outlays, fuel prices, interest rates, as well as many other factors. Adverse economic and other conditions may cause the Company's customers to forego or otherwise postpone purchases in favor of repairing existing equipment.

 

 
5

 

 

In the event of an increase in the global demand for steel, the Company could be adversely affected if it experiences shortages of raw castings and forgings used in the manufacturing of its products. With the continued development of certain developing economies, in particular China and India, the global demand for steel has risen significantly in recent years. The Company selects its suppliers based on a number of criteria, and the Company expects that they will be able to support its growing needs. However, there can be no assurance that a significant increase in demand, capacity constraints or other issues experienced by the Company’s suppliers will not result in shortages or delays in their supply of raw materials to the Company. If the Company were to experience a significant or prolonged shortage of critical components from any of its suppliers, particularly those who are sole sources, and could not procure the components from other sources, the Company would be unable to meet its production schedules for some of its key products and would miss product delivery dates which would adversely affect its sales, profitability and relationships with its customers.

 

The Company continues to face the prospect of increasing commodity costs, including steel, other raw materials and energy that could have an adverse effect on future profitability. To date, the Company has been successful with offsetting the effects of increased commodity costs through cost reduction programs and pricing actions. However, if material prices were to continue to increase at a rate that could not be recouped through product pricing, it could potentially have an adverse effect on the Company’s future profitability.

 

If the Company were to lose business with any key customers, the Company’s business would be adversely affected. Although there was only one customer, Great Lakes Power Companies, that accounted for 10% or more of consolidated net sales in fiscal 2017, deterioration of a business relationship with one or more of the Company’s significant customers would cause its sales and profitability to be adversely affected.

 

The termination of relationships with the Company’s suppliers, or the inability of such suppliers to perform, could disrupt its business and have an adverse effect on its ability to manufacture and deliver products. The Company relies on raw materials, component parts, and services supplied by outside third parties. If a supplier of significant raw materials, component parts or services were to terminate its relationship with the Company, or otherwise cease supplying raw materials, component parts, or services consistent with past practice, the Company’s ability to meet its obligations to its customers may be affected. Such a disruption with respect to numerous products, or with respect to a few significant products, could have an adverse effect on the Company’s profitability and financial condition.

 

A significant design, manufacturing or supplier quality issue could result in recalls or other actions by the Company that could adversely affect profitability. As a manufacturer of highly engineered products, the performance, reliability and productivity of the Company’s products is one of its competitive advantages. While the Company prides itself on putting in place procedures to ensure the quality and performance of its products and suppliers, a significant quality or product issue, whether due to design, performance, manufacturing or supplier quality issue, could lead to warranty actions, scrapping of raw materials, finished goods or returned products, the deterioration in a customer relationship, or other action that could adversely affect warranty and quality costs, future sales and profitability.

 

 
6

 

 

The Company faces risks associated with its international sales and operations that could adversely affect its business, results of operations or financial condition. Sales to customers outside the United States approximated 51% of the Company’s consolidated net sales for fiscal 2017. The Company has international manufacturing operations in Belgium, Italy, and Switzerland. In addition, the Company has international distribution operations in Singapore, China, Australia, Japan, Italy, Belgium, India and Canada. The Company’s international sales and operations are subject to a number of risks, including:

 

 

currency exchange rate fluctuations

 

export and import duties, changes to import and export regulations, and restrictions on the transfer of funds

 

problems with the transportation or delivery of its products

 

issues arising from cultural or language differences

 

potential labor unrest

 

longer payment cycles and greater difficulty in collecting accounts receivables

 

compliance with trade and other laws in a variety of jurisdictions

 

changes in tax law

 

These factors could adversely affect the Company’s business, results of operations or financial condition.

 

A material disruption at the Company’s manufacturing facilities in Racine, Wisconsin could adversely affect its ability to generate sales and meet customer demand. The majority of the Company’s manufacturing, based on fiscal 2017 sales, came from its facilities in Racine, Wisconsin. If operations at these facilities were to be disrupted as a result of significant equipment failures, natural disasters, power outages, fires, explosions, adverse weather conditions or other reasons, the Company’s business and results of operations could be adversely affected. Interruptions in production would increase costs and reduce sales. Any interruption in production capability could require the Company to make substantial capital expenditures to remedy the situation, which could negatively affect its profitability and financial condition. The Company maintains property damage insurance which it believes to be adequate to provide for reconstruction of its facilities and equipment, as well as business interruption insurance to mitigate losses resulting from any production interruption or shutdown caused by an insured loss. However, any recovery under this insurance policy may not offset the lost sales or increased costs that may be experienced during the disruption of operations. Lost sales may not be recoverable under the policy and long-term business disruptions could result in a loss of customers. If this were to occur, future sales levels and costs of doing business, and therefore profitability, could be adversely affected.

 

Any failure to meet debt obligations and maintain adequate asset-based borrowing capacity could adversely affect the Company’s business and financial condition. The Company’s five-year revolving credit facility entered into in April 2016 is secured by certain personal property assets such as accounts receivable, inventory, and machinery and equipment. Under this agreement, the Company’s borrowing capacity is based on the eligible balances of these assets and it is required to maintain sufficient borrowing base at all times to secure its outstanding borrowings. As of June 30, 2017, the Company had a borrowing capacity that exceeded its outstanding loan balance (see Note G of the Notes to the Consolidated Financial Statements). Based on its annual financial plan, the Company believes that it will generate sufficient cash flow levels throughout fiscal 2018 in order to maintain compliance with this borrowing base. However, as with all forward-looking information, there can be no assurance that the Company will achieve the planned results in future periods especially due to the significant uncertainties flowing from the current economic environment. If the Company is not able to achieve these objectives and to meet the required covenants under the agreements, the Company may require forbearance from its existing lenders in the form of waivers and/or amendments of its credit facilities or be required to arrange alternative financing. Failure to obtain relief from covenant violations or to obtain alternative financing, if necessary, would have a material adverse impact on the Company.

 

The Company recorded significant non-cash goodwill impairment charges in fiscal 2017 and 2016. The Company carries a remaining balance of goodwill in the amount of $2.6 million as of June 30, 2017 after the impairment charges recognized in fiscal 2017 and fiscal 2016. Any further deterioration in the industry or business may trigger future impairment charges, which may have a material adverse effect to our financial results.

 

The Company may experience negative or unforeseen tax consequences. The Company reviews the probability of the realization of its net deferred tax assets each period based on forecasts of taxable income in both the U.S. and foreign jurisdictions. This review uses historical results, projected future operating results based upon approved business plans, eligible carryforward periods, tax planning opportunities and other relevant considerations. Adverse changes in the profitability and financial outlook in the U.S. or foreign jurisdictions may require the creation of a valuation allowance to reduce the Company’s net deferred tax assets. Such changes could result in material non-cash expenses in the period in which the changes are made and could have a material adverse impact on the Company’s results of operations and financial condition.

 

 
7

 

 

Taxing authority challenges may lead to tax payments exceeding current reserves. The Company is subject to ongoing tax examinations in various jurisdictions. As a result, the Company may record incremental tax expense based on expected outcomes of such matters. In addition, the Company may adjust previously reported tax reserves based on expected results of these examinations. Such adjustments could result in an increase or decrease to the Company’s effective tax rate. Future changes in tax law in various jurisdictions around the world and income tax holidays could have a material impact on the Company’s effective tax rate, foreign rate differential, future income tax expense and cash flows.

 

Security breaches and other disruptions could compromise the Company’s information and expose it to liability, which would cause its business and reputation to suffer. In the ordinary course of its business, the Company collects and stores sensitive data, including its proprietary business information and that of its customers, suppliers and business partners, as well as personally identifiable information of its customers and employees, in its internal and external data centers, cloud services, and on its networks. The secure processing, maintenance and transmission of this information is critical to the Company’s operations and business strategy. Despite the Company’s security measures, its information technology and infrastructure, and that of its partners, may be vulnerable to malicious attacks or breaches due to employee error, malfeasance or other disruptions, including as a result of rollouts of new systems. Any such breach or operational failure would compromise the Company’s networks and/or that of its partners and the information stored there could be accessed, publicly disclosed, lost or stolen. Any such access, disclosure or other loss of information could result in legal claims or proceedings and/or regulatory penalties, disrupt the Company’s operations, damage its reputation, and/or cause a loss of confidence in its products and services, which could adversely affect its business.

 

Item 1B. Unresolved Staff Comments

 

None.

 

 
8

 

 

Item 2. Properties

 

Manufacturing Segment

The Company owns two manufacturing, assembly and office facilities in Racine, Wisconsin, U.S.A., one in Nivelles, Belgium, two in Decima, Italy and one in Novazzano, Switzerland. The aggregate floor space of these six plants approximates 767,000 square feet. One of the Racine facilities includes office space, which includes the Company's corporate headquarters. The Company leases additional manufacturing, assembly and office facilities in Italy (Limite sull’Arno) and India (Kancheepuram).

 

Distribution Segment

The Company also has operations in the following locations, all of which are leased and are used for sales offices, warehousing and light assembly or product service:

 

Jacksonville, Florida, U.S.A.

Gold Coast, Queensland, Australia

   

Coburg, Oregon, U.S.A.

Singapore

   

Kent, Washington, U.S.A.

Shanghai, China

   

Edmonton, Alberta, Canada

Guangzhou, China

   

Burnaby, British Columbia, Canada

Chennai, India

   

Brisbane, Queensland, Australia

Coimbatore, India

   

Perth, Western Australia, Australia

Saitama City, Japan

 

The Company believes its properties are well maintained and adequate for its present and anticipated needs.

 

Item 3. Legal Proceedings

 

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

 

Item 4. Mine Safety Disclosures

 

Not applicable.

 

 
9

 

 

Executive Officers of the Registrant

 

Pursuant to General Instruction G(3) of Form 10-K, the following list is included as an unnumbered Item in Part I of this Report in lieu of being included in the Proxy Statement for the Annual Meeting of Shareholders to be held on October 26, 2017.

 

Name

Age

Position

John H. Batten

52

President, Chief Executive Officer 

Jeffrey S. Knutson

52

Vice President – Finance, Chief Financial Officer, Treasurer and Secretary

Malcolm F. Moore

66

Executive Vice President, Chief Operating Officer

Dean J. Bratel

53

Vice President – Sales and Applied Technology

Denise L. Wilcox

60

Vice President – Human Resources

Michael B. Gee

50

Vice President – Engineering

Donald J. Nelson

56

Vice President – Operations

Debbie A. Lange

59

Corporate Controller

 

Officers are elected annually by the Board of Directors at the Board meeting held in conjunction with each Annual Meeting of the Shareholders. Each officer holds office until a successor is duly elected, or until he/she resigns or is removed from office.

