twin20190630_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, 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 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

Trading Symbol(s)

Name of each exchange on which registered

Common Stock (No Par Value)

TWIN

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 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 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 [  ]

 

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 [  ].

 

1

 

 

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

YES [  ] NO [ √ ]

 

At December 28, 2018, the last business day of the registrant’s most recently completed second fiscal quarter, the aggregate market value of the common stock held by non-affiliates of the registrant was $152,303,678. 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 22, 2019, the registrant had 13,332,485 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 31, 2019, 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, 2019

 

PART I.

   
     
 

Item 1.

Business.

4

 

Item 1A.

Risk Factors.

5

 

Item 1B.

Unresolved Staff Comments.

9

 

Item 2.

Properties.

10

 

Item 3.

Legal Proceedings.

10

 

Item 4.

Mine Safety Disclosure.

10

   

Information About Our Executive Officers.

11

       

PART II.

   
     
 

Item 5.

Market for the Registrant’s Common Stock, Related Stockholder Matters and Issuer Purchases of Equity Securities.

12

 

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.

22

 

Item 8.

Financial Statements and Supplementary Data.

22

 

Item 9.

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

22

 

Item 9A.

Controls and Procedures.

23

 

Item 9B.

Other Information.

24

       

PART III.

   
     
 

Item 10.

Directors, Executive Officers and Corporate Governance.

24

 

Item 11.

Executive Compensation.

25

 

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

25

 

Item 13.

Certain Relationships and Related Transactions, Director Independence.

25

 

Item 14.

Principal Accounting Fees and Services.

25

       

PART IV.

   
     
 

Item 15.

Exhibits, Financial Statement Schedules.

25

       
    Exhibit Index.

68

   

Signatures.

71

 

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, 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 pleasure craft, commercial 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.

 

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.

 

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 49% and 57% of the Company's consolidated net sales during the years ended June 30, 2019 and June 30, 2018, respectively. There were no customers that accounted for 10% of consolidated net sales in fiscal 2019.

 

Unfilled open orders for the next six months of $99.6 million at June 30, 2019 compares to $115.0 million at June 30, 2018. 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 $2.4 million and $1.6 million in fiscal 2019 and 2018, respectively. Total engineering and development costs were $12.6 million and $9.9 million in fiscal 2019 and 2018, respectively.

 

4

 

 

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.

 

The number of persons employed by the Company at June 30, 2019 was 873.

 

A summary of financial data by segment, geographic area, and classes of products that accounted for more than 10% of consolidated sales revenues for the years ended June 30, 2019 and 2018 appears in Note L, Business Segments and Foreign Operations, 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. The SEC maintains an internet site (www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers, such as the Company, that file electronically with the SEC. 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. In addition, recent developments in tariff regulations in the U.S. and foreign jurisdictions have resulted in uncertainty regarding international trade policies and future commodity prices, contributing to an increased risk of higher commodity costs that could have an adverse impact on the Company’s profitability, financial condition and results of operations. The Company’s profitability is dependent, in part, on commodity costs. 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.

 

The current United States administration has signaled support for implementing, and in some instances, has already proposed or taken action with respect to, major changes to certain trade policies, such as the imposition of additional tariffs on imported products and the withdrawal from or renegotiation of certain trade agreements, including the North American Free Trade Agreement. In response to such actions, certain countries have imposed retaliatory actions against the United States. The Company anticipates that additional tariffs or trade restrictions resulting from “trade wars” could result in an increase in its cost of sales and there can be no assurance that the Company will be able to pass any of the increases in raw material costs directly resulting from the tariff to its customers. Given that it procures many of the raw materials that it uses to create its products directly or indirectly from outside of the United States, the imposition of tariffs and other potential changes in U.S. trade policy could increase the cost or limit the availability of such raw materials, which could hurt its competitive position and adversely impact its business, financial condition and results of operations. In addition, the Company sells a significant proportion of its products to customers outside of the United States. Retaliatory actions by other countries could result in increases in the price of its products, which could limit demand for such products, hurt its global competitive position and have a material adverse effect on the Company’s business, financial condition and results of operations.

 

If the Company were to lose business with any key customers, the Company’s business would be adversely affected. Although there were no customers that accounted for 10% or more of consolidated net sales in fiscal 2019, 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.

 

6

 

 

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.

