twin20190331_10q.htm
 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION     

WASHINGTON, D.C. 20549

Form 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarter ended March 29, 2019

 

Commission File Number 1-7635

 

 

TWIN DISC, INCORPORATED

(Exact name of registrant as specified in its charter)

 

Wisconsin

39-0667110

(State or other jurisdiction of

(I.R.S. Employer

Incorporation or organization)

Identification No.)

   

1328 Racine Street, Racine, Wisconsin 53403

(Address of principal executive offices)

 

(262) 638-4000

(Registrant's telephone number, including area code)

 

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

Yes          No          

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files).          Yes          No__

 

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 definition 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       

                 

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 Exchange Act).

Yes               No     

 

At April 30, 2019, the registrant had 13,098,512 shares of its common stock outstanding.

 

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

 

Title of each class

Trading Symbol(s)

Name of each exchange on which registered

Common Stock (No Par Value)

TWIN 

The NASDAQ Stock Market LLC 

 

 

 

 

 

Part I.     FINANCIAL INFORMATION

 

Item 1.     Financial Statements

TWIN DISC, INCORPORATED

CONDENSED CONSOLIDATED BALANCE SHEETS

(IN THOUSANDS, EXCEPT SHARE AMOUNTS)

(UNAUDITED)

 

   

March 29, 2019

   

June 30, 2018

 
                 

ASSETS

               

Current assets:

               

Cash

  $ 15,757     $ 15,171  

Trade accounts receivable, net

    48,207       45,422  

Inventories

    128,168       84,001  

Prepaid expenses

    7,591       8,423  

Other

    8,591       6,252  

Total current assets

    208,314       159,269  
                 

Property, plant and equipment, net

    67,422       55,467  

Goodwill, net

    26,672       2,692  

Intangible assets, net

    23,114       1,906  

Deferred income taxes

    15,313       18,056  

Other assets

    3,989       3,850  
                 

Total assets

  $ 344,824     $ 241,240  
                 

LIABILITIES AND EQUITY

               

Current liabilities:

               

Current maturities of long-term debt

  $ 2,000     $ -  

Accounts payable

    27,825       29,368  

Accrued liabilities

    39,512       32,976  

Total current liabilities

    69,337       62,344  
                 

Long-term debt

    47,280       4,824  

Lease obligations

    13,325       6,527  

Accrued retirement benefits

    19,172       21,068  

Deferred income taxes

    6,971       1,203  

Other long-term liabilities

    2,097       1,658  
                 

Total liabilities

    158,182       97,624  
                 

Commitments and contingencies (Note F)

               
                 

Equity:

               

Twin Disc shareholders' equity:

               

Preferred shares authorized: 200,000; issued: none; no par value

    -       -  

Common shares authorized: 30,000,000; issued: 14,632,802 and 13,098,468, respectively; no par value

    44,755       11,570  

Retained earnings

    197,293       178,896  

Accumulated other comprehensive loss

    (32,462 )     (23,792 )
      209,586       166,674  

Less treasury stock, at cost (1,534,290 and 1,545,783 shares, respectively)

    23,500       23,677  
                 

Total Twin Disc shareholders' equity

    186,086       142,997  
                 

Noncontrolling interest

    556       619  
                 

Total equity

    186,642       143,616  
                 

Total liabilities and equity

  $ 344,824     $ 241,240  

 

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

 

2

 

 

 

TWIN DISC, INCORPORATED

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME

(IN THOUSANDS, EXCEPT PER SHARE DATA)

(UNAUDITED)

 

   

For the Quarter Ended

   

For the Three Quarters Ended

 
   

March 29, 2019

   

March 30, 2018

   

March 29, 2019

   

March 30, 2018

 
                                 

Net sales

  $ 77,420     $ 65,349     $ 230,216     $ 166,960  

Cost of goods sold

    54,303       44,527       157,026       113,922  

Gross profit

    23,117       20,822       73,190       53,038  
                                 

Marketing, engineering and administrative expenses

    17,375       14,549       55,269       43,013  

Restructuring expenses

    131       452       738       2,501  

Other operating income

    (1,357 )     -       (1,357 )     -  

Income from operations

    6,968       5,821       18,540       7,524  
                                 

Interest expense

    449       80       1,583       227  

Other expense (income), net

    490       272       1,608       1,206  
      939       352       3,191       1,433  
                                 

Income before income taxes and noncontrolling interest

    6,029       5,469       15,349       6,091  

Income tax expense

    1,442       1,133       3,780       2,401  
                                 

Net income

    4,587       4,336       11,569       3,690  

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

    (27 )     (28 )     (75 )     (104 )
                                 

Net income attributable to Twin Disc

  $ 4,560     $ 4,308     $ 11,494     $ 3,586  
                                 

Income per share data:

                               

Basic income per share attributable to Twin Disc common shareholders

  $ 0.35     $ 0.37     $ 0.91     $ 0.31  

Diluted income per share attributable to Twin Disc common shareholders

  $ 0.34     $ 0.37     $ 0.90     $ 0.31  
                                 

Weighted average shares outstanding data:

                               

Basic shares outstanding

    12,914       11,313       12,437       11,289  

Diluted shares outstanding

    13,146       11,344       12,652       11,320  
                                 

Comprehensive income

                               

Net income

  $ 4,587     $ 4,336     $ 11,569     $ 3,690  

Benefit plan adjustments, net of income taxes of $146, $212, $437 and $1,164, respectively

    478       474       1,427       2,682  

Foreign currency translation adjustment

    (869 )     1,849       (3,217 )     4,878  

Comprehensive income

    4,196       6,659       9,779       11,250  

Less: Comprehensive income attributable to noncontrolling interest

    (44 )     (26 )     (52 )     (95 )
                                 

Comprehensive income attributable to Twin Disc

  $ 4,152     $ 6,633     $ 9,727     $ 11,155  

 

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

 

3

 

 

 

TWIN DISC, INCORPORATED

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(IN THOUSANDS)

(UNAUDITED)

 

   

For the Three Quarters Ended

 
   

March 29, 2019

   

March 30, 2018

 
                 

Cash flows from operating activities:

               
                 

Net income

  $ 11,569     $ 3,690  

Adjustments to reconcile net income to net cash (used) provided by operating activities, net of acquired assets:

               

Depreciation and amortization

    6,974       4,908  

Amortization of inventory fair value step-up

    3,223       -  

Restructuring expenses

    28       162  

Gain on sale of Mill Log

    (865 )     -  

Gain on contingent consideration of Veth Propulsion acquisition

    (492 )     -  

Provision for deferred income taxes

    1,158       3,455  

Stock compensation expense and other non-cash changes, net

    2,123       1,330  

Net change in operating assets and liabilities

    (35,876 )     (12,544 )
                 

Net cash (used) provided by operating activities

    (12,158 )     1,001  
                 

Cash flows from investing activities:

               
                 

Proceeds from sale of Mill Log, net of costs to sell

    5,158       -  

Acquisition of Veth Propulsion, less cash acquired

    (60,195 )     -  

Acquisitions of fixed assets

    (8,911 )     (4,354 )

Proceeds from sale of fixed assets

    145       141  

Other, net

    (229 )     (129 )
                 

Net cash used by investing activities

    (64,032 )     (4,342 )
                 

Cash flows from financing activities:

               
                 

Proceeds from issuance of common stock, net

    32,210       -  

Proceeds from exercise of stock options

    36       -  

Borrowings under long-term debt arrangement

    44,151       -  

Repayments of long-term borrowings

    (23,872 )     -  

Borrowings under revolving loan arrangement

    123,904       54,415  

Repayments of revolver loans

    (99,156 )     (53,138 )

Dividends paid to noncontrolling interest

    (115 )     (172 )

Payments of withholding taxes on stock compensation

    (926 )     (422 )
                 

Net cash provided by financing activities

    76,232       683  
                 

Effect of exchange rate changes on cash

    544       1,406  
                 

Net change in cash

    586       (1,252 )
                 

Cash:

               

Beginning of period

    15,171       16,367  
                 

End of period

  $ 15,757     $ 15,115  

 

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

 

4

 

 

TWIN DISC, INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)

(UNAUDITED)

 

 

A.

Basis of Presentation

 

The unaudited condensed consolidated financial statements have been prepared by Twin Disc, Incorporated (the “Company”) pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) and, in the opinion of the Company, include adjustments, consisting primarily of normal recurring items, necessary for a fair statement of results for each period. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such SEC rules and regulations. The Company believes that the disclosures made are adequate to make the information presented not misleading. It is suggested that these financial statements be read in conjunction with the consolidated financial statements and the notes thereto included in the Company’s Annual Report filed on Form 10-K for June 30, 2018. The year-end condensed balance sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States.