 

John H. Batten, President, Chief Executive Officer. Effective November 1, 2013, Mr. Batten was named President, Chief Executive Officer. Prior to this promotion, Mr. Batten served as President and Chief Operating Officer since July 2008, Executive Vice President since November 2004, Vice President and General Manager – Marine and Propulsion since October 2001 and Commercial Manager – Marine and Propulsion since 1998. Mr. Batten joined Twin Disc in 1996 as an Application Engineer.

 

Jeffrey S. Knutson, Vice President – Finance, Chief Financial Officer, Treasurer and Secretary. Mr. Knutson was named Chief Financial Officer and Treasurer in June 2015. Mr. Knutson was named Vice President – Finance, Interim Chief Financial Officer and Interim Treasurer in February 2015. Mr. Knutson was appointed Corporate Secretary in June 2013, and was Corporate Controller from his appointment in October 2005 until August 2015. Mr. Knutson joined the Company in February 2005 as Controller of North American Operations. Prior to joining Twin Disc, Mr. Knutson held Operational Controller positions with Tower Automotive (since August 2002) and Rexnord Corporation (since November 1998).

 

Malcolm F. Moore, Executive Vice President, Chief Operating Officer.  Mr. Moore was appointed to the role of Executive Vice President, Chief Operating Officer effective August 1, 2016.  He was hired as Executive Vice President – Operations effective July 1, 2015 after resigning from the Twin Disc Board of Directors on June 30, 2015.  Prior to joining Twin Disc, Mr. Moore was President and CEO of Digi-Star LLC, a leading supplier of electronic components and software used in precision agriculture. Prior to leading Digi-Star, he held a variety of positions including Executive Vice President and COO, President and COO, and President and CEO of Gehl Company, a publicly-owned manufacturer and distributor of equipment used in construction and agriculture.

 

Dean J. Bratel, Vice President – Sales and Applied Technology. Mr. Bratel assumed his current role on August 1, 2016, after serving as Vice President, Sales and Marketing since January 2015.  He served as Vice President, Americas (since June 2013), Vice President, Engineering (since November 2004), Director of Corporate Engineering (since January 2003), Chief Engineer (since October 2001) and Engineering Manager (since December 1999).  Mr. Bratel joined Twin Disc in 1987.

 

Denise L. Wilcox, Vice President - Human Resources. Ms. Wilcox was promoted to her current role in November 2004, after serving in the role of Director, Corporate Human Resources since 2002. Prior to that, she held the role of Manager, Compensation and Benefits since her hire in 1998. Before joining the Company, Ms. Wilcox held positions at Johnson International and Runzheimer International.

 

 
10

 

 

Michael B. Gee, Vice President – Engineering. Mr. Gee was promoted to his current role in January 2015, after serving in the role of Director of Engineering since July of 2013. Prior to that, he was Chief Engineer (since September 2004) and has held several other positions in the Company, including Engineering Manager, Project Engineer, Design Engineer, and Experimental Engineer.

 

Donald J. Nelson, Vice President – Operations. Mr. Nelson was hired as Vice President, Operations in December 2016. Prior to joining the Company, Mr. Nelson was President, AeroSpace; Group Vice Executive Vice President at Rexnord Industries, LLC (since 2014), and President, Autolite Spark Plug, a division of UCI-FRAM Group, LLC (since 2012). Prior to these positions, he held several positions at Rexnord Industries, LLC (from 2006-2011), including Vice President/General Manager of Rexnord Aerospace Group, Vice President/General Manager of Rexnord Gear Group, and Director of Operations, Falk. Mr. Nelson also held positions at Alcoa, Inc. and at The Boeing Company.

 

Debbie A. Lange, Corporate Controller – Ms. Lange was hired as Corporate Controller effective August 4, 2015. Prior to joining the Company, Ms. Lange was the Director of Accounting Research & Special Projects at Sealed Air Corporation (since 2011), a global manufacturer and provider of food packaging solutions, product packaging and cleaning and hygiene solutions. Prior to her role at Sealed Air, Ms. Lange held the position of Director of Global Accounting and Reporting at Diversey, Inc.

 

PART II

 

Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters

 

The Company's common stock is traded on the NASDAQ Global Select Market under the symbol TWIN. The price information below represents the high and low sales prices per quarter from July 1, 2015 through June 30, 2017:

 

   

Fiscal Year Ended 6/30/17

   

Fiscal Year Ended 6/30/16

 

Quarter

 

High

   

Low

   

Dividend

   

High

   

Low

   

Dividend

 

First Quarter

  $ 13.34     $ 9.35     $ -     $ 18.80     $ 12.11     $ 0.09  

Second Quarter

    15.52       10.01       -       14.71       10.20       0.09  

Third Quarter

    21.75       14.38       -       11.50       8.19       -  

Fourth Quarter

    21.27       14.81       -       13.43       8.50       -  

 

For information regarding the Company’s equity-based compensation plans, see the discussion under Item 12 of this report. As of August 24, 2017, shareholders of record numbered 484. The closing price of Twin Disc common stock as of August 24, 2017 was $16.83.

 

Issuer Purchases of Equity Securities

 

Period

(a) Total

Number of

Shares

Purchased

(b) Average

Price Paid per

Share

(c) Total Number of

Shares Purchased as Part

of Publicly Announced

Plans or Programs

(d) Maximum

Number of Shares

that May Yet Be

Purchased Under the

Plans or Programs

April 1, 2017 – April 28, 2017

0

NA

0

315,000

April 29, 2017 – May 26, 2017

0

NA

0

315,000

May 27, 2017 - June 30, 2017

0

NA

0

315,000

Total

0

NA

0

315,000

 

 
11

 

 

On February 1, 2008, the Board of Directors authorized the purchase of up to 500,000 shares of Common Stock at market values, of which 250,000 shares were purchased during fiscal 2009 and 125,000 shares were purchased during fiscal 2012. On July 27, 2012, the Board of Directors authorized the purchase of an additional 375,000 shares of Common Stock at market values. This authorization has no expiration. During the second quarter of fiscal 2013, the Company purchased 185,000 shares under this authorization. The Company did not make any purchases during fiscal 2015, 2016 and 2017. As of June 30, 2017, 315,000 shares remain authorized for purchase.

 

Performance Graph

 

The following table compares total shareholder return over the last five fiscal years to the Standard & Poor’s 500 Machinery (Industrial) Index and the Russell 2000 index. The S&P 500 Machinery (Industrial) Index consists of a broad range of manufacturers. The Russell 2000 Index consists of a broad range of 2,000 companies. The Company believes, because of the similarity of its business with those companies contained in the S&P 500 Machinery (Industrial) Index, that comparison of shareholder return with this index is appropriate. Total return values for the Corporation’s common stock, the S&P 500 Machinery (Industrial) Index and the Russell 2000 Index were calculated based upon an assumption of a $100 investment on June 30, 2012 and based upon cumulative total return values assuming reinvestment of dividends on a quarterly basis.

 

 

 

 
12

 

 

Item 6. Selected Financial Data

 

Financial Highlights

(in thousands, except per share amounts)

 

Fiscal Years Ended June 30,

Statement of Operations Data:

 

2017

   

2016

   

2015

   

2014

   

2013

 

Net sales

  $ 168,182     $ 166,282     $ 265,790     $ 263,909     $ 285,282  

Net (loss) earnings

    (6,115 )     (13,013 )     11,385       3,870       4,251  

Net (loss) earnings attributable to Twin Disc

    (6,294 )     (13,104 )     11,173       3,644       3,882  

Basic (loss) earnings per share attributable to Twin Disc common shareholders

    (0.56 )     (1.17 )     0.99       0.32       0.34  

Diluted (loss) earnings per share attributable to Twin Disc common shareholders

    (0.56 )     (1.17 )     0.99       0.32       0.34  

Dividends per share

    -       0.18       0.36       0.36       0.36  

 

June 30,

Balance Sheet Data

 

2017

   

2016

   

2015

   

2014

   

2013

 

Total assets

  $ 210,898     $ 213,922     $ 249,862     $ 266,985     $ 285,458  

Total long-term debt

    6,323       8,501       10,231       14,800       23,472  

 

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

 

Note on Forward-Looking Statements

 

Statements in this report (including but not limited to certain statements in Items 1, 3 and 7) and in other Company communications that are not historical facts are forward-looking statements, which are based on management’s current expectations. These statements involve risks and uncertainties that could cause actual results to differ materially from what appears here.

 

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 the Company 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, could cause actual results to be materially different from what is presented in any forward-looking statements.

 

 
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Results of Operations

 

(In thousands)

                                               
   

2017

   

%

   

2016

   

%

   

2015

   

%

 

Net sales

  $ 168,182             $ 166,282             $ 265,790          

Cost of goods sold

    119,950               125,687               182,758          
                                                 

Gross profit

    48,232       28.7       40,595       24.4       83,032       31.2  
                                                 

Marketing, engineering and administrative expenses

    52,773       31.4       57,113       34.3       64,264       24.2  

Restructuring of operations

    1,791       1.1       921       0.6       3,282       1.2  

Goodwill and other asset impairment charge

    2,646       1.6       7,602       4.6       -       -  

Other operating expense (income)

    -       -       (445 )     (0.3 )     -       -  
                                                 

(Loss) earnings from operations

  $ (8,978 )     (5.3 )   $ (24,596 )     (14.8 )   $ 15,486       5.8  

 

Fiscal 2017 Compared to Fiscal 2016

 

Net Sales

 

Net sales for fiscal 2017 increased 1.1%, or $1.9 million, to $168.2 million from $166.3 million in fiscal 2016. The slight increase reflects an increase in demand for the Company’s oil and gas related products in North America, primarily during the second half of fiscal 2017. Asian demand for the Company’s commercial marine products remained depressed, while demand from European customers also remained weak, hampered by local economic concerns and an unfavorable currency dynamic for the Company’s U.S. produced goods. Excluding oil and gas applications, North American demand remained relatively stable for the Company’s commercial marine and industrial products. Currency translation had a negligible impact on fiscal 2017 sales.