 

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 56% of the Company’s consolidated net sales for fiscal 2019. The Company has international manufacturing operations in Belgium, Italy, the Netherlands and Switzerland. In addition, the Company has international distribution operations in Singapore, China, Australia, Japan, Italy, Belgium, and India. 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 2019 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 on June 29, 2018 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, 2019, the Company had a borrowing capacity that exceeded its outstanding loan balance (see Note I, Debt, 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 2020 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.

 

7

 

 

The Company has made certain assumptions relating to the acquisition of Veth Propulsion in its forecasts that may prove to be materially inaccurate. The integration of Veth Propulsion into the Company’s business processes is ongoing. While the integration is currently proceeding as planned, the Company has made certain longer term assumptions relating to the forecast level of synergies and associated costs of the acquisition of Veth Propulsion that may be inaccurate based on the information that was available to the Company or as a result of the failure to realize the expected benefits of the acquisition, higher than expected integration costs, unknown liabilities and global economic and business conditions that may adversely affect the combined company following the completion of the acquisition. The combination of the businesses will require significant management attention, and the Company may incur significant additional integration costs because of integration difficulties and other challenges.

 

As part of the acquisition of Veth Propulsion, the Company entered into a new credit agreement and significantly increased its indebtedness. The ability to service the requirements of the new debt depends on the ability to generate cash and/or refinance its indebtedness as it becomes due, and depends on many factors, some of which are beyond the Company’s control. The Company’s ability to make payments on its indebtedness, including those under the new credit agreement, and to fund planned capital expenditures, research and development efforts and other corporate expenses depends on the Company’s future operating performance and on economic, financial, competitive, legislative, regulatory and other factors. Many of these factors are beyond its control. The Company cannot assure that its business will generate sufficient cash flow from operations, or operating improvements will be realized or that future borrowings will be available to it in an amount sufficient to enable it to repay its indebtedness or to fund its other operating requirements. Significant delays in its planned capital expenditures may materially and adversely affect the Company’s future revenue prospects.

 

As a result of the acquisition of Veth Propulsion, the Company recorded a significant amount of goodwill and other intangible assets, but it may never fully realize the full value of these assets. The accounting for the acquisition, including the purchase price allocation has been completed. The Company recorded a significant amount of goodwill and identifiable intangible assets, including customer relationships, trademarks and developed technologies.

 

The Company tests goodwill and intangible assets with indefinite useful lives for possible impairment annually during the fourth quarter of each fiscal year or more frequently if events or changes in circumstances indicate that the asset might be impaired. Amortizable intangible assets are periodically reviewed for possible impairment whenever there is evidence that events or changes in circumstances indicate that the carrying value may not be recoverable. Impairment may result from, among other things, (i) a decrease in its expected net earnings; (ii) adverse equity market conditions; (iii) a decline in current market multiples; (iv) a decline in its common stock price; (v) a significant adverse change in legal factors or business climates; (vi) an adverse action or assessment by a regulator; (vii) heightened competition; (viii) strategic decisions made in response to economic or competitive conditions; or (ix) a more-likely-than-not expectation that a reporting unit or a significant portion of a reporting unit will be sold or disposed of. In the event that it determines that events or circumstances exist that indicate that the carrying value of goodwill or identifiable intangible assets may no longer be recoverable, it might have to recognize a non-cash impairment of goodwill or other identifiable intangible assets, which could have a material adverse effect on the Company’s consolidated financial condition or results of operations.

 

The Company recorded significant non-cash goodwill impairment charges in fiscal 2017 and 2016. The Company carries goodwill in the amount of $26.0 million as of June 30, 2019, of which $23.4 million is newly-acquired from the Veth Propulsion acquisition this year. In fiscal 2017 and 2016, when the Company’s markets were significantly adversely affected by the global oil and gas decline, it recorded significant impairment charges related to two of its prior acquisitions. Any deterioration in the industries or businesses of the Company may trigger future impairment charges, which may have a material adverse effect to the Company’s financial results.

 

8

 

 

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.

 

Taxing authority challenges and changes to tax laws 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.

 

The Tax Cuts and Jobs Act (the “Tax Act”) was signed into law in December 2017. The new law made numerous changes to U.S. federal corporate tax law that the Company expects will impact its effective tax rate in future periods. The changes included in the Tax Act are broad and complex. The final impact of the Tax Act may differ from the Company’s current estimates, possibly materially, due to, among other things, changes in interpretations of the Tax Act, any legislative action