 

The unaudited condensed consolidated financial statements and information included in this Quarterly Report on Form 10-Q (“Form 10-Q”) includes the financial results of Veth Propulsion Holding BV (“Veth Propulsion”) for the period beginning July 2, 2018 through March 29, 2019. The financial results included in this Form 10-Q related to the acquisition method of accounting for the Veth Propulsion acquisition are subject to change as the acquisition method accounting is not yet finalized and dependent upon the finalization of management’s review of certain independent valuations and studies that are still in process. See Note B, “Acquisition of Veth Propulsion Holding BV” for further information about the acquisition and related transactions and the acquisition accounting.

 

Recently Adopted Accounting Standards

 

 

a.

In May 2014, the Financial Accounting Standards Board (“FASB”) issued updated guidance (ASU 2014-09) on revenue from contracts with customers. This revenue recognition guidance supersedes existing guidance, including industry-specific guidance. The core principle is that an entity should recognize revenue to depict the transfer of control over promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance identifies steps to apply in achieving this principle. The Company adopted this guidance effective July 1, 2018, using the modified retrospective method and applied the cumulative effect to its retained earnings balance as of that date. Prior periods presented were not retrospectively adjusted for this change. The Company has applied the new revenue recognition standard only to contracts that were not completed as of July 1, 2018.

 

The Company determined that deferral of revenue is appropriate for certain agreements where the performance of services after product delivery is required. Such services primarily pertain to technical commissioning services by its entities in its marine and propulsion business, whereby the Company’s technicians calibrate the controls and transmission to ensure proper performance for the customer’s specific application. This service helps identify issues with the ship's design or performance that need to be remediated by the ship builder or other component suppliers prior to the ship being officially accepted into service by the ship buyer. The cumulative effect adjustment of adopting the new standard is not significant to the Company’s results of operations and financial condition.

 

 

b.

In February 2016, the FASB issued guidance (ASU 2016-02) which replaces the existing guidance for leases. The new standard establishes a right-of-use (“ROU”) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. The Company elected to early adopt the standard effective July 1, 2018 concurrent with the adoption of ASU 2014-09, Revenue from Contracts with Customers, using the modified retrospective approach at the beginning of the earliest comparative period presented in the financial statements, which required the Company to restate each prior reporting period presented.

 

For operating leases in which the Company is a lessee, the Company concluded that all existing operating leases under the old guidance continue to be classified as operating leases under the new guidance, and all existing capital leases under the old guidance are classified as finance leases under the new guidance. The Company excluded any lease contracts with terms of twelve months or less as of the adoption date. The Company has lease agreements with lease and non-lease components, which are generally accounted for as separate lease components. The Company accounts for short-term leases on a straight-line basis over the lease term.

 

5

 

 

The following table presents the effect of the adoption of ASU 2016-02 on the Company’s condensed consolidated balance sheet as of June 30, 2018:

 

   

June 30, 2018

   

Adoption

   

June 30, 2018

 
   

As Reported

   

Impact

   

Restated

 

Property, plant and equipment, net

  $ 48,940     $ 6,527     $ 55,467  

Lease obligations

    -       6,527       6,527  

 

The adoption of ASU 2014-09 and ASU 2016-02 did not have an impact on the Company’s condensed consolidated statement of operations and comprehensive income for the quarter and three quarters ended March 30, 2018, or condensed consolidated statement of cash flows for the three quarters ended March 30, 2018.

 

 

c.

In March 2017, the FASB issued guidance (ASU 2017-07) intended to improve the presentation of net periodic pension cost and net periodic postretirement cost. This guidance requires that an employer report the service cost component in the same line item as other compensation costs arising from services rendered by the pertinent employees during the period. The other components of net benefit cost are required to be presented in the statement of operations separately from the service cost component and outside the subtotal of income from operations. The Company adopted this guidance effective July 1, 2018 on a retrospective basis, which resulted in the reclassification of certain amounts from cost of goods sold and marketing, engineering and administrative expenses to other expense (income), net in the condensed consolidated statements of operations and comprehensive income. As a result, prior period amounts impacted have been revised accordingly.

 

The following table presents the effect of the adoption of ASU 2017-07 on the Company’s condensed consolidated statements of operations and comprehensive income for the quarter and three quarters ended March 30, 2018:

 

   

For the Quarter Ended

   

For the Three Quarters Ended

 
   

March 30, 2018

   

Adoption

   

March 30, 2018

   

March 30, 2018

   

Adoption

   

March 30, 2018

 
   

As Reported

   

Impact

   

Restated

   

As Reported

   

Impact

   

Restated

 

Cost of goods sold

  $ 44,624     $ (97 )   $ 44,527     $ 114,214     $ (292 )   $ 113,922  

Gross profit

    20,725       97       20,822       52,746       292       53,038  

Marketing, engineering and administrative expenses

    14,747       (198 )     14,549       43,683       (670 )     43,013  

Income from operations

    5,526       295       5,821       6,562       962       7,524  

Other expense (income), net

    (23 )     295       272       244       962       1,206  

 

 

d.

In February 2018, the FASB issued guidance (ASU 2018-02) intended to eliminate the stranded tax effects resulting from the Tax Cuts and Jobs Act by allowing a reclassification from accumulated other comprehensive income to retained earnings. The Company elected to early adopt this guidance effective July 1, 2018 by making a reclassification of $6,903 from accumulated other comprehensive loss to retained earnings.

 

 

e.

In October 2016, the FASB issued updated guidance (ASU 2016-16) that changes the recognition of income tax consequences of an intra-entity transfer of an asset other than inventory. The Company adopted this guidance effective July 1, 2018. The adoption of this guidance did not have a material impact on the Company’s financial statements and disclosures.

 

 

f.

In August 2016, the FASB issued updated guidance (ASU 2016-15) that addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice. The Company adopted this guidance effective July 1, 2018. The adoption of this guidance did not have a material impact on the Company’s financial statements and disclosures.

 

 

g.

In August 2018, the SEC issued Release No. 33-10532, Disclosure Update and Simplification. In addition to eliminating certain disclosure requirements, this release also amends the interim financial statement requirements to require provision of the information required by Regulation S-X Rule 3-04 for the current and comparative year-to-date periods, with subtotals for each interim period. Rule 3-04 requires a reconciliation of stockholders’ equity beginning and ending balances for each period for which a statement of comprehensive income is required to be filed. The Company adopted this guidance during the Company’s second quarter of fiscal year 2019. The adoption of this guidance did not have a material impact on the Company’s disclosures.

 

New Accounting Releases

 

In August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging (ASC 815) - Targeted Improvements to Accounting for Hedging Activities. The amendments in this guidance better align an entity’s risk management activities and financial reporting for hedging relationships through changes to both the designation and measurement guidance for qualifying hedging relationships and the presentation of hedge results. The ASU is effective for annual periods beginning after December 15, 2018 (the Company’s fiscal 2020), and interim periods within those annual periods, with early adoption permitted. The Company plans to early adopt this guidance during the fourth quarter of fiscal 2019. The Company is currently evaluating the potential impact of this guidance on the Company’s condensed consolidated financial statements.

 

6

 

 

In August 2018, the FASB issued updated guidance (ASU 2018-13) as part of the disclosure framework project, which focuses on improving the effectiveness of disclosures in the notes to the financial statements. The amendments in this update modify the disclosure requirements on fair value measurements in Topic 820, Fair Value Measurement. The amendments in this guidance are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019 (the Company’s fiscal 2021), with early adoption permitted. The Company is currently evaluating the potential impact of this guidance on the Company’s disclosures.

 

In August 2018, the FASB issued updated guidance (ASU 2018-14) intended to modify the disclosure requirements for employers that sponsor defined pension or postretirement plans. The amendments in this guidance are effective for fiscal years ending after December 15, 2020 (the Company’s fiscal 2021), with early adoption permitted. The Company is currently evaluating the potential impact of this guidance on the Company’s disclosures.

 

Special Note Regarding Smaller Reporting Company Status

 

In June 2018, the SEC issued Release 33-10513; 34-83550, Amendments to Smaller Reporting Company Definition, which changes the definition of a smaller reporting company in Rule 12b-2 of the Securities Exchange Act of 1934, as amended.  Under this release, the new thresholds for qualifying are (1) public float of less than $250 million or (2) annual revenue of less than $100 million and public float of less than $700 million (including no public float).  The rule change is effective on September 10, 2018, the Company’s first fiscal quarter of fiscal year 2019.  Under this release, the Company continues to qualify as a smaller reporting company based on its public float as of the last business day of its second fiscal quarter of fiscal year 2019. A smaller reporting company may choose to comply with scaled or non-scaled financial and non-financial disclosure requirements on an item-by-item basis. The Company has not scaled its disclosures of financial and non-financial information in this Quarterly Report. The Company may determine to provide scaled disclosures of financial or non-financial information in future quarterly reports, annual reports and/or proxy statements if it remains a smaller reporting company under SEC rules.