 

Sales at our manufacturing segment increased 3.9%, or $5.5 million, versus the same period last year. In the current fiscal year, the Company’s North American manufacturing operation, the largest, experienced a 15.7% increase in sales compared to fiscal 2016. The primary driver for this significant increase was improved demand for the Company’s oil and gas related products, both new units and aftermarket service parts, primarily during the second half of the fiscal year. This increase is driven by stabilizing oil prices and consistent production levels requiring reinvestment in capital equipment following a lengthy pause created by the decline in oil prices starting in fiscal 2015. The Company’s Italian manufacturing operations, which have been adversely impacted by the softness in the European mega yacht and industrial markets, experienced a sales decrease of 3.7% compared to the prior fiscal year. The Company’s Belgian manufacturing operation saw a 19.4% decrease in sales in fiscal 2017 as the marine markets served by this operation continue to struggle. The Company’s Swiss manufacturing operation, which supplies customized propellers for the global mega yacht and patrol boat markets, experienced a 4.4% increase in sales, primarily due to improvements in the global patrol boat market.

 

Sales at our distribution segment were down 8.6%, or $6.4 million, compared to fiscal 2016. The Company’s distribution operation in Singapore, its largest Company-owned distribution operation, experienced a 26.9% reduction in sales due to a continuing decline in demand for various commercial applications and pressure-pumping transmissions for the Chinese oil and gas market following several years of very strong growth. The Company’s distribution operation in the Northwest of the United States and Southwest of Canada experienced an increase in sales of 4.8% on the improved activity in the North American oil and gas market during the second half of the fiscal year. The Company’s distribution operation in Australia, which provides boat accessories, propulsion and marine transmission systems primarily for the pleasure craft market, saw sales improve by 8.3%, driven by improved activity in the Australian pleasure craft market over the prior fiscal year.

 

 
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Net sales for the Company’s largest product market, marine transmission and propulsion systems, were down 7.4% compared to the prior fiscal year. This decrease reflects a continuing decline in the Asian commercial marine market and continued weakness in the global pleasure craft market. In the off-highway transmission market, the year-over-year increase of 46.0% can be attributed primarily to increased shipments of the Company’s pressure pumping transmission systems and components to the North American oil and gas market, primarily during the second half of the fiscal year. The decrease experienced in the Company’s industrial products of 11.3% was due to reduced volume in agriculture, mining and general industrial markets, primarily in the North American and Italian regions.

 

Geographically, sales to the U.S. and Canada improved 8% in fiscal 2017 compared to fiscal 2016, representing 55% of consolidated sales for fiscal 2017 compared to 52% in fiscal 2016. North American sales benefited from increased demand for oil and gas related products in the second half of the fiscal year. Sales into China declined 12.0% compared to fiscal 2016, driven by the combination of reduced oil and gas demand and a decline in commercial marine activity. China sales represented 4.7% of 2017 consolidated net sales, down from 5.4% in fiscal 2016 and 7.4% in fiscal 2015. Overall sales into the Asia Pacific market represented approximately 17% of sales in fiscal 2017, compared to 20% in fiscal 2016. Sales into the European market declined approximately 3% from fiscal 2016 levels while accounting for 21% of consolidated net sales compared to 22% in fiscal 2016. See Note J of the Notes to the consolidated financial statements for more information on the Company’s business segments and foreign operations.

 

Gross Profit

 

In fiscal 2017, gross profit increased $7.6 million, or 18.8%, to $48.2 million on a sales increase of only $1.9 million. Gross profit as a percentage of sales increased 430 basis points in fiscal 2017 to 28.7%, compared to 24.4% in fiscal 2016. The table below summarizes the gross profit trend by quarter for fiscal years 2017 and 2016:

 

   

1st Qtr

   

2nd Qtr

   

3rd Qtr

   

4th Qtr

   

Year

 

Gross Profit:

                                       

($ millions)

                                       

2017

  $ 9.2     $ 8.9     $ 13.3     $ 16.8     $ 48.2  

2016

  $ 8.2     $ 11.6     $ 9.6     $ 11.2     $ 40.6  
                                         

% of Sales:

                                       

2017

    25.6 %     26.6 %     29.5 %     31.4 %     28.7 %

2016

    21.9 %     25.9 %     23.2 %     26.2 %     24.4 %

 

There were a number of factors that impacted the Company’s overall gross profit rate in fiscal 2017. Gross profit for the year was favorably impacted by higher volumes, a favorable product mix, a favorable exchange impact ($0.3 million) and positive cost reduction efforts. The Company estimates the net favorable impact of increased volumes on gross margin in fiscal 2017 was approximately $0.8 million. The favorable shift in product mix, primarily related to the improved North American demand for the Company’s oil and gas transmission products, had an estimated favorable impact of $2.3 million. The remaining improvement in margin ($4.2 million) is due to the continued benefit of cost reduction actions across the global enterprise, along with significant improvements in operating efficiency.

 

 
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Marketing, Engineering and Administrative (ME&A) Expenses

 

Marketing, engineering, and administrative (ME&A) expenses of $52.8 million were down $4.3 million, or 7.6%, compared to the prior fiscal year. As a percentage of sales, ME&A expenses decreased to 31.4% of sales versus 34.3% of sales in fiscal 2016. The reduction in fiscal 2017 compared to the prior year was driven by lower pension expense ($0.3 million), reduced corporate development spending ($0.9 million) and the positive impact of an aggressive global cost reduction program ($5.0 million). These savings were partially offset by an increase to bonus expense ($1.6 million) and stock based compensation ($0.3 million).

 

Restructuring of Operations

 

During the course of fiscal 2017, the Company executed a series of targeted restructuring activities, resulting in a pre-tax restructuring charge of $1.8 million, or $0.16 per diluted share. These actions are focused on reducing the Company’s operating costs due to the challenging global market conditions, and resulted in headcount reductions at the Company’s operations in Italy, Belgium, India and the United States.

 

Goodwill and Other Asset Impairment Charge

 

For the quarter ended March 31, 2017, the Company performed a review of potential triggering events, such as the continued market softness and operating losses experienced during the quarter, and concluded that there were sufficient qualitative indicators in the third fiscal quarter that made it more likely than not that an impairment of the domestic industrial goodwill may have occurred. The Company completed a full impairment test, the result of which was a full impairment of the goodwill related to the U.S. Industrial business unit ($2.5 million) that remained after the fiscal 2016 impairment. An asset impairment charge of $0.1 million was also recorded related to the restructuring activities in India. See further discussion in Note P in the Notes to the Consolidated Financial Statements.

 

In fiscal 2016, the Company conducted its annual assessment for goodwill impairment as of June 30, 2016 using updated inputs, including appropriate risk-based, country and company specific weighted average discount rates for all of the Company’s reporting units. The analysis identified an impairment in the domestic industrial business and the European propulsion business resulting in a charge of $7.6 million. See further discussion in Note D in the Notes to the Consolidated Financial Statements.

 

Other Operating Income

 

During 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. As a result, a net operating gain of $0.4 million was recorded.

 

Interest Expense

 

Interest expense of $0.3 million for fiscal 2017 was down 29% versus fiscal 2016. Interest on the Company’s revolving credit facility (“revolver”) in fiscal 2017 was level with fiscal 2016 at $0.2 million, as a lower average balance was offset by a slightly higher average interest rate. The average borrowing on the revolver, computed monthly, decreased to $8.4 million in fiscal 2017, compared to $12.3 million in the prior fiscal year. The interest rate on the revolver was a range of 1.20% to 2.21% in the prior fiscal year compared to a range of 2.22% to 2.80% in the current year. The interest expense on the Company’s $25 million Senior Note, which carried a fixed rate of 6.05%, totaled $0.2 million in fiscal 2016. The final payment on the Senior Note was made in April 2016.

 

Other income (expense), net and Interest Income

 

In fiscal 2017, the decrease in other income (expense), net, was primarily due to lower fixed asset disposal losses when compared to the prior year. Interest income was lower in fiscal 2017 when compared to the prior year due to lower cash balances as the Company paid down long term debt.

 

 
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Income Taxes

 

The effective tax rate for the twelve months of fiscal 2017 was 35.8%, which was significantly lower than the prior year rate of 48.6%. The fiscal 2016 effective tax rate was favorably impacted by a tax strategy which resulted in the recognition of foreign tax credits associated with the repatriation of $9.7 million in cash from our European operations ($2.4 million). Adjusting for this non-recurring tax benefit, the fiscal 2016 effective tax rate would have been 39.1%

 

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. During fiscal 2017, the Company reported operating income in certain foreign jurisdictions where the loss carryforward period is unlimited. The Company has evaluated the likelihood of whether the net deferred tax assets related to these jurisdictions would be realized and concluded that based primarily upon the uncertainty to achieve levels of sustained improvement and uncertain exchange rates in these jurisdictions: (a) it is more likely than not that $3.8 million of deferred tax assets would not be realized; and that (b) a full valuation allowance on the balance of deferred tax assets relating to these jurisdictions continues to be necessary. The Company recorded a net increase in valuation allowance of $0.7 million in fiscal 2017 due to higher cumulative operating losses in these jurisdictions. Management believes that it is more likely than not that the results of future operations will generate sufficient taxable income and foreign source income to realize the remaining deferred tax assets.

 

Order Rates

 

As of June 30, 2017, the Company’s backlog of orders scheduled for shipment during the next six months (six-month backlog) was $46.4 million, or approximately 30% higher than the six-month backlog of $35.7 million as of June 30, 2016. The Company’s backlog improved during the second half of the fiscal 2017 with the increase in North American demand for the Company’s oil and gas related products.

 

Fiscal 2016 Compared to Fiscal 2015

 

Net Sales

 

Net sales for fiscal 2016 decreased 37.4%, or $99.5 million, to $166.3 million from $265.8 million in fiscal 2015. The decrease was primarily the result of a dramatic reduction in demand for the Company’s oil and gas related products in both North America and Asia driven by the extended global decline in oil and natural gas prices, along with weakening demand in Asia for the Company’s commercial marine products. Demand from European customers remained weak, hampered by local economic concerns and an unfavorable currency dynamic for the Company’s U.S. produced goods. Excluding oil and gas applications, North American demand remained relatively stable for the Company’s commercial marine and industrial products. Currency translation had a $7.9 million unfavorable impact on fiscal 2016 sales compared to the prior year due to the strengthening of the U.S. dollar against the euro and Asian currencies.

 

Sales at our manufacturing segment were down 39.4%, or $91.6 million, versus the same period last year. Compared to fiscal 2015, on average, the U.S. dollar strengthened against the euro. The net translation effect of this on foreign manufacturing operations was to reduce revenues for the manufacturing segment by approximately $3.8 million versus the prior year, before eliminations. In the current fiscal year, the Company’s North American manufacturing operation, the largest, experienced a 50.7% decrease in sales compared to fiscal 2015. The primary driver for this significant decrease was a sharp decline in global demand for oil and gas related products as a result of the decline in global oil prices, along with reduced demand in Asia for commercial marine products due to generally challenging Asian economic conditions. The Company’s Italian manufacturing operations, which have been adversely impacted by the softness in the European mega yacht and industrial markets, experienced a sales decrease of 14.2% compared to the prior fiscal year. The Company’s Belgian manufacturing operation saw 6.8% decrease in sales in fiscal 2016 as stable North American demand was offset by unfavorable currency movements. The Company’s Swiss manufacturing operation, which supplies customized propellers for the global mega yacht and patrol boat markets, experienced an 11.4% decrease in sales, primarily due to unfavorable currency movements along with the timing of shipments for the global patrol boat and Italian mega yacht markets.

 

 
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Sales at our distribution segment were down 38.5%, or $46.4 million, compared to fiscal 2015. Compared to fiscal 2015, on average, the Asian currencies weakened against the U.S. dollar. The net translation effect of this on foreign distribution operations was to decrease revenues for the distribution segment by approximately $4.1 million versus the prior year, before eliminations. The Company’s distribution operation in Singapore, its largest Company-owned distribution operation, experienced a 54.9% reduction in sales due to a decline in demand for various commercial applications and pressure-pumping transmissions for the Chinese oil and gas market following several years of very strong growth. The Company’s distribution operation in the Northwest of the United States and Southwest of Canada experienced a decrease in sales of 42.8% on the decline of the North American oil and gas market throughout the fiscal year. The Company’s distribution operation in Australia, which provides boat accessories, propulsion and marine transmission systems for the pleasure craft market, saw flat sales despite an unfavorable currency movement, driven by improved shipments in the Australian mega yacht market over the prior fiscal year.

 

Net sales for the Company’s largest product market, marine transmission and propulsion systems, were down 29.9% compared to the prior fiscal year. This decrease reflects a sharp decline in the Asian commercial marine market, reduced demand for offshore supply vessels driven by the global decline in oil prices, continued weakness in the global pleasure craft market and a significant currency impact. In the off-highway transmission market, the year-over-year decrease of 62% can be attributed primarily to reduced shipments of the Company’s pressure pumping transmission systems and components to the North American and Asian oil and gas market. The decrease experienced in the Company’s industrial products of nearly 23% was due to decreased sales into the North American oil and gas market, along with reduced volume in agriculture, mining and general industrial markets, primarily in the North American and Italian regions.

 

Geographically, sales to the U.S. and Canada declined nearly 41% in fiscal 2016 compared to fiscal 2015, representing 52% of consolidated sales for fiscal 2016 compared to 55% in fiscal 2015. North American sales were severely impacted by reduced demand for oil and gas related products throughout the fiscal year. Sales into China declined 54.2% compared to fiscal 2015, driven by the combination of reduced oil and gas demand and a decline in commercial marine activity. China sales represented 5.4% of 2016 consolidated net sales, down from 7.4% in fiscal 2015 and 12.8% in fiscal 2014. Overall sales into the Asia Pacific market represented approximately 20% of sales in fiscal 2016, compared to 21% in fiscal 2015. Sales into the European market also suffered, reporting a 17% decrease from fiscal 2015 levels while accounting for 22% of consolidated net sales compared to only 17% in fiscal 2015. See Note J of the Notes to the consolidated financial statements for more information on the Company’s business segments and foreign operations.

 

 
18

 

 

Gross Profit

 

In fiscal 2016, gross profit decreased $42.4 million, or 51.1%, to $40.6 million. Gross profit as a percentage of sales decreased 680 basis points in fiscal 2016 to 24.4%, compared to 31.2% in fiscal 2015. The table below summarizes the gross profit trend by quarter for fiscal years 2016 and 2015:

 

   

1st Qtr

   

2nd Qtr

   

3rd Qtr

   

4th Qtr

   

Year

 

Gross Profit:

                                       

($ millions)

                                       

2016

  $ 8.2     $ 11.6     $ 9.6     $ 11.2     $ 40.6  

2015

  $ 22.4     $ 22.1     $ 19.0     $ 19.5     $ 83.0  
                                         

% of Sales:

                                       

2016

    21.9 %     25.9 %     23.2 %     26.2 %     24.4 %

2015

    34.5 %     30.4 %     31.2 %     29.0 %     31.2 %

 

There were a number of factors that impacted the Company’s overall gross profit rate in fiscal 2016. Gross profit for the year was negatively impacted by significantly lower volumes, an unfavorable product mix and an unfavorable exchange impact ($1.1 million). The Company estimates the net unfavorable impact of decreased volumes on gross margin in fiscal 2016 was approximately $44.4 million. The unfavorable shift in product mix, primarily related to the significant decline in the Company’s oil and gas transmission business, had an estimated unfavorable impact of $4.0 million. These unfavorable movements were partially offset by an aggressive effort to reduce the Company’s fixed cost structure, resulting in savings of $7.1 million in fiscal 2016.

 

Marketing, Engineering and Administrative (ME&A) Expenses

 

Marketing, engineering, and administrative (ME&A) expenses of $57.1 million were down $7.2 million, or 11.1%, compared to the prior fiscal year. As a percentage of sales, ME&A expenses increased to 34.3% of sales versus 24.2% of sales in fiscal 2015. The reduction in fiscal 2016 compared to the prior year was driven by lower bonus expense ($3.2 million), a favorable currency impact ($1.7 million) and aggressive spending reductions across the global enterprise ($5.9 million). These savings were partially offset by an increase to pension expense ($2.0 million), stock based compensation ($0.7 million), spending on corporate development activities ($0.7 million) and costs related to third quarter activity to revise the Wells Fargo and Prudential credit agreements ($0.2 million).

 

Restructuring of Operations

 

During the course of fiscal 2016, the Company executed a series of targeted restructuring activities, resulting in a pre-tax restructuring charge of $0.9 million, or $0.08 per diluted share. These actions are focused on reducing the Company’s operating costs due to the challenging global market conditions, and resulted in headcount reductions at the Company’s operations in Italy, Singapore and the United States.

 

Goodwill Impairment Charge

 

The Company conducted its annual assessment for goodwill impairment as of June 30, 2016 using updated inputs, including appropriate risk-based, country and company specific weighted average discount rates for all of the Company’s reporting units. The analysis identified an impairment in the domestic industrial business and the European propulsion business resulting in a charge of $7.6 million. See further discussion in Note D in the Notes to the Consolidated Financial Statements.

 

Other Operating Income

 

During 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. As a result, a net operating gain of $0.4 million was recorded.

 

 
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Interest Expense

 

Interest expense of $0.4 million for fiscal 2016 was down 30% versus fiscal 2015. Interest on the Company’s revolving credit facility (“revolver”) increased to $0.2 million in fiscal 2016. The increase can be attributed to an overall increase in the average borrowings and the average interest rate year-over-year. The average borrowing on the revolver, computed monthly, increased to $12.3 million in fiscal 2016, compared to $10.7 million in the prior fiscal year. The interest rate on the revolver was a range of 1.16% to 1.20% in the prior fiscal year compared to a range of 1.20% to 2.21% in the current year. The interest expense on the Company’s $25 million Senior Note, which carried a fixed rate of 6.05%, decreased $0.2 million to $0.2 million, due to a lower remaining principal balance. The final payment on the Senior Note was made in April 2016.

 

Other income (expense), net and Interest Income

 

For the fiscal 2016 full year, Other, net declined by $1.3 million due primarily to a prior year life insurance benefit and unfavorable exchange movements related to the Japanese yen, Singapore dollar, euro and Australian dollar. Interest income was flat in fiscal 2016 compared to the prior year.

 

Income Taxes

 

The effective tax rate for the twelve months of fiscal 2016 was 48.6%, which is significantly higher than the prior year rate of 28.4%. The full year effective rates are impacted by the non-deductibility of operating results in a certain foreign jurisdiction that is subject to a full valuation allowance. Adjusting both fiscal years for the results of this jurisdiction, the fiscal 2016 full year rate would have been 45.0% compared to 30.9% for the same period in fiscal 2015. The fiscal 2016 effective tax rate was favorably impacted by a tax strategy which resulted in the recognition of foreign tax credits associated with the repatriation of $9.7 million in cash from our European operations ($2.4 million). Adjusting for this non-recurring tax benefit, the fiscal 2016 effective tax rate would have been 36.2%. The fiscal 2015 rate was favorably impacted by a change in the jurisdictional mix of earnings, along with favorable discrete items related to foreign earnings, and the reinstatement of the research and development credit for calendar 2015.

 

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. During fiscal 2016, the Company reported operating income in certain foreign jurisdictions where the loss carryforward period is unlimited. The Company has evaluated the likelihood of whether the net deferred tax assets related to these jurisdictions would be realized and concluded that based primarily upon the uncertainty to achieve levels of sustained improvement and uncertain exchange rates in these jurisdictions; (a) it is more likely than not that $3.1 million of deferred tax assets would not be realized; and that (b) a full valuation allowance on the balance of deferred tax assets relating to these jurisdictions continues to be necessary. The Company recorded a net decrease in valuation allowance of $0.5 million in fiscal 2016 due to lower cumulative operating losses in these jurisdictions. Management believes that it is more likely than not that the results of future operations will generate sufficient taxable income and foreign source income to realize the remaining deferred tax assets.

 

Order Rates

 

As of June 30, 2016, the Company’s backlog of orders scheduled for shipment during the next six months (six-month backlog) was $35.7 million, or approximately 4% higher than the six-month backlog of $34.4 million as of June 30, 2015. The Company’s backlog remained relatively consistent through the year, as markets remained at a relatively low level throughout fiscal 2016.

 

 
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Liquidity and Capital Resources

 

Fiscal Years 2017, 2016 and 2015 

 

The net cash provided by operating activities in fiscal 2017 totaled $3.2 million, a slight decrease ($0.2 million or 6%) from fiscal 2016. The slight change is primarily the result of a significant improvement in net earnings ($6.9 million) being offset by moderating working capital improvements ($8.3 million lower in fiscal 2017), as the prior fiscal year benefited from successful inventory reductions. While inventory improved slightly in fiscal 2017 ($0.4 million), fiscal 2016 saw a $13.7 million improvement driven by declining volumes and strong working capital management. While the accounts receivable balance increased significantly in fiscal 2017 ($6.0 million) on the strong second half sales volume, receivable performance improved in fiscal 2017, with days sales outstanding falling from 66 days at June 30, 2016 to 56 days at June 30, 2017. Accounts payable saw a corresponding volume-driven increase ($6.6 million).