 

 

B.

Acquisition of Veth Propulsion Holding BV

 

On July 2, 2018, the Company completed the acquisition of 100% of the outstanding common stock of Veth Propulsion. Veth Propulsion is a global manufacturer of highly-engineered primary and auxiliary propulsions and propulsion machinery for maritime vessels, including rudder propellers, bow thrusters, generator sets and engine service and repair, based in the Netherlands. These products are complementary to and expand the Company’s current product offerings in the marine and propulsion markets. Prior to the acquisition, the Company was a distributor of Veth products in North America and Asia. This acquisition was pursuant to a Share Purchase Agreement (“Purchase Agreement”) entered into by Twin Disc NL Holding B.V., a wholly-owned subsidiary of the Company, with Het Komt Vast Goed B.V., the prior parent of Veth Propulsion, on June 13, 2018. Veth Propulsion is reported as part of the Company’s manufacturing segment.

 

Under the terms of the Purchase Agreement, the Company paid an aggregate of approximately $58,862 in cash at closing, which included a base payment plus adjustments for net cash and working capital. In January 2019, the Company paid an additional amount of $545 in consideration of the final determination of working capital adjustments pursuant to the Purchase Agreement. The total purchase consideration is further subject to an earn-out (contingent consideration). The earn-out would be paid if the earnings before interest, tax, depreciation and amortization (“EBITDA”) of Veth Propulsion in the period January 1, 2018 through December 31, 2018 were to exceed the agreed upon threshold amount. The maximum earn-out is approximately $3,700 and would be paid in the form of Company stock. The earn-out has been determined and is expected to be settled in May 2019. See Note N, Restructuring of Operations and Other Operating Income, for further discussion.

 

The Company financed the payment of the cash consideration through borrowings under a new credit agreement entered into on June 29, 2018 with BMO Harris Bank N.A. (the “Credit Agreement”). The Credit Agreement is further discussed in Note L, Long-term Debt.

 

7

 

 

Consideration Transferred

 

The following table summarizes the consideration transferred at the acquisition date, which includes the subsequent settlement of the working capital adjustment as of the acquisition date pursuant to the Purchase Agreement.

 

Cash at closing (a)

  $ 58,862  

Working capital adjustment settlement

    545  

Fair value of contingent consideration at acquisition date (b)

    2,921  

Total

  $ 62,328  

 

 

(a)

In the statement of cash flows, the cash used in the acquisition of Veth Propulsion in the amount of $60,195 includes the cash used to pay off the loan to the prior parent of Veth Propulsion, and is net of the cash, including restricted cash, acquired in the transaction, of $1,078 (see below for fair value of assets acquired and liabilities assumed).

 

 

(b)

This pertains to the fair value of the earn-out at acquisition date, which was estimated based on a probability-weighted approach. Under ASC 805, Business Combinations, changes in fair value of this amount is recognized in the income statement and is not an adjustment to the opening balance sheet or the determination of goodwill. See discussion of Fair Value Adjustment of Contingent Consideration in Note N, Restructuring of Operations and Other Operating Income.

 

Fair Value Estimate of Assets Acquired and Liabilities Assumed

 

The Company is continuing its review of the fair value estimate of assets acquired and liabilities assumed during the measurement period, which will conclude as soon as the necessary information regarding the facts and circumstances that existed as of the acquisition date is obtained, or otherwise not available. This measurement period will not exceed one year from the acquisition date. At the effective date of the acquisition, the assets acquired and liabilities assumed are required to be measured at fair value. The fair value estimates are pending completion of several elements, including the finalization of an independent appraisal and final review by the Company. Accordingly, until the fair values are final, there could be material adjustments to the Company’s consolidated financial statements, including changes to depreciation and amortization expense related to the valuation of property and equipment and intangible assets acquired and their respective useful lives, among other adjustments.

 

Upon the final determination of the fair value of assets acquired and liabilities assumed, the excess of the purchase price over such fair values is allocated to goodwill. The final determination of the purchase price, fair values and resulting goodwill may differ significantly from what is reflected in these consolidated financial statements.

 

The following summarizes the preliminary estimate of fair value of the assets acquired and liabilities assumed at the acquisition date. Some of these amounts reflect updated values from those previously reported as of December 28, 2018, the Company’s prior fiscal quarter, due to management’s ongoing fair value assessment during the measurement period.

 

 

Fair Value of Assets Acquired

         

Cash, including restricted cash

  $ 1,078  

(a)

Accounts receivable and other current assets

    10,437  

(b)

Inventories

    27,750  

(c)

Property, plant and equipment

    2,661  

(d)

Intangibles

    24,000  

(e)

Accounts payable and accrued liabilities

    (21,208 )  

Deferred tax liability

    (7,376 )

(f)

Total net assets acquired

    37,342    

Goodwill

    24,986  

(g)

Total consideration

  $ 62,328    

 

8

 

 

The following information provides further details about the estimated net step-up in fair value and/or the estimated fair value at the acquisition date for some key balance sheet items. 

 

(a) Included in cash is restricted cash in the amount of $698. This amount is restricted and not available for general business use in order to guarantee performance obligations by Veth Propulsion under certain employee and customer contracts. A significant majority of these arrangements have expired as of March 29, 2019 and they are not expected to be renewed.

 

(b) Accounts receivable represents contractual amounts receivable from customers less an allowance for doubtful accounts. This amount approximates fair value.

 

(c) Inventories consist of:

 

Inventories

       

Raw materials

  $ 13,307  

Projects work in progress at fair value

    14,443  

Inventories at fair value

    27,750  

Inventories at book value

    23,375  

Step-up

  $ 4,375  

 

 

As of the effective date of the acquisition, inventory is required to be measured at fair value. Raw materials are typically utilized in operations within one year of purchase and therefore book values approximate fair value. Projects work in progress are estimated to be approximately 70% complete, and the step-up to fair value less estimated costs to complete and sell resulted in a step-up value of approximately $4,375.

 

(d) The fair value of property, plant and equipment is estimated at $2,661. These assets primarily consist of manufacturing equipment, test equipment, vehicles, and office and plant fixtures. Their estimated useful lives range from 2 to 13 years.

 

(e) Intangible assets consist of:

 

   

Estimated fair

   

Estimated average

   

Annual

 
   

value

   

useful lives

   

amortization

 

Customer relationships

  $ 13,800       12     $ 1,150  

Technology and know-how

    8,400       7       1,200  

Tradename

    1,800       10       180  

Total

  $ 24,000             $ 2,530  

 

 

The preliminary fair values were determined primarily using an income method, which utilizes financial forecasts of expected future cash flows. Some of the more significant assumptions used in the development of intangible asset values include: the amount and timing of projected future cash flows, the discount rate selected to measure the risks inherent in future cash flows, and the assessment of the asset’s life cycle and competitive trends impacting the asset, as well as other factors.

 

(f) This represents the net deferred tax liability associated with the fair value of assets acquired and liabilities assumed.

 

(g) The Company is not able to deduct any of the goodwill for tax purposes.

 

The fair values presented above are preliminary until the Company completes its work with the use of a third party valuation firm. These values are subject to change. Any changes to the initial estimates of the fair value of assets and liabilities will impact residual goodwill and may affect future earnings.

 

As part of the acquisition, the Company entered into a fifteen-year lease with Het Komt Vast Goed B.V., the owner of the real property where Veth Propulsion’s operations are located. Under this lease, the Company pays an annual market-based rent of $1,249, with provisions for increasing rent based on the prevailing consumer price index.

 

9

 

 

Summary Financial Information

 

The following table presents financial information for Veth Propulsion that is included in the Company’s consolidated statement of operations for the quarter and three quarters ended March 29, 2019:

 

   

Quarter Ended

   

Three Quarters Ended

 
   

March 29, 2019

   

March 29, 2019

 

Net sales

  $ 15,496     $ 42,931  

Gross profit (a)

    3,024       8,916  

Operating income (b)

    244       204  

Net income (loss) attributable to Twin Disc

    6       (569 )

 

(a) Gross profit includes the non-recurring purchase accounting charge for the step-up of inventories acquired of $1,050 and $3,223 for the quarter and three quarters ended March 29, 2019, respectively.

 

(b) In addition to (a), operating income includes the depreciation of property, plant and equipment and amortization of intangible assets acquired of $749 and $1,985 for the quarter and three quarters ended March 29, 2019, respectively. Operating income also includes one-time transaction charges related to the acquisition of $2 and $461 for the quarter and three quarters ended March 29, 2019, respectively.

 

The following table presents unaudited supplemental pro forma information as if the acquisition of Veth Propulsion had occurred on July 1, 2017.

 

   

Quarter Ended

   

Three Quarters Ended

 
   

March 30, 2018

   

March 30, 2018

 

Net sales

  $ 78,615     $ 209,517  

Gross profit (a)

    23,384       61,993  

Net income attributable to Twin Disc (b)

    2,859       784  

Basic income per share attributable to Twin Disc common shareholders

  $ 0.25     $ 0.07  

Diluted income per share attributable to Twin Disc common shareholders

  $ 0.25     $ 0.07  
                 

Weighted average number of common shares outstanding:

               

Basic

    11,313       11,289  

Diluted

    11,344       11,320  

 

(a) Gross profit includes the amortization of the step-up of inventories of $1,179 and $3,537 for the quarter and three quarters ended March 30, 2018, respectively.

 

(b) In addition to (a), this includes the amortization of intangible assets acquired and interest expense on borrowings under the Credit Agreement net of other expenses, amounting to $1,136 and $3,408, before tax, for the quarter and three quarters ended March 30, 2018, respectively.

 

 

C.

Revenue Recognition

 

Revenue from contracts with customers is recognized using a five-step model consisting of the following: (1) identify the contract with a customer; (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to the performance obligations in the contract; and (5) recognize revenue when (or as) the Company satisfies a performance obligation. Performance obligations are satisfied when the Company transfers control of a good or service to a customer, which can occur over time or at a point in time. The amount of revenue recognized is based on the consideration to which the Company expects to be entitled in exchange for those goods or services, including the expected value of variable consideration. The customer’s ability and intent to pay the transaction price is assessed in determining whether a contract exists with the customer. If collectibility of substantially all of the consideration in a contract is not probable, consideration received is not recognized as revenue unless the consideration is nonrefundable and the Company no longer has an obligation to transfer additional goods or services to the customer or collectibility becomes probable.

 

10

 

 

The Company designs, manufactures and sells marine and heavy duty off highway power transmission equipment. Products offered include: marine transmissions, azimuth drives, 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.

 

Identify contract with customer:

 

The Company gathered customer contracts and representative customer purchase orders of its various locations. The Company’s customers consist of distributors and direct end-users. With regard to distributors, the Company generally has written distribution agreements which describe the terms of the distribution arrangement, such as the product range, the sales territory, product pricing, sales support, payment and returns policy, etc. Customer contracts are generally in the form of acknowledged purchase orders. Services to be rendered, as part of the delivery of those products, are also generally specified. Such services include installation reviews and technical commissioning.

 

Performance obligations:

 

The Company’s performance obligation as it relates to the delivery of goods is straightforward; the recognition of revenue is generally driven by shipment date and the terms of sale. As it relates to the Company’s service obligations, the Company determined that installation reviews, shift development and technical commissioning are separate and distinct performance obligations.

 

Transaction price:

 

The Company considers the invoice price as the transaction price.

 

Allocation of transaction price:

 

The Company determined that the most relevant allocation method for its service obligations is to apply the expected cost plus appropriate margin. This is the Company’s current practice of billing for repairs, overhaul, and other product service related time incurred by its technicians.

 

Recognize revenue:

 

Revenue is recognized upon transfer of control of the products to the customer. For installation review, shift development, and technical commissioning services, revenue is recognized upon completion of the service.

 

Disaggregated revenue:

 

The following table presents details deemed most relevant to the users of the financial statements for the quarter and three quarters ended March 29, 2019.

 

Net sales by product group for the quarter ended March 29, 2019 is summarized as follows:

 

                   

Elimination of

         
   

Manufacturing

   

Distribution

   

Intercompany Sales

   

Total

 

Industrial

  $ 8,149     $ 2,457     $ (1,070 )   $ 9,536  

Land-based transmissions

    27,133       8,309       (8,538 )     26,904  

Marine and propulsion systems

    36,076       15,573       (11,908 )     39,741  

Other

    16       1,208       15       1,239  

Total

  $ 71,374     $ 27,547     $ (21,501 )   $ 77,420  

 

11

 

 

Net sales by product group for the three quarters ended March 29, 2019 is summarized as follows:

 

                   

Elimination of

         
   

Manufacturing

   

Distribution

   

Intercompany Sales

   

Total

 

Industrial

  $ 22,883     $ 6,434     $ (3,619 )   $ 25,698  

Land-based transmissions

    86,876       20,765       (21,322 )     86,319  

Marine and propulsion systems

    101,464       46,037       (33,629 )     113,872  

Other

    50       4,321       (44 )     4,327  

Total

  $ 211,273     $ 77,557     $ (58,614 )   $ 230,216  

 

Contract assets/liabilities:

 

There are no significant balances of contract assets or liabilities as of March 29, 2019.

 

 

D.

Inventories

 

The major classes of inventories were as follows:

 

   

March 29, 2019

   

June 30, 2018

 

Inventories:

               

Finished parts

  $ 53,992     $ 49,332  

Work in process

    26,050       13,183  

Raw materials

    48,126       21,486  
    $ 128,168     $ 84,001  

 

 

E.

Warranty

 

The Company engages in extensive product quality programs and processes, including actively monitoring and evaluating the quality of its suppliers. However, its warranty obligation is affected by product failure rates, the number of units affected by the failure and the expense involved in satisfactorily addressing the situation. The warranty reserve is established based on our best estimate of the amounts necessary to settle future and existing claims on products sold as of the balance sheet date. When evaluating the adequacy of the reserve for warranty costs, management takes into consideration the term of the warranty coverage, historical claim rates and costs of repair, knowledge of the type and volume of new products and economic trends. While we believe the warranty reserve is adequate and that the judgment applied is appropriate, such amounts estimated to be due and payable in the future could differ materially from what actually transpires. The following is a listing of the activity in the warranty reserve for the quarter and three quarters ended March 29, 2019 and March 30, 2018:

 

   

For the Quarter Ended

   

For the Three Quarters Ended

 
   

March 29, 2019

   

March 30, 2018

   

March 29, 2019

   

March 30, 2018

 

Reserve balance, beginning of period

  $ 3,843     $ 2,467     $ 4,407     $ 2,062  

Current period expense and adjustments

    670       1,217       1,527       2,598  

Payments or credits to customers

    (742 )     (559 )     (2,688 )     (1,581 )

Acquisition

    -       -       557       -  

Translation

    (21 )     24       (53 )     70  

Reserve balance, end of period

  $ 3,750     $ 3,149     $ 3,750     $ 3,149  

 

The current portion of the warranty accrual ($2,983 and $2,705 as of March 29, 2019 and March 30, 2018, respectively) is reflected in accrued liabilities, while the long-term portion ($767 and $444 as of March 29, 2019 and March 30, 2018, respectively) is included in other long-term liabilities on the consolidated balance sheets.

 

 

F.

Contingencies

 

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

 

 

G.

Business Segments

 

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

 

12

 

 

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

 

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

 

 

   

For the Quarter Ended

   

For the Three Quarters Ended

 
   

March 29, 2019

   

March 30, 2018

   

March 29, 2019

   

March 30, 2018

 

Net sales

                               

Manufacturing segment sales

  $ 71,374     $ 58,482     $ 211,273     $ 146,935  

Distribution segment sales

    27,547       22,854       77,557       61,852  

Inter/Intra segment elimination – manufacturing

    (16,272 )     (13,494 )     (45,953 )     (33,315 )

Inter/Intra segment elimination – distribution

    (5,229 )     (2,493 )     (12,661 )     (8,512 )
    $ 77,420     $ 65,349     $ 230,216     $ 166,960  

Net income (loss) attributable to Twin Disc

                               

Manufacturing segment net income

  $ 6,350     $ 6,910     $ 21,509     $ 12,100  

Distribution segment net (loss) income

    (498 )     1,149       935       2,205  

Corporate and eliminations

    (1,292 )     (3,751 )     (10,950 )     (10,719 )
    $ 4,560     $ 4,308     $ 11,494     $ 3,586  
                                 

 

Assets

 

March 29, 2019

   

June 30, 2018

                 

Manufacturing segment assets

  $ 385,078     $ 266,417                  

Distribution segment assets

    49,446       52,230                  

Corporate assets and elimination of intercompany assets

    (89,700 )     (77,407 )                
    $ 344,824     $ 241,240                  

 

 

H.