 

The net cash provided by operating activities in fiscal 2016 totaled $3.4 million, a decrease of $13.7 million, or approximately 80%, versus fiscal 2015. The decrease compared to the prior fiscal year is primarily due to the decline in earnings totaling $24.4 million. This decline was partially offset by reduced working capital. Accounts receivable decreased by $18.4 million, driven by the reduced sales volume and strong collection efforts. The inventory improvement is the successful result of a concerted global effort to manage working capital levels in light of the challenging market conditions. Net inventory as a percentage of the six-month backlog decreased from 232% as of June 30, 2015 to 186% as of June 30, 2016. The decrease in accounts payable reflects the reduced purchasing activity throughout the fiscal year as a result of the reduced volume, while accrued liabilities declined with the payment of severance and bonus obligations.

 

The net cash provided by operating activities in fiscal 2015 totaled $17.1 million, a decrease of $8.7 million, or approximately 33.7%, versus fiscal 2014. The reduction compared to fiscal 2014 primarily relates to an increase in accounts receivable, a reduction in accrued retirement benefits and an increase in a life insurance receivable. These unfavorable movements were partially offset by a significant reduction in inventory. Adjusted for an $8.1 million impact of foreign currency translation, net inventory decreased by $9.3 million compared to the prior fiscal year end. The majority of this decrease was seen at the Company’s North American operations in response to the decline in demand through the second half of the fiscal year. Net inventory as a percentage of the six-month backlog increased from 148% as of June 30, 2014 to 232% as of June 30, 2015. The increase in receivables compared to the prior year end relates to timing of shipments within the fourth quarter, along with a slight easing of payment patterns due to economic pressures in the oil and gas market. The decrease in accounts payable is in line with the reduced purchase activity through the fourth quarter.

 

The net cash used by investing activities primarily represents capital spending activity totaling $3.1 million. The fiscal 2017 capital projects were again limited to critical replacement and maintenance items and costs related to new product introduction. This was partially offset by proceeds from the sale of certain operating assets, primarily associated with the closure of our India plant.

 

The net cash provided by investing activities in fiscal 2016 of $1.1 million represents primarily the proceeds from the sale of Twin Disc Southeast in the first quarter of the fiscal year ($3.5 million) and the proceeds from a life insurance policy ($2.0 million), partially offset by relatively modest capital spending activity totaling $4.2 million. The capital projects for fiscal 2016 were limited to key replacement items and high potential new product introductions.

 

The net cash used for investing activities in fiscal 2015 of $6.8 million consisted primarily of capital expenditures for machinery and equipment and facility upgrades at our U.S., Belgian and Singapore facilities. In fiscal 2015, the Company spent $9.0 million for capital expenditures, up from $7.2 million in fiscal 2014. The Company also received a net reimbursement of premiums paid on executive split dollar life insurance policies during the year ($1.9 million) due to resignations and retirements.

 

The net cash used by financing activities in fiscal 2017 of $2.4 million consisted primarily of net payments of debt ($2.2 million). During fiscal 2017, the Company did not purchase any shares as part of its Board-authorized stock repurchase program. The Company has 315,000 shares remaining under its authorized stock repurchase plan.

 

 
21

 

 

The net cash used by financing activities in fiscal 2016 of $8.1 million consisted primarily of dividends paid to shareholders ($2.0 million) and net payments of debt ($5.3 million). During fiscal 2016, the Company did not purchase any shares as part of its Board-authorized stock repurchase program. The Company has 315,000 shares remaining under its authorized stock repurchase plan.

 

In fiscal 2015, the net cash used by financing activities of $9.2 million consisted primarily of dividends paid to shareholders of the Company of $4.1 million and net payments of debt of $4.6 million. During fiscal 2015, the Company did not purchase any shares as part of its Board-authorized stock repurchase program.

 

Future Liquidity and Capital Resources 

 

On June 30, 2014, the Company entered into the Wells Fargo Agreement, which was subsequently amended on February 1, 2016. Prior to the February 1, 2016 amendment, it permitted the Company to enter into unsecured revolving credit loans up to the amount of $60 million. This amendment provided for a borrowing base calculation to determine borrowing capacity, up to a maximum of $40 million. This capacity was based upon eligible domestic inventory, eligible accounts receivable and machinery and equipment, subject to certain adjustments. The amended Wells Fargo Agreement also revised the definition of EBITDA for the four consecutive fiscal quarters ending on and including December 25, 2015 to and including September 30, 2016 to add $0.5 million, reflective of the restructuring charge taken by the Company in the second quarter of the fiscal year ending June 30, 2016, and further adjusted the definition of EBITDA to add back non-cash stock based compensation expense and additional restructuring charges not to exceed $0.3 million in the fiscal quarter ending March 25, 2016, and $0.3 million in each subsequent fiscal quarter. The amended Wells Fargo Agreement also waived any events of default that may have occurred under the terms of the agreement prior to its February 1, 2016 amendment.

 

Borrowings under the amended Wells Fargo Agreement were 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 had also pledged 65% of its equity interests in certain foreign subsidiaries.

 

Loans under the Wells Fargo Agreement were generally charged interest at the LIBOR Rate plus (a) 1.00% if the Company’s adjusted four-quarter EBITDA (as defined) was at least $11 million, or (b) 1.50% if the Company’s adjusted four-quarter EBITDA (as defined) was less than $11 million.

 

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. On the day of the closing of the BMO Agreement, the Company used proceeds to pay off the loan balance under the Wells Fargo Agreement.

 

In general, each revolving loan under the BMO Agreement will bear interest at a Eurodollar Rate, as defined. This rate as of June 30, 2017 was 2.80%. 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. 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.

 

 
22

 

 

A private shelf agreement (“the Prudential Agreement”) was entered into on June 30, 2014. Among other things, the Prudential Agreement: (a) amended and restated the note agreement between the Company and purchasers dated as of April 10, 2006, as it had been amended from time to time; and (b) set forth the terms of the potential sale and purchase of up to $50 million in shelf notes by the Company to the Prudential group of companies, the lender. The notes bear interest on the outstanding principal balance at a fixed rate of 6.05% per annum, payable quarterly. The principal was payable in annual installments of $3.6 million, and matured and became due and payable in full on April 10, 2016.

 

The Prudential Agreement included financial covenants regarding minimum net worth, minimum EBITDA and a maximum total funded debt to EBITDA ratio. It also included certain covenants that limit, among other things, certain indebtedness, acquisitions, investments, capital expenditures and dividends. The amendment to the Prudential Agreement waived any events of default that may have occurred under the terms of the agreement prior to its February 1, 2016 amendment.

 

The final payment of $3.6 million was made on April 11, 2016. In addition, the shelf notes arrangement under the Prudential Agreement was terminated on April 21, 2016.

 

The Company’s balance sheet remains very strong, there are no material off-balance-sheet arrangements, and we continue to have sufficient liquidity for near-term needs. The Company had approximately $21.4 million of available borrowings under the BMO Agreement as of June 30, 2017. The Company expects to continue to generate enough cash from operations, as well as its credit facilities, to meet its operating and investing needs. As of June 30, 2017, the Company also had cash of $16.4 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 2018, the Company expects to contribute $2.3 million to its defined benefit pension plans, the minimum contribution required.

 

Net working capital decreased $4.0 million, or 4.5%, during fiscal 2017, and the current ratio (calculated as total current assets divided by total current liabilities) decreased from 3.5 at June 30, 2016 to 2.9 at June 30, 2017. The decrease in net working capital was primarily driven by an increase in accounts payable (volume driven) and accrued expenses (bonus accrual), and a decrease in cash (foreign repatriation). These favorable movements were partially offset by a volume driven increase in accounts receivable.

 

The Company expects capital expenditures to be approximately $7 million - $9 million in fiscal 2018. These anticipated expenditures reflect the Company’s plans to invest in modern equipment to drive productivity improvements, its global sourcing program and new products.

 

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

 

Off Balance Sheet Arrangements and Contractual Obligations

 

The Company had no off-balance sheet arrangements, other than operating leases, as of June 30, 2017 and 2016.

 

The Company has obligations under non-cancelable operating lease contracts and loan and senior note agreements for certain future payments. A summary of those commitments follows (in thousands):

 

Contractual Obligations

 

Total

   

Less than 1

Year

   

1-3

Years

   

3-5

Years

   

After 5

Years

 

Revolving loan borrowing

  $ 6,285     $ -     $ -     $ 6,285     $ -  

Long-term debt, including current maturities

  $ 38     $ 2     $ 6     $ 6     $ 24  

Operating leases

  $ 5,128     $ 2,435     $ 1,456     $ 999     $ 238  

 

The table above does not include tax liabilities for unrecognized tax benefits totaling $0.8 million, excluding related interest and penalties, as the timing of their resolution cannot be estimated. See Note N of the Notes to the consolidated financial statements for disclosures surrounding uncertain income tax positions.

 

 
23

 

 

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. The Company estimates that fiscal 2018 contributions to all defined benefit plans will total $2.3 million.

 

Other Matters 

 

Critical Accounting Policies

 

The preparation of this Annual 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.

 

The Company’s significant accounting policies are described in Note A to the consolidated financial statements. Not all of these significant accounting policies require management to make difficult, subjective, or complex judgments or estimates. However, the policies management considers most critical to understanding and evaluating its reported financial results are the following:

 

Accounts Receivable 

 

The Company performs ongoing credit evaluations of our customers and adjusts credit limits based on payment history and the customer’s credit-worthiness as determined by review of current credit information. We continuously monitor collections and payments from our customers and maintain a provision for estimated credit losses based upon our historical experience and any specific customer-collection issues. In addition, senior management reviews the accounts receivable aging on a monthly basis to determine if any receivable balances may be uncollectible. Although our accounts receivable are dispersed among a large customer base, a significant change in the liquidity or financial position of any one of our largest customers could have a material adverse impact on the collectability of our accounts receivable and future operating results.

 

Inventory 

 

Inventories are valued at the lower of cost or market. Cost has been determined by the last-in, first-out (LIFO) method for the majority of the inventories located in the United States, and by the first-in, first-out (FIFO) method for all other inventories. Management specifically identifies obsolete products and analyzes historical usage, forecasted production based on future orders, demand forecasts, and economic trends when evaluating the adequacy of the reserve for excess and obsolete inventory. The adjustments to the reserve are estimates that could vary significantly, either favorably or unfavorably, from the actual requirements if future economic conditions, customer demand or competitive conditions differ from expectations.

 

Goodwill

 

Goodwill is tested for impairment annually or more frequently if events or changes in circumstances indicate that an impairment might exist. The Company performs impairment reviews for its reporting units using a fair-value method based on management’s judgments and assumptions or third party valuations.

 

 
24

 

 

In determining the fair value of our reporting units, management is required to make estimates of future operating results, including growth rates, and a weighted-average cost of capital that reflects current market conditions, among others. The development of future operating results incorporates management's best estimates of current and future economic and market conditions which are derived from a review of past results, current results and approved business plans. Many of the factors used in assessing fair value are outside the control of management, and these assumptions and estimates can change in future periods. While the Company believes its judgments and assumptions were reasonable, different assumptions, economic factors and/or market indicators could materially change the estimated fair values of the Company’s reporting units.

 

The following are key assumptions to the Company’s discounted cash flow model:

 

Business Projections – The Company makes assumptions about the level of sales for each fiscal year including expected growth, if any. This assumption drives its planning for volumes, mix, and pricing. The Company also makes assumptions about its cost levels (e.g., capacity utilization, cost performance, etc.). These assumptions are key inputs for developing its cash flow projections. These projections are derived using the Company’s internal business plans that are reviewed during the annual budget process.

 

Discount Rates – When measuring a possible impairment, future cash flows are discounted at a rate that is consistent with a weighted average cost of capital for a potential market participant. The weighted average cost of capital is an estimate of the overall after-tax rate of return required by equity and debt holders of a business enterprise. There are a number of assumptions that management makes when calculating the appropriate discount rate, including the targeted leverage ratio.

 

The Company is subject to financial statement risk to the extent the carrying amount of a reporting unit exceeds its fair value. Based upon the goodwill impairment review completed at the end of the third quarter of fiscal 2017, the Company recorded a non-cash impairment charge of $2.5 million. In 2016, the Company recorded a non-cash impairment charge of $7.6 million. See discussion in Note D in the Notes to the Consolidated Financial Statements.

 

Long-lived Assets 

 

The Company reviews long-lived assets for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable. For property, plant and equipment and other long-lived assets, excluding indefinite-lived intangible assets, the Company performs undiscounted operating cash flow analyses to determine if an impairment exists. If an impairment is determined to exist, any related impairment loss is calculated based on fair value. Fair value is primarily determined using discounted cash flow analyses; however, other methods may be used to substantiate the discounted cash flow analyses, including third party valuations when necessary. In fiscal 2017, the Company recorded $0.1 million asset impairment charge related to its India restructuring activities. See discussion in Note P in the Notes to the Consolidated Financial Statements.

 

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 extent of the market 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.

 

 
25

 

 

Pension and Other Postretirement Benefit Plans

 

The Company provides a wide range of benefits to employees and retired employees, including pensions and postretirement health care coverage. Plan assets and obligations are recorded annually based on the Company’s measurement date utilizing various actuarial assumptions such as discount rates, expected return on plan assets, compensation increases, retirement and mortality tables, and health care cost trend rates as of that date. The approach used to determine the annual assumptions are as follows:

 

Discount Rate – based on the Willis Towers Watson BOND:Link model at June 30, 2017 as applied to the expected payouts from the pension plans. This yield curve is made up of Corporate Bonds rated AA or better.

Expected Return on Plan Assets – based on the expected long-term average rate of return on assets in the pension funds, which is reflective of the current and projected asset mix of the funds and considers historical returns earned on the funds.

Compensation Increase – reflect the long-term actual experience, the near-term outlook and assumed inflation.

Retirement and Mortality Rates – based upon the Society of Actuaries RP-2014 base tables for annuitants and non-annuitants, adjusted for generational mortality improvement based on the Society of Actuaries MP-2016 projection scale.

Health Care Cost Trend Rates – developed based upon historical cost data, near-term outlook and an assessment of likely long-term trends.

 

Measurements of net periodic benefit cost are based on the assumptions used for the previous year-end measurements of assets and obligations. The Company reviews its actuarial assumptions on an annual basis and makes modifications to the assumptions when appropriate. The effects of the modifications are recorded currently or amortized over future periods. Based on information provided by its independent actuaries and other relevant sources, the Company believes that the assumptions used are reasonable; however, changes in these assumptions could impact the Company’s financial position, results of operations or cash flows.

 

 Income Taxes 

 

Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. 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. 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.

 

Recently Issued Accounting Standards

 

See Note A, Significant Accounting Policies, to the consolidated financial statements for a discussion of recently issued accounting standards.

 

Item 7A. Quantitative and Qualitative Disclosure About Market Risk

 

The Company is exposed to market risks from changes in interest rates, commodities and foreign currency exchange rates. To reduce such risks, the Company selectively uses financial instruments and other proactive 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. Discussion of the Company’s accounting policies and further disclosure relating to financial instruments is included in Note A to the consolidated financial statements.

 

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 June 30, 2017 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.

 

 
26

 

 

Commodity price risk - The Company is exposed to fluctuations in market prices for such commodities as steel and aluminum. The Company does not utilize commodity price hedges to manage commodity price risk exposure. Direct material cost as a percent of total cost of goods sold was 53.7% for fiscal 2017.

 

Currency risk - The Company has exposure to foreign currency exchange fluctuations. Approximately 29% of the Company’s revenues in the year ended June 30, 2017 were denominated in currencies other than the U.S. dollar. Of that total, approximately 58% was denominated in euros with the balance comprised of Japanese yen, Indian rupee, Swiss franc 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 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 department and restrict derivative transactions to those intended for hedging purposes. The use of financial instruments for trading purposes is prohibited. The Company 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 June 30, 2017, one of the Company’s foreign subsidiaries had three outstanding forward exchange contracts to purchase U.S. dollars in the notional value of $1,050,000 with a weighted average maturity of 53 days. The fair value of the Company’s contract was a loss of $29,000 at June 30, 2017. The Company had no outstanding forward exchange contracts at June 30, 2016.

 

 
27

 

 

Item 8. Financial Statements and Supplementary Data

 

See Consolidated Financial Statements and Financial Statement Schedule.

 

Sales and Earnings by Quarter - Unaudited (in thousands, except per share amounts)

 

2017

 

1st Qtr.

   

2nd Qtr.

   

3rd Qtr.

   

4th Qtr.

   

Year

 
                                         

Net sales

  $ 35,835     $ 33,672     $ 45,084     $ 53,591     $ 168,182  

Gross profit

    9,173       8,949       13,294       16,816       48,232  

Restructuring expenses

    258       816       293       424       1,791  

Goodwill and other asset impairment charge

    -       -       2,637       9       2,646  

Net (loss) earnings

    (2,671 )     (2,892 )     (1,728 )     1,176       (6,115 )

Net (loss) earnings attributable to Twin Disc

    (2,696 )     (2,912 )     (1,849 )     1,163       (6,294 )

Basic (loss) earnings per share attributable to Twin Disc common shareholders

    (0.24 )     (0.26 )     (0.16 )     0.10       (0.56 )

Diluted (loss) earnings per share attributable to Twin Disc common shareholders

    (0.24 )     (0.26 )     (0.16 )     0.10       (0.56 )

Dividends per share

    -       -       -       -       -  

 

2016

 

1st Qtr.

   

2nd Qtr.

   

3rd Qtr.

   

4th Qtr.

   

Year

 
                                         

Net sales

  $ 37,373     $ 44,829     $ 41,434     $ 42,646     $ 166,282  

Gross profit

    8,190       11,606       9,618       11,181       40,595  

Restructuring expenses

    -       515       272       134       921  

Goodwill impairment charge

    -       -       -       7,602       7,602  

Net loss

    (4,275 )     (2,289 )     (931 )     (5,518 )     (13,013 )

Net loss attributable to Twin Disc

    (4,323 )     (2,301 )     (963 )     (5,517 )     (13,104 )

Basic loss per share attributable to Twin Disc common shareholders

    (0.39 )     (0.21 )     (0.09 )     (0.48 )     (1.17 )

Diluted loss per share attributable to Twin Disc common shareholders

    (0.39 )     (0.21 )     (0.09 )     (0.48 )     (1.17 )

Dividends per share

    0.09       0.09       -       -       0.18  

 

Item 9. Change in and Disagreements with Accountants on Accounting and Financial Disclosure

 

None.

 

 
28

 

 

Item 9A. Controls and Procedures

 

Conclusion Regarding Disclosure Controls and Procedures

 

As required by Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as of the end of the period covered by this report and under the supervision and with the participation of management, including the Chief Executive Officer and the Chief Financial Officer, the Company has evaluated the effectiveness of the design and operation of its disclosure controls and procedures. Based on such evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that such disclosure controls and procedures are effective to provide reasonable assurance that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms, and to provide reasonable assurance that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, as appropriate, to allow timely decisions regarding disclosure.

 

Management’s Report on Internal Control Over Financial Reporting

 

Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s internal control over financial reporting is designed 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. The Company’s internal control over financial reporting includes those policies and procedures that:

 

 

1.

pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the Company,

 

2.

provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company, and

 

3.

provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of the effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies and procedures included in such controls may deteriorate.

 

The Company conducted an evaluation of the effectiveness of our internal control over financial reporting based upon the framework (2013 edition) in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based upon such evaluation, our management concluded that our internal control over financial reporting was effective as of June 30, 2017.

 

PricewaterhouseCoopers LLP, an independent registered public accounting firm, has audited the Company’s internal control over financial reporting as of June 30, 2017, as stated in their report which appears herein.

 

Changes in Internal Control Over Financial Reporting

 

During the fourth quarter of fiscal 2017, there have not been any changes in the Company’s internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

Item 9B. Other Information

Not applicable.

 

 
29

 

 

PART III

 

Item 10. Directors and Executive Officers of the Registrant

 

For information with respect to the executive officers of the Registrant, see "Executive Officers of the Registrant" at the end of Part I of this report.

 

For information with respect to the Directors of the Registrant, see "Election of Directors" in the Proxy Statement for the Annual Meeting of Shareholders to be held October 26, 2017, which is incorporated into this report by reference.

 

For information with respect to compliance with Section 16(a) of the Securities Exchange Act of 1934, see "Section 16(a) Beneficial Ownership Reporting Compliance" in the Proxy Statement for the Annual Meeting of Shareholders to be held October 26, 2017, which is incorporated into this report by reference.