Stock-Based Compensation

 

Performance Stock Awards (“PSA”)

 

During the first three quarters of fiscal 2019 and 2018, the Company granted a target number of 42.3 and 54.9 PSAs, respectively, to various employees of the Company, including executive officers. The fiscal 2019 PSAs will vest if the Company achieves performance-based target objectives relating to average return on invested capital, average annual sales and average annual Earnings Per Share (“EPS”) (as defined in the PSA Grant Agreement), in the cumulative three fiscal year period ending June 30, 2021. These PSAs are subject to adjustment if the Company’s return on invested capital, net sales, and EPS for the period falls below or exceeds the specified target objective, and the maximum number of performance shares that can be awarded if the target objective is exceeded is 63.4. Based upon favorable actual results to date, the Company is currently accruing compensation expense for these PSAs.

 

The fiscal 2018 PSAs will vest if the Company achieves performance-based target objectives relating to average return on invested capital, average annual sales and average annual EPS (as defined in the PSA Grant Agreement), in the cumulative three fiscal year period ending June 30, 2020. These PSAs are subject to adjustment if the Company’s return on invested capital, net sales, and EPS for the period falls below or exceeds the specified target objective, and the maximum number of performance shares that can be awarded if the target objective is exceeded is 69.2. Based upon favorable actual results to date, the Company is currently accruing compensation expense for these PSAs.

 

There were 188.0 and 206.2 unvested PSAs outstanding at March 29, 2019 and March 30, 2018, respectively. The fair value of the PSAs (on the date of grant) is expensed over the performance period for the shares that are expected to ultimately vest. Compensation expense of $240 and $138 was recognized for the quarters ended March 29, 2019 and March 30, 2018, respectively, related to PSAs. Compensation expense of $1,028 and $274 was recognized for the three quarters ended March 29, 2019 and March 30, 2018, respectively, related to PSAs. The weighted average grant date fair value of the unvested awards at March 29, 2019 was $15.02. At March 29, 2019, the Company had $1,281 of unrecognized compensation expense related to the unvested shares that would vest if the specified target objective was achieved for the fiscal 2019, 2018 and 2017 awards. The total fair value of PSAs vested as of March 29, 2019 and March 30, 2018 was $0.

 

13

 

 

Restricted Stock Awards (“RS”)

 

The Company has unvested RS awards outstanding that will vest if certain service conditions are fulfilled. The fair value of the RS grants is recorded as compensation expense over the vesting period, which is generally 1 to 3 years. During the first three quarters of fiscal 2019 and 2018, the Company granted 35.6 and 85.3 service based restricted shares, respectively, to employees and non-employee directors. There were 184.3 and 237.7 unvested shares outstanding at March 29, 2019 and March 30, 2018, respectively. A total of 3.8 and 32.7 shares of restricted stock were forfeited during the three quarters ended March 29, 2019 and March 30, 2018, respectively. Compensation expense of $280 and $186 was recognized for the quarters ended March 29, 2019 and March 30, 2018, respectively. Compensation expense of $796 and $1,113 was recognized for the three quarters ended March 29, 2019 and March 30, 2018, respectively. The total fair value of restricted stock grants vested as of March 29, 2019 and March 30, 2018 was $2,102 and $1,809, respectively. As of March 29, 2019, the Company had $912 of unrecognized compensation expense related to restricted stock which will be recognized over the next three years.

 

Restricted Stock Unit Awards (“RSU”)

 

Under the 2018 Long Term Incentive Plan, the Company has been authorized to issue RSUs. The RSUs entitle the employee to shares of common stock of the Company if the employee remains employed by the Company through a specified date, generally three years from the date of grant. During the first three quarters of fiscal 2019, the Company granted 38.0 RSUs to various employees of the Company, including executive officers. The fair value of the RSUs (on the date of grant) is recorded as compensation expense over the vesting period. There were 38.0 unvested RSUs outstanding at March 29, 2019. Compensation expense of $81 was recognized for the quarter ended March 29, 2019. Compensation expense of $217 was recognized for the three quarters ended March 29, 2019. The weighted average grant date fair value of the unvested awards at March 29, 2019 was $25.77. As of March 29, 2019, the Company had $761 of unrecognized compensation expense related to restricted stock which will be recognized over the next three years.

 

 

I.

Pension and Other Postretirement Benefit Plans

 

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

 

   

For the Quarter Ended

   

For the Three Quarters Ended

 
   

March 29, 2019

   

March 30, 2018

   

March 29, 2019

   

March 30, 2018

 

Pension Benefits:

                               

Service cost

  $ 242     $ 260     $ 739     $ 763  

Interest cost

    1,095       1,089       3,270       3,225  

Expected return on plan assets

    (1,329 )     (1,524 )     (3,992 )     (4,565 )

Amortization of transition obligation

    9       9       26       27  

Amortization of prior service cost

    1       1       3       3  

Amortization of actuarial net loss

    678       759       2,033       2,277  

Net periodic benefit cost

  $ 696     $ 594     $ 2,079     $ 1,730  
                                 

Postretirement Benefits:

                               

Service cost

  $ 5     $ 5     $ 14     $ 15  

Interest cost

    76       78       228       247  

Amortization of actuarial net loss

    (69 )     (59 )     (206 )     (115 )

Net periodic benefit cost

  $ 12     $ 24     $ 36     $ 147  

 

The Company expects to contribute approximately $2,382 to its pension plans in fiscal 2019. As of March 29, 2019, the amount of $2,305 in contributions has been made.

 

The Company has reclassified $478 (net of $146 in taxes) of benefit plan adjustments from accumulated other comprehensive loss during the quarter ended March 29, 2019, and $474 (net of $212 in taxes) during the quarter ended March 30, 2018. The Company has reclassified $1,427 (net of $437 in taxes) of benefit plan adjustments from accumulated other comprehensive loss during the three quarters ended March 29, 2019, and $2,682 (net of $1,164 in taxes) during the three quarters ended March 30, 2018. These reclassifications are included in the computation of net periodic benefit cost.

 

14

 

 

 

J.

Income Taxes

 

On December 22, 2017, the Tax Cuts and Jobs Act (the “Tax Act”) was signed into law in the United States. The Tax Act, among other provisions, introduced changes in the U.S corporate tax rate, business related exclusions, deductions, and credits, and has tax consequences for companies that operate internationally. Most of the changes introduced in the Tax Act were effective beginning on January 1, 2018; however, as the Company has a fiscal year end of June 30, the effective dates for the Company are various and different.

 

For the three quarters ended March 29, 2019 and March 30, 2018, the Company’s effective income tax rate was 24.6% and 39.4%, respectively. In the prior year, increased and sustained profitablility in a foreign jurisdiction resulted in the release of a $3,803 valuation allowance, which decreased the effective tax rate by 62.4%. In the prior year, the impact of the Tax Act was reflected resulting in an increase to tax expense of $4,243, which increased the effective tax rate by 69.7%. Foreign tax reform also relected in the prior year increased tax expense by $392 and resulted in an increase in the effective tax rate of 6.4%.

 

Within the calculation of the Company’s annual effective tax rate the Company has used assumptions and estimates that may change as a result of future guidance, interpretation, and rule-making from the Internal Revenue Service, the SEC, and the FASB and/or various other taxing jurisdictions. Further, the Company anticipates that the state jurisdictions will continue to determine and announce their conformity to the Tax Act, which could have an impact on the annual effective tax rate.

 

The permanent reduction to the U.S. federal corporate income tax rate from 35% to 21% was effective January 1, 2018. The effective tax rate in the current quarter of fiscal 2019 reflects the reduction in the statutory federal income tax rate to 21%.

 

The deemed repatriation transition tax is a tax on previously untaxed accumulated and current earnings and profits of certain foreign subsidiaries. To determine the amount of the transition tax, the Company calculated the amount of post-1986 earnings and profits for all foreign subsidiaries as well as the amount of non-U.S. income taxes paid on such earnings. The Company calculated the amount of the transition tax and determined it to be zero based on overall net historical negative earnings and profits.

 

As no new material information nor material interpretational changes have developed, the Company’s previous calculation reflected in fiscal 2018 has not changed and the Company considers this final. With the enactment of the transition tax, any future dividends repatriated would benefit from the 100% Dividends Received Deduction. The Company reaffirms its positon that the earnings of certain foreign subsidiaries remain permanently reinvested. An analysis was also completed to verify the future utilization of tax attributes and it was determined that full utilization would be realized and no valuation allowance was required. The Company has completed a provisional analysis of the global intangible low taxed income (“GILTI”) provisions and anticipates no impact to the financial statements due to the offset of the inclusion with the associated foreign tax credits. A provisional foreign-derived intangible income (“FDII”) calculation was completed and the benefit has been reflected in the quarterly provision. The Company has provisionally elected to treat GILTI as a period expense; however, the Company has not made a final accounting policy decision with respect to this item. A provisional analysis of the new base erosion anti-abuse tax (“BEAT”) rules has been completed and the Company does not meet the minimum thresholds at this time and is therefore not subject to this tax. These estimates may be impacted by actual future data, additional guidance or other unforeseen circumstances.

 

Under ASC 740, Income Taxes, a company is generally required to recognize the effect of changes in tax laws in its financial statements in the period in which the legislation is enacted. U.S. income tax laws are deemed to be effective on the date the president signs tax legislation. The president signed the Tax Act legislation on December 22, 2017. As such, the Company is required to recognize the related impacts to the financial statements in the quarter ended December 29, 2017. In acknowledgment of the substantial changes incorporated in the Tax Act, in conjunction with the timing of the enactment being just weeks before the majority of the provisions became effective, the SEC staff issued Staff Accounting Bulletin ("SAB") 118 to provide certain guidance in determining the accounting for income tax effects of the legislation in the accounting period of enactment as well as provide a measurement period (similar to that used when accounting for business combinations) within which to finalize and reflect such final effects associated with the Tax Act. Further, SAB 118 summarizes a three-step approach to be applied each reporting period within the overall measurement period: (1) amounts should be reflected in the period including the date of enactment for those items which are deemed to be complete (i.e. all information is available and appropriately analyzed to determine the applicable financial statement impact), (2) to the extent the effects of certain changes due to the Tax Act for which the accounting is not deemed complete but for which a reasonable estimate can be determined, such provisional amount(s) should be reflected in the period so determined and adjusted in subsequent periods as such effects are finalized and (3) to the extent a reasonable estimate cannot be determined for a specific effect of the tax law change associated with the Tax Act, no provisional amount should be recorded but rather, continue to apply ASC 740 based upon the tax law in effect prior to the enactment of the Tax Act. Such measurement period is deemed to end when all necessary information has been obtained, prepared and analyzed such that a final accounting determination can be concluded, but in no event should the period extend beyond one year. If a company does not have the necessary information available, prepared or analyzed for certain income tax effects of the Tax Act, SAB 118 allows a company to report provisional numbers and adjust those amounts during the measurement period not to extend beyond one year. For the three quarters ended March 29, 2019, the Company has recorded all known and estimable impacts of the Tax Act that are effective for fiscal year 2019. Future adjustments to the provisional numbers will be recorded as discrete adjustments to income tax expense in the period in which those adjustments become estimable and/or are finalized.

 

15

 

 

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. In addition, all other available positive and negative evidence is taken into consideration, including all new impacts of the Tax Act. The Company has evaluated the realizability of the net deferred tax assets related to its operations and based on this evaluation management has concluded that no valuation allowances are required.

 

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

 

The Company has approximately $1,152 of unrecognized tax benefits, including related interest and penalties, as of March 29, 2019, which, if recognized, would favorably impact the effective tax rate. There was no significant change in the total unrecognized tax benefits due to the settlement of audits, the expiration of statutes of limitations or for other items during the three quarters ended March 29, 2019. It appears possible that the amount of unrecognized tax benefits could change in the next twelve months due to on-going audit activity.

 

Annually, the Company files income tax returns in various taxing jurisdictions inside and outside the United States. In general, the tax years that remain subject to examination are 2011 through 2018 for the major operations in Italy, Canada, Belgium, and Japan. The tax years open to examination in the U.S. are for years subsequent to fiscal 2015. The state of Wisconsin income tax audit remains ongoing for the fiscal years 2010 through 2013. It is reasonably possible that other audit cycles will be completed during fiscal 2019.

 

 

K.     Goodwill and Other Intangibles

 

Goodwill represents the excess of the consideration transferred net of the acquisition-date fair values of the identifiable assets acquired and the liabilities assumed.

 

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

 

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

 

On July 2, 2018, as discussed in Note B, the Company acquired goodwill in the estimated amount of $24,986 and intangible assets in the estimated amount of $24,000 as part of the acquisition of Veth Propulsion Holding BV. These estimates are preliminary and are pending completion of several elements, including finalization of an independent valuation of fair value of the assets acquired and liabilities assumed and final review by the Company’s management. The final determination of fair values and resulting goodwill may differ significantly from what is currently reflected.

 

16

 

 

As of March 29, 2019, changes in the carrying amount of goodwill is summarized as follows:

 

   

Net Book Value Rollforward

   

By Reporting Unit

 
   

Gross Carrying

Amount

   

Accumulated

Amortization / Impairment

   

Net Book

Value

   

European

Industrial

   

European

Propulsion

 

Balance at June 30, 2018

  $ 16,514     $ (13,822 )   $ 2,692     $ 2,692     $ -  

Acquisition

    24,986       -       24,986       -       24,986  

Translation adjustment

    (1,006 )     -       (1,006 )     (72 )     (934 )

Balance at March 29, 2019

  $ 40,494     $ (13,822 )   $ 26,672     $ 2,620     $ 24,052  

 

For the quarter ended March 29, 2019, the Company performed a review of potential triggering events, and concluded there were no triggering events that indicated that the fair value of its European Industrial and European Propulsion reporting units had not more likely than not declined to below their carrying values at March 29, 2019. The Company will perform its annual impairment test for all its operating units as of June 30, 2019.

 

As of March 29, 2019, the following acquired intangible assets have definite useful lives and are subject to amortization:

 

   

Net Book Value Rollforward

   

Net Book Value By Asset Type

 
   

Gross Carrying

Amount

   

Accumulated Amortization/

Impairment

   

Net Book

Value

   

Trade Name

   

Customer

Relationships

   

Technology

Know-how

   

Other

 

Balance at June 30, 2018

  $ 13,485     $ (11,781 )   $ 1,704     $ 1,288     $ -     $ -     $ 416  

Acquisition

    24,000       -       24,000       1,800       13,800       8,400       -  

Other additions

    103       -       103       -       -       -       103  

Amortization

    -       (1,995 )     (1,995 )     (196 )     (846 )     (883 )     (70 )

Translation adjustment

    (898 )     -       (898 )     (98 )     (500 )     (298 )     (2 )

Balance at March 29, 2019

  $ 36,690     $ (13,776 )   $ 22,914     $ 2,794     $ 12,454     $ 7,219     $ 447  

 

Other intangibles consist of certain amortizable acquisition costs, proprietary technology, computer software, licensing agreements and certain customer relationships.

 

The weighted average remaining useful life of the intangible assets included in the table above is approximately 10 years.

 

Intangible amortization expense was $746 and $46 for the quarters ended March 29, 2019, and March 30, 2018, respectively. Intangible amortization expense was $1,995 and $135 for the three quarters ended March 29, 2019, and March 30, 2018, respectively. Estimated intangible amortization expense for the remainder of fiscal 2019 and each of the next five fiscal years is as follows:

 

Fiscal Year

       

2019

  $ 689  

2020

    2,659  

2021

    2,609  

2022

    2,586  

2023

    2,579  

2024

    2,549  

 

The gross carrying amount of the Company’s intangible assets that have indefinite lives and are not subject to amortization as of March 29, 2019 and June 30, 2018 was $200 and $202, respectively. These assets are comprised of acquired trade names.

 

17

 

 

 

L.

Long-term Debt

 

Long-term debt at March 29, 2019 and June 30, 2018 consisted of the following:

 

   

March 29, 2019

   

June 30, 2018

 

Borrowings under the Credit Agreement

               

Revolving loans

  $ 28,893     $ 4,787  

Term loan (due March 2026)

    20,000       -  

Other

    387       37  

Subtotal

    49,280       4,824  

Less: current maturities

    (2,000 )     -  

Total long-term debt

  $ 47,280     $ 4,824  

 

On June 29, 2018, the Company entered into a new credit agreement (the “Credit Agreement”) with BMO Harris Bank N.A. (“BMO”) that provided for the assignment and assumption of the previously existing loans between the Company and Bank of Montreal (the “2016 Credit Agreement”) and subsequent amendments into a term loan (the “Term Loan”) and revolving credit loans (each a “Revolving Loan” and, collectively, the “Revolving Loans,” and, together with the Term Loan, the “Loans”). Pursuant to the Credit Agreement, BMO agreed to make the Term Loan to the Company in a principal amount not to exceed $35,000 and the Company may, from time to time prior to the maturity date, enter into Revolving Loans in amounts not to exceed, in the aggregate, $50,000 (the “Revolving Credit Commitment”). The Credit Agreement also allows the Company to obtain Letters of Credit from BMO, which if drawn upon by the beneficiary thereof and paid by BMO, would become Revolving Loans.