 

For information with respect to the Company’s Code of Ethics, see "Guidelines for Business Conduct and Ethics” in the Proxy Statement for the Annual Meeting of Shareholders to be held October 26, 2017, which is incorporated into this report by reference. The Company’s Code of Ethics, entitled, “Guidelines for Business Conduct and Ethics,” is included on the Company’s website, www.twindisc.com. If the Company makes any substantive amendment to the Code of Ethics, or grants a waiver from a provision of the Code of Ethics for its Chief Executive Officer, Chief Financial Officer or Chief Accounting Officer (or any person performing similar functions), it intends to disclose the nature of such amendment on its website within four business days of the amendment or waiver in lieu of filing a Form 8-K with the SEC.

 

For information with respect to procedures by which shareholders may recommend nominees to the Company’s Board of Directors, see “Director Committee Functions: Nominating and Governance Committee” in the Proxy Statement for the Annual Meeting of Shareholders to be held October 26, 2017, which is incorporated into this report by reference. There were no changes to these procedures since the Company’s last disclosure relating to these procedures.

 

For information with respect to the Audit Committee Financial Expert, see “Director Committee Functions: Audit Committee” in the Proxy Statement for the Annual Meeting of Shareholders to be held October 26, 2017, which is incorporated into this report by reference.

 

For information with respect to the Audit Committee Disclosure, see “Director Committee Functions: Audit Committee” in the Proxy Statement for the Annual Meeting of Shareholders to be held October 26, 2017, which is incorporated into this report by reference.

 

For information with respect to the Audit Committee Membership, see “Director Committee Functions: Committee Membership” in the Proxy Statement for the Annual Meeting of Shareholders to be held October 26, 2017, which is incorporated into this report by reference.

 

Item 11. Executive Compensation

 

The information set forth under the captions "Executive Compensation," "Director Compensation,” “Compensation Committee Interlocks and Insider Participation,” and “Compensation and Executive Development Committee Report,” in the Proxy Statement for the Annual Meeting of Shareholders to be held on October 26, 2017, is incorporated into this report by reference. Discussion in the Proxy Statement under the caption “Compensation and Executive Development Committee Report” is incorporated by reference but shall not be deemed “soliciting material” or to be “filed” as part of this report.

 

 
30

 

 

Item 12. Security Ownership of Certain Beneficial Owners and Management

 

Security ownership of certain beneficial owners and management is set forth in the Proxy Statement for the Annual Meeting of Shareholders to be held on October 26, 2017 under the captions "Principal Shareholders” and “Directors and Executive Officers" and incorporated into this report by reference.

 

For information regarding securities authorized for issuance under equity compensation plans of the Company, see “Equity Compensation Plan Information” in the Proxy Statement for the Annual Meeting of Shareholders to be held on October 26, 2017, which is incorporated into this report by reference.

 

There are no arrangements known to the Registrant, the operation of which may at a subsequent date result in a change in control of the Registrant.

 

Item 13. Certain Relationships and Related Transactions, Director Independence

 

For information with respect to transactions with related persons and policies for the review, approval or ratification of such transactions, see “Corporate Governance – Review, Approval or Ratification of Transactions with Related Persons” in the Proxy Statement for the Annual Meeting of Shareholders to be held October 26, 2017, which is incorporated into this report by reference.

 

For information with respect to director independence, see “Corporate Governance – Board Independence” in the Proxy Statement for the Annual Meeting of Shareholders to be held October 26, 2017, which is incorporated into this report by reference.

 

Item 14. Principal Accounting Fees and Services

 

The Company incorporates by reference the information contained in the Proxy Statement for the Annual Meeting of Shareholders to be held October 26, 2017 under the headings “Fees to Independent Registered Public Accounting Firm” and “Pre-approval Policies and Procedures.”

 

PART IV

 

Item 15. Exhibits, Financial Statement Schedules

 

(a)(1) Consolidated Financial Statements

 

See Index to Consolidated Financial Statements and Financial Statement Schedule, the Report of Independent Registered Public Accounting Firm and the Consolidated Financial Statements, all of which are incorporated by reference.

 

(a)(2) Consolidated Financial Statement Schedule

 

See Index to Consolidated Financial Statements and Financial Statement Schedule, and the Consolidated Financial Statement Schedule, all of which are incorporated by reference.

 

(a)(3) Exhibits. See Exhibit Index included as the last page of this form, which is incorporated by reference.

 

 
31

 

 

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND

FINANCIAL STATEMENT SCHEDULE

 

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

Page

   

Report of Independent Registered Public Accounting Firm

33

   

Consolidated Balance Sheets as of June 30, 2017 and 2016

34

   

Consolidated Statements of Operations and Comprehensive Income for the years ended June 30, 2017, 2016 and 2015

35

   

Consolidated Statements of Cash Flows for the years ended June 30, 2017, 2016 and 2015

36

   

Consolidated Statements of Changes in Equity for the years ended June 30, 2017, 2016 and 2015

37

   

Notes to Consolidated Financial Statements

38-62

   
   

INDEX TO FINANCIAL STATEMENT SCHEDULE

 
   

Schedule II - Valuation and Qualifying Accounts

63

 

 

Schedules, other than those listed, are omitted for the reason that they are inapplicable, are not required, or the information required is shown in the financial statements or the related notes.

 

 
32

 

 

Report of Independent Registered Public Accounting Firm

 

To the Board of Directors and Shareholders of Twin Disc, Incorporated:

 

In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Twin Disc, Incorporated and its subsidiaries at June 30, 2017 and June 30, 2016, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 2017 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of June 30, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management's Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company's internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

 

A company’s internal control over financial reporting is a process designed 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. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

/s/ PricewaterhouseCoopers LLP

Milwaukee, Wisconsin

August 31, 2017

 

 
33

 

 

TWIN DISC, INCORPORATED AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

June 30, 2017 and 2016

(In thousands, except share amounts)

 

 

   

2017

   

2016

 
                 

ASSETS

               

Current assets:

               

Cash

  $ 16,367     $ 18,273  

Accounts receivable, net

    31,392       25,363  

Inventories

    66,193       66,569  

Prepaid expenses

    8,295       7,353  

Other

    7,187       7,477  

Total current assets

    129,434       125,035  
                 

Property, plant and equipment, net

    48,212       51,665  

Goodwill, net

    2,585       5,120  

Deferred income taxes

    24,198       25,870  

Intangible assets, net

    2,009       2,164  

Other assets

    4,460       4,068  
                 

Total assets

  $ 210,898     $ 213,922  
                 

LIABILITIES AND EQUITY

               

Current liabilities:

               

Accounts payable

  $ 21,301     $ 14,716  

Accrued liabilities

    23,222       21,415  

Total current liabilities

    44,523       36,131  
                 

Long-term debt

    6,323       8,501  

Accrued retirement benefits

    33,706       48,705  

Deferred income taxes

    1,011       827  

Other long-term liabilities

    1,768       2,705  
                 

Total liabilities

    87,331       96,869  
                 

Commitments and contingencies (Note O)

               
                 

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

    10,429       11,761  

Retained earnings

    169,368       175,662  

Accumulated other comprehensive loss

    (32,671 )     (44,143 )
      147,126       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

    122,921       116,490  
                 

Noncontrolling interest

    646       563  
                 

Total equity

    123,567       117,053  
                 

Total liabilities and equity

  $ 210,898     $ 213,922  

 

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

 

 
34

 

 

TWIN DISC, INCORPORATED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME

For the years ended June 30, 2017, 2016 and 2015

(In thousands, except share amounts)

 

   

2017

   

2016

   

2015

 
                         

Net sales

  $ 168,182     $ 166,282     $ 265,790  

Cost of goods sold

    119,950       125,687       182,758  

Gross profit

    48,232       40,595       83,032  
                         

Marketing, engineering and administrative expenses

    52,773       57,113       64,264  

Restructuring expenses

    1,791       921       3,282  

Goodwill and other asset impairment charge

    2,646       7,602       -  

Other operating expense (income)

    -       (445 )     -  

(Loss) earnings from operations

    (8,978 )     (24,596 )     15,486  
                         

Other income (expense):

                       

Interest income

    72       147       124  

Interest expense

    (303 )     (426 )     (606 )

Other income (expense), net

    (320 )     (420 )     896  
      (551 )     (699 )     414  
                         

(Loss) earnings before income taxes and noncontrolling interest

    (9,529 )     (25,295 )     15,900  
                         

Income tax (benefit) expense

    (3,414 )     (12,282 )     4,515  
                         

Net (loss) earnings

    (6,115 )     (13,013 )     11,385  
                         

Less: Net earnings attributable to noncontrolling interest, net of tax

    (179 )     (91 )     (212 )
                         

Net (loss) earnings attributable to Twin Disc

  $ (6,294 )   $ (13,104 )   $ 11,173  
                         

(Loss) earnings per share data:

                       

Basic (loss) earnings per share attributable to Twin Disc common shareholders

  $ (0.56 )   $ (1.17 )   $ 0.99  

Diluted (loss) earnings per share attributable to Twin Disc common shareholders

  $ (0.56 )   $ (1.17 )   $ 0.99  
                         

Weighted average shares outstanding data:

                       

Basic shares outstanding

    11,239       11,203       11,273  

Dilutive stock awards

    -       -       4  
                         

Diluted shares outstanding

    11,239       11,203       11,277  
                         

Comprehensive income (loss):

                       

Net (loss) earnings

  $ (6,115 )   $ (13,013 )   $ 11,385  

Foreign currency translation adjustment

    985       (1,557 )     (14,119 )

Benefit plan adjustments, net of income taxes of $6,149, ($3,340) and ($2,974), respectively

    10,500       (7,080 )     (5,499 )

Comprehensive income (loss)

    5,370       (21,650 )     (8,233 )

Less: Comprehensive income attributable to noncontrolling interest

    (193 )     (114 )     (132 )
                         

Comprehensive income (loss) attributable to Twin Disc

  $ 5,177     $ (21,764 )   $ (8,365 )

 

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

 

 
35

 

  

TWIN DISC, INCORPORATED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the years ended June 30, 2017, 2016 and 2015

(In thousands)

 

   

2017

   

2016

   

2015

 

Cash flows from operating activities:

                       

Net (loss) earnings

  $ (6,115 )   $ (13,013 )   $ 11,385  

Adjustments to reconcile net (loss) earnings to net cash provided by operating activities:

                       

Depreciation and amortization

    7,017       8,847       10,161  

Goodwill and other asset impairment charge

    2,646       7,602       -  

Stock compensation expense

    1,615       1,295       696  

Restructuring of operations

    92       354       3,282  

Provision for deferred income taxes

    (4,245 )     (12,203 )     (442 )

Other, net

    7       74       215  

Changes in operating assets and liabilities

                       

Trade accounts receivable

    (5,885 )     18,422       (7,248 )