 

On July 2, 2018, in connection with the acquisition of Veth Propulsion, as described in Note B, the Company drew a total of $60,729 of additional borrowings on the Credit Agreement, consisting of a $35,000 Term Loan payable and revolver borrowings of $25,729. The new borrowing was used to pay the cash consideration at closing of $58,862, and to pay off the loan owed to the prior parent of Veth Propulsion in the amount of $1,865.

 

On September 25, 2018, the Company used the proceeds of a stock offering (see Note M) of $32,210 to partially pay down the Term Loan and Revolving Loans.

 

On March 4, 2019, the Company entered into a second amendment (the “Second Amendment”) to the Credit Agreement. The Second Amendment reduced the principal amount of the Term Loan commitment under the Credit Agreement from $35,000 to $20,000. In connection with the Second Amendment, the Company issued an amended and restated term note in the amount of $20,000 to BMO, which amended the original $35,000 note provided under the Credit Agreement.

 

Prior to entering into the Second Amendment, the outstanding principal amount of the Term Loan under the Credit Agreement was $10,849. On the date of the Second Amendment, the Bank made an additional advance on the Term Loan to the Company in the amount of $9,151. The Second Amendment also extended the maturity date of the Term Loan from January 2, 2020 to March 4, 2026, and added a requirement that the Company make principal installments of $500 per quarter starting with the quarter ending June 30, 2019.

 

The Second Amendment also reduces the applicable margin for purposes of determining the interest rate applicable to the Term Loan. Previously, the applicable margin was 3.00%, which was added to the Monthly Reset LIBOR Rate or the Adjusted LIBOR, as applicable. Under the Second Amendment, the applicable margin is between 1.375% and 2.375%, depending on the Company’s total funded debt to EBITDA ratio.

 

The Second Amendment also adjusts certain financial covenants made by the Company under the Credit Agreement. Specifically, the Company has covenanted (i) not to allow its total funded debt to EBITDA ratio to be greater than 3.00 to 1.00 (the cap had previously been 3.50 to 1.00 for quarters ending on or before September 30, 2019 and 3.25 to 1.00 for quarters ending on or about December 31, 2019 through September 30, 2020), and (ii) that its tangible net worth will not be less than $100,000 plus 50% of net income for each fiscal year ending on and after June 30, 2019 for which net income is a positive number (the $100,000 figure had previously been $70,000).

 

Borrowings under the Credit Agreement are secured by substantially all of the Company’s personal property, including accounts receivable, inventory, machinery and equipment, and intellectual property. 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 also entered into a Collateral Assignment of Rights under Purchase Agreement for its acquisition of Veth Propulsion described in Note B.

 

Other long-term debt pertains mainly to a financing arrangement in Europe. During the third quarter of fiscal 2019, the Company entered into sale leaseback agreements with a leasing company covering various Company vehicles. Under the terms of the agreements, the Company received $370 in cash proceeds and agreed to lease back those same vehicles under various terms, ranging from 3 to 5 years. Under ASC 842, Leases, these agreements are required to be accounted for as financing transactions. Consequently, the Company recorded long-term liabilities for the proceeds received, and they are reduced as lease payments are made. These liabilities carry implied interest rates ranging from 7% to 25%. A total amount of $12 in principal was paid on these liabilities during the current quarter.

 

18

 

 

During the quarter ended March 29, 2019, the average interest rate was 4.72% on the Term Loan, and 2.98% on the Revolving Loans. During the three quarters ended March 29, 2019, the average interest rate was 5.04% on the Term Loan, and 3.18% on the Revolving Loans.

 

As of March 29, 2019, the Company’s borrowing capacity on the Revolving Loans under the terms of the Credit Agreement was $50,000, and the Company had approximately $21,107 of available borrowings. In addition to the Credit Agreement, the Company has established unsecured lines of credit that are used from time to time to secure certain performance obligations by the Company.

 

The Company’s borrowings described above approximates fair value at March 29, 2019 and June 30, 2018. If measured at fair value in the financial statements, long-term debt (including the current portion) would be classified as Level 2 in the fair value hierarchy.

 

On April 22, 2019, the Company entered into an interest rate swap arrangement with Bank of Montreal, with a notional amount of $20,000 and a maturity date of March 4, 2026 to hedge the Term Loan. This swap has been designated as a cash flow hedge under ASC 815, Derivatives and Hedging. The Company will commence the reporting and related disclosures on this arrangement in its June 30, 2019 Form 10-K.

 

 

M.

Shareholders’ Equity

 

The Company completed the sale of 1,533.3 shares of its common stock through a registered offering which closed on September 25, 2018, at a price to the public of $22.50 per share. The net proceeds received by the Company and after underwriting expenses of $2,070 and offering expenses of $220, were $32,210 and were recorded as paid-in capital as of March 29, 2019. The proceeds were used to partially pay down the Term Loan and Revolving Loans (see Note L).

 

The Company, from time to time, makes open market purchases of its common stock under authorizations given to it by the Board of Directors, of which 315.0 shares as of March 29, 2019 remain authorized for purchase.  The Company did not make any open market purchases of its shares during the quarters ended March 29, 2019 and March 30, 2018.

 

19

 

 

The following is a reconciliation of the Company’s equity balances for the first three fiscal quarters of 2019 and 2018:

 

   

Twin Disc, Inc. Shareholders’ Equity

 
                   

Accumulated

                         
                   

Other

           

Non-

         
   

Common

   

Retained

   

Comprehensive

   

Treasury

   

Controlling

   

Total

 
   

Stock

   

Earnings

   

Income (Loss)

   

Stock

   

Interest

   

Equity

 

Balance, June 30, 2018

  $ 11,570     $ 178,896     $ (23,792 )   $ (23,677 )   $ 619     $ 143,616  

Net income

            2,861                       41       2,902  

Translation adjustments

                    (536 )             (25 )     (561 )

Benefit plan adjustments, net of tax

                    471                       471  

Release stranded tax effects

            6,903       (6,903 )                     -  

Cash dividends

                                    (115 )     (115 )

Compensation expense

    850                                       850  

Common stock issued, net

    32,210                                       32,210  

Shares acquired, net

    (586 )                     (328 )             (914 )

Balance, September 28, 2018

    44,044       188,660       (30,760 )     (24,005 )     520       178,459  

Net income

            4,073                       6       4,079  

Translation adjustments

                    (1,773 )             (13 )     (1,786 )

Benefit plan adjustments, net of tax

                    478                       478  

Compensation expense

    590                                       590  

Shares (acquired) issued, net

    (497 )                     520               23  

Balance, December 28, 2018

    44,137       192,733       (32,055 )     (23,485 )     513       181,843  

Net income

            4,560                       27       4,587  

Translation adjustments

                    (885 )             16       (869 )

Benefit plan adjustments, net of tax

                    478                       478  

Compensation expense

    603                                       603  

Shares issued (acquired), net

    15                       (15 )             -  

Balance, March 29, 2019

  $ 44,755     $ 197,293     $ (32,462 )   $ (23,500 )   $ 556     $ 186,642  

 

   

Twin Disc, Inc. Shareholders’ Equity

 
                   

Accumulated

                         
                   

Other

           

Non-

         
   

Common

   

Retained

   

Comprehensive

   

Treasury

   

Controlling

   

Total

 
   

Stock

   

Earnings

   

Income (Loss)

   

Stock

   

Interest

   

Equity

 

Balance, June 30, 2017

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

Net income

            3,391                       13       3,404  

Translation adjustments

                    2,547               (6 )     2,541  

Benefit plan adjustments, net of tax

                    474                       474  

Cash dividends

                                    (172 )     (172 )

Compensation expense

    479                                       479  

Shares (acquired) issued, net

    (1,030 )                     817               (213 )

Balance, September 29, 2017

    9,878       172,759       (29,650 )     (23,388 )     481       130,080  

Net (loss) income

            (4,113 )                     63       (4,050 )

Translation adjustments

                    489               (1 )     488  

Benefit plan adjustments, net of tax

                    1,734                       1,734  

Compensation expense

    584                                       584  

Shares (acquired) issued, net

    (376 )                     189               (187 )

Balance, December 29, 2017

    10,086       168,646       (27,427 )     (23,199 )     543       128,649  

Net income

            4,308                       28       4,336  

Translation adjustments

                    1,851               (2 )     1,849  

Benefit plan adjustments, net of tax

                    474                       474  

Compensation expense

    324                                       324  

Shares issued (acquired), net

    492                       (514 )             (22 )

Balance, March 30, 2018

  $ 10,902     $ 172,954     $ (25,102 )   $ (23,713 )   $ 569     $ 135,610  

 

20

 

 

Reconciliations for the changes in accumulated other comprehensive income (loss), net of tax, by component for the quarters ended September 28, December 28, 2018, and March 29, 2019 and September 29, December 29, 2017, and March 30, 2018 are as follows:

 

 

   

Translation

   

Benefit Plan

 
   

Adjustment

   

Adjustment

 

Balance at June 30, 2018

  $ 7,085     $ (30,877 )

Translation adjustment during the quarter

    (536 )     -  

Release stranded tax effects

    -       (6,903 )

Amounts reclassified from accumulated other comprehensive income

    -       471  

Net current period other comprehensive loss

    (536 )     (6,432 )

Balance at September 28, 2018

    6,549       (37,309 )
                 

Translation adjustment during the quarter

    (1,773 )     -  

Amounts reclassified from accumulated other comprehensive income

    -       478  

Net current period other comprehensive (loss) income

    (1,773 )     478  

Balance at December 28, 2018

    4,776       (36,831 )
                 

Translation adjustment during the quarter

    (885 )     -  

Amounts reclassified from accumulated other comprehensive income

    -       478  

Net current period other comprehensive (loss) income

    (885 )     478  

Balance at March 29, 2019

  $ 3,891     $ (36,353 )

 

 

   

Translation

   

Benefit Plan

 
   

Adjustment

   

Adjustment

 

Balance at June 30, 2017

  $ 6,130     $ (38,801 )

Translation adjustment during the quarter

    2,547       -  

Amounts reclassified from accumulated other comprehensive income

    -       474  

Net current period other comprehensive income

    2,547       474  

Balance at September 29, 2017

    8,677       (38,327 )
                 

Translation adjustment during the quarter

    489       -  

Other comprehensive income before reclassifications

    -       1,695  

Amounts reclassified from accumulated other comprehensive income

    -       39  

Net current period other comprehensive income

    489       1,734  

Balance at December 29, 2017

    9,166       (36,593 )
                 

Translation adjustment during the quarter

    1,851       -  

Amounts reclassified from accumulated other comprehensive income

    -       474  

Net current period other comprehensive income

    1,851       474  

Balance at March 30, 2018

  $ 11,017     $ (36,119 )

 

Reconciliation for the changes in benefit plan adjustments, net of tax for the quarter and three quarters ended March 29, 2019 are as follows:

 

   

Amount Reclassified

     

Amount Reclassified

   
   

Quarter Ended

     

Three Quarters Ended

   
   

March 29, 2019

     

March 29, 2019

   

Changes in benefit plan items

                   

Actuarial losses

  $ 614  

(a)

  $ 1,835  

(a)

Transition asset and prior service benefit

    10  

(a)

    29  

(a)

Total amortization

    624         1,864    

Income taxes

    146         437    

Total reclassification net of tax

  $ 478       $ 1,427    

 

21

 

 

Reconciliation for the changes in benefit plan adjustments, net of tax for the quarter and three quarters ended March 30, 2018 is as follows:

 

   

Amount Reclassified

     

Amount Reclassified

   
   

Quarter Ended

     

Three Quarters Ended

   
   

March 30, 2018

     

March 30, 2018

   

Changes in benefit plan items

                   

Actuarial losses

  $ 676  

(a)

  $ 2,121  

(a)

Transition asset and prior service benefit

    10  

(a)

    30  

(a)

Total amortization

    686         2,151    

Other benefit plan adjustments

    -         (1,695 )  

Income taxes

    212         1,164    

Total reclassification net of tax

  $ 474       $ 2,682    

 

 

(a)

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

 

 

N.

Restructuring of Operations and Other Operating Income

 

Restructuring expenses

 

The Company has implemented various restructuring programs in response to unfavorable macroeconomic trends in certain of the Company’s markets since the fourth quarter of fiscal 2015. These programs primarily involved the reduction of workforce in several of the Company’s manufacturing locations, under a combination of voluntary and involuntary programs.

 

During the current year, the Company implemented continued actions to reduce personnel costs in its Belgian operations and reorganize for productivity in its European operations. These actions resulted in restructuring charges of $131 and $738 in the quarter and three quarters ended March 29, 2019, respectively. For the quarter and three quarters ended March 30, 2018, restructuring charges of $452 and $2,501, respectively, pertained to similar actions to reduce personnel costs in the Company’s Belgian operations, as well as costs associated with the India manufacturing operations exit.

 

Restructuring activities since June 2015 have resulted in the elimination of 176 full-time employees in the manufacturing segment. Accumulated costs to date under these programs within the manufacturing segment through March 29, 2019 were $10,011.

 

The following is a rollforward of restructuring activity:

 

Accrued restructuring liability, June 30, 2018

  $ 90  

Additions during the year

    738  

Payments and adjustments during the year

    (800 )

Accrued restructuring liability, March 29, 2019

  $ 28  

 

Other Operating Income – Sale of Mill Log Business

 

On February 7, 2019, as part of its ongoing initiative to focus resources on core manufacturing and product development activities, the Company entered into an asset purchase agreement with one of its major distributor customers. Under this agreement, the Company sold substantially all of the assets and intangible rights of Mill-Log Equipment Co., Inc. and Mill-Log Wilson Equipment Ltd. (the “Mill Log Business”), its wholly-owned subsidiaries which distributed Twin Disc products in the northwestern U.S. and western Canada territories. The Mill Log Business reported pre-tax loss of $1,968 and pre-tax income of $421 for the quarters ended March 29, 2019 and March 30, 2018, respectively, and reported pre-tax loss of $1,636 and pre-tax income of $901 for the three quarters ended March 29, 2019 and March 30, 2018, respectively. The results of operations from the Mill Log Business are reported as part of the Company’s distribution segment. Assets sold consisted primarily of inventories, with a carrying value of $6,298, and property and equipment including right-of-use leases, with a carrying value of $495. The sale closed on March 4, 2019 and the Company received a total consideration of $7,658, consisting of cash proceeds of $5,158 and a note receivable for $2,500 due on March 4, 2020. The Company recognized a pre-tax gain on sale of the Mill Log Business of $865, and recorded it as part of other operating income in the statement of operations in the current quarter. The Company is currently winding down the affairs of this legal entity and anticipates certain adjustments to this gain. Any adjustments to this amount will be recorded in the quarter in which it is determined.

 

22

 

 

Other Operating Income – Fair Value Adjustment of Contingent Consideration

 

As discussed in Note B, the Company issued a contingent consideration as part of the Veth Propulsion acquisition. Under the terms of the Purchase Agreement, in addition to the cash consideration, the Company would pay an earn-out (a contingent consideration) if the EBITDA of Veth Propulsion for the period January 1, 2018 through December 31, 2018 were to exceed the agreed upon threshold amount. The maximum earn-out is approximately $3,700 and would be paid in the form of common stock. Under ASC 805, any changes in fair value of the contingent consideration is recognized in the current period income statement and is not an adjustment to the opening balance sheet or the determination of goodwill.

 

As of March 29, 2019, the Company re-measured this liability at fair value, using the maximum issuable shares under the Purchase Agreement, multiplied by the closing price of the Company’s common stock. This resulted in a fair value of $2,320 and a recognition of a gain of $492, included in other operating income in the current fiscal quarter.

 

In April 2019, the Company made a determination to settle the earn-out at the maximum issuable shares. These shares are expected to be issued in May 2019.

 

 

O.

Earnings Per Share

 

The Company calculates basic earnings per share based upon the weighted average number of common shares outstanding during the period, while the calculation of diluted earnings per share includes the dilutive effect of potential common shares outstanding during the period.  The calculation of diluted earnings per share excludes all potential common shares if their inclusion would have an anti-dilutive effect. Certain restricted stock award recipients have a non-forfeitable right to receive dividends declared by the Company, and are therefore included in computing earnings per share pursuant to the two-class method. 

 

The components of basic and diluted earnings per share were as follows:

 

   

For the Quarter Ended

   

For the Three Quarters Ended

 
   

March 29, 2019

   

March 30, 2018

   

March 29, 2019

   

March 30, 2018

 

Basic:

                               

Net income

  $ 4,587     $ 4,336     $ 11,569     $ 3,690  

Less: Net earnings attributable to noncontrolling interest

    (27 )     (28 )     (75 )     (104 )

Less: Undistributed earnings attributable to unvested shares

    (59 )     (98 )     (166 )     (86 )

Net income available to Twin Disc shareholders

    4,501       4,210       11,328       3,500  
                                 

Weighted average shares outstanding - basic

    12,914       11,313       12,437       11,289  
                                 

Basic Income Per Share:

                               

Net income per share - basic

  $ 0.35     $ 0.37