Inventories

    624       10,060       8,860  

Other assets

    (682 )     938       (4,090 )

Accounts payable

    6,034       (6,285 )     914  

Accrued liabilities

    983       (12,580 )     380  

Accrued/prepaid retirement benefits

    1,087       (120 )     (7,053 )
                         

Net cash provided by operating activities

    3,178       3,391       17,060  
                         

Cash flows from investing activities:

                       

Proceeds from sale of business (see Note P)

    -       3,500       -  

Proceeds from life insurance policy

    -       2,002       -  

Proceeds from sale of plant assets

    217       124       279  

Capital expenditures

    (3,133 )     (4,214 )     (9,049 )

Other, net

    (126 )     (270 )     1,934  
                         

Net cash (used) provided by investing activities

    (3,042 )     1,142       (6,836 )
                         

Cash flows from financing activities:

                       

Payments of senior notes

    -       (3,571 )     (3,600 )

Borrowings under revolving loan agreement

    53,920       89,473       83,681  

Repayments under revolving loan agreement

    (56,113 )     (91,203 )     (84,674 )

Proceeds from exercise of stock options

    -       12       15  

Dividends paid to shareholders

    -       (2,041 )     (4,061 )

Dividends paid to noncontrolling interest

    (109 )     (192 )     (220 )

Excess tax benefits (shortfall) from stock compensation

    -       (349 )     (26 )

Payments of withholding taxes on stock compensation

    (140 )     (190 )     (313 )
                         

Net cash used by financing activities

    (2,442 )     (8,061 )     (9,198 )
                         

Effect of exchange rate changes on cash

    400       (1,135 )     (2,847 )
                         

Net change in cash

    (1,906 )     (4,663 )     (1,821 )
                         

Cash:

                       

Beginning of year

    18,273       22,936       24,757  
                         

End of year

  $ 16,367     $ 18,273     $ 22,936  
                         

Supplemental cash flow information:

                       

Cash paid during the year for:

                       

Interest

  $ 300     $ 474     $ 569  

Income taxes

    27       1,758       5,061  

 

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

 

 
36

 

 

TWIN DISC, INCORPORATED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

For the years ended June 30, 2017, 2016 and 2015

(In thousands)

 

   

Twin Disc, Inc. Shareholders’ Equity

 
                   

Accumulated

                         
                   

Other

           

Non-

         
   

Common

   

Retained

   

Comprehensive

   

Treasury

   

Controlling

   

Total

 
   

Stock

   

Earnings

   

Income (Loss)

   

Stock

   

Interest

   

Equity

 

Balance at June 30, 2014

  $ 11,973     $ 183,695     $ (15,943 )   $ (28,141 )   $ 727     $ 152,311  
                                                 

Net earnings

            11,173                       212       11,385  

Translation adjustments

                    (14,039 )             (80 )     (14,119 )

Benefit plan adjustments, net of tax

                    (5,499 )                     (5,499 )

Cash dividends

            (4,061 )                     (220 )     (4,281 )

Compensation expense and windfall tax benefits

    668                                       668  

Shares (acquired) issued, net

    (382 )                     84               (298 )
                                                 

Balance at June 30, 2015

    12,259       190,807       (35,481 )     (28,057 )     639       140,167  
                                                 

Net (loss) earnings

            (13,104 )                     91       (13,013 )

Translation adjustments

                    (1,582 )             25       (1,557 )

Benefit plan adjustments, net of tax

                    (7,080 )                     (7,080 )

Cash dividends

            (2,041 )                     (192 )     (2,233 )

Compensation expense and windfall tax benefits

    946                                       946  

Shares (acquired) issued, net

    (1,444 )                     1,267               (177 )
                                                 

Balance at June 30, 2016

    11,761       175,662       (44,143 )     (26,790 )     563       117,053  
                                                 

Net (loss) earnings

            (6,294 )                     179       (6,115 )

Translation adjustments

                    972               13       985  

Benefit plan adjustments, net of tax

                    10,500                       10,500  

Cash dividends

                                    (109 )     (109 )

Compensation expense and windfall tax benefits

    1,393                                       1,393  

Shares (acquired) issued, net

    (2,725 )                     2,585               (140 )
                                                 

Balance at June 30, 2017

  $ 10,429     $ 169,368     $ (32,671 )   $ (24,205 )   $ 646     $ 123,567  

 

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

 

 
37

 

 

TWIN DISC, INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(AMOUNTS IN THOUSANDS, EXCEPT SHARE AMOUNTS AND PER SHARE DATA)

 

 

A. SIGNIFICANT ACCOUNTING POLICIES

 

The following is a summary of the significant accounting policies followed in the preparation of these financial statements:

 

Consolidation Principles--The consolidated financial statements include the accounts of Twin Disc, Incorporated and its wholly and majority-owned domestic and foreign subsidiaries (the “Company”). Certain foreign subsidiaries are included based on fiscal years ending May 31, to facilitate prompt reporting of consolidated accounts. The Company also has a controlling interest in a Japanese joint venture, which is consolidated based upon a fiscal year ending March 31. All significant intercompany transactions have been eliminated.

 

Management Estimates--The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual amounts could differ from those estimates.

 

Translation of Foreign Currencies--The financial statements of the Company’s non-U.S. subsidiaries are translated using the current exchange rate for assets and liabilities and the weighted-average exchange rate for the year for revenues and expenses. The resulting translation adjustments are recorded as a component of accumulated other comprehensive loss, which is included in equity. Gains and losses from foreign currency transactions are included in earnings. Included in other income (expense) are foreign currency transaction (losses) gains of ($318), ($320) and $491 in fiscal 2017, 2016 and 2015, respectively.

 

Cash--The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalent. Under the Company’s cash management system, cash balances at certain banks are funded when checks are presented for payment. To the extent that checks issued, but not yet presented for payment, exceed the balance on hand at the specific bank against which they were written, the amount of those un-presented checks is included in accounts payable.

 

Accounts Receivable--These represent trade accounts receivable and are stated net of an allowance for doubtful accounts of $1,519 and $1,824 at June 30, 2017 and 2016, respectively. The Company records an allowance for doubtful accounts provision for certain customers where a risk of default has been specifically identified as well as provisions determined on a general basis when it is believed that some default is probable and estimable. The assessment of likelihood of customer default is based on a variety of factors, including the length of time the receivables are past due, the historical collection experience and existing economic conditions. Various factors may adversely impact our customer’s ability to access sufficient liquidity and capital to fund their operations and render the Company’s estimation of customer defaults inherently uncertain. While the Company believes current allowances for doubtful accounts are adequate, it is possible that these factors may cause higher levels of customer defaults and bad debt expense in future periods.

 

Fair Value of Financial Instruments--The carrying amount reported in the consolidated balance sheets for cash, trade accounts receivable and accounts payable approximate fair value because of the immediate short-term maturity of these financial instruments. If measured at fair value, cash would be classified as Level 1 and all other items listed above would be classified as Level 2 in the fair value hierarchy, as described in Note M. The Company’s borrowings under the revolving loan agreement, which is classified as long-term debt and consists of loans that are routinely borrowed and repaid throughout the year, approximate fair value at June 30, 2017. If measured at fair value in the financial statements, long-term debt (including any current portion) would be classified as Level 2 in the fair value hierarchy, as described in Note M.

 

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

 

 
38

 

 

Periodically, the Company 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 income (expense) 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 June 30, 2017, one of the Company’s foreign subsidiaries had three outstanding forward exchange contracts to purchase U.S. dollars in the notional value of $1,050 with a weighted average maturity of 53 days. The fair value of the Company’s contract was a loss of $29 at June 30, 2017. The Company had no outstanding forward exchange contracts at June 30, 2016.

 

Inventories--Inventories are valued at the lower of cost or market. Cost has been determined by the last-in, first-out (LIFO) method for the majority of inventories located in the United States, and by the first-in, first-out (FIFO) method for all other inventories. Management specifically identifies obsolete products and analyzes historical usage, forecasted production based on future orders, demand forecasts, and economic trends, among others, when evaluating the adequacy of the reserve for excess and obsolete inventory.

 

Property, Plant and Equipment and Depreciation--Assets are stated at cost. Expenditures for maintenance, repairs and minor renewals are charged against earnings as incurred. Expenditures for major renewals and betterments are capitalized and depreciated. Depreciation is provided on the straight-line method over the estimated useful lives of the assets. The lives assigned to buildings and related improvements range from 10 to 40 years, and the lives assigned to machinery and equipment range from 5 to 15 years. Upon disposal of property, plant and equipment, the cost of the asset and the related accumulated depreciation are removed from the accounts and the resulting gain or loss is reflected in earnings. Fully depreciated assets are not removed from the accounts until physically disposed.

 

Impairment of Long-lived Assets--The Company reviews long-lived assets for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable. For property, plant and equipment and other long-lived assets, excluding indefinite-lived intangible assets, the Company performs undiscounted operating cash flow analyses to determine if an impairment exists. If an impairment is determined to exist, any related impairment loss is calculated based on fair value. Fair value is primarily determined using discounted cash flow analyses; however, other methods may be used to determine the fair value, including third party valuations when necessary.

 

Goodwill and Other Intangibles--Goodwill and other indefinite-lived intangible assets, primarily tradenames, are tested for impairment at least annually on the last day of the Company’s fiscal year and more frequently if an event occurs which indicates the asset may be impaired. If applicable, goodwill and other indefinite-lived intangible assets not subject to amortization have been assigned to reporting units for purposes of impairment testing based upon the relative fair value of the asset to each reporting unit.

 

A significant amount of judgment is involved in determining if an indicator of impairment has occurred. Such indicators may include, among others: a significant decline in expected future cash flows; a sustained, significant decline in the Company’s stock price and market capitalization; a significant adverse change in legal factors or in the business climate; unanticipated competition; the testing for recoverability of a significant asset group within a reporting unit; and slower growth rates. Any adverse change in these factors could have a significant impact on the recoverability of these assets and could have a material impact on the Company’s consolidated financial statements.

 

The Company early-adopted the new goodwill guidance, ASU 2017-04, during the third quarter of fiscal 2017. Under the new guidance, the goodwill impairment process has been simplified to a one-step approach. The fair value of a reporting unit, as defined, is compared to the carrying value of the reporting unit, including goodwill. The fair value is primarily determined using discounted cash flow analyses which is driven by projected growth rates, and which applies an appropriate market-participant discount rate; the fair value determined is also compared to the value obtained using a market approach from guideline public company multiples. If the carrying amount exceeds the fair value, that difference is recognized as an impairment loss.

 

 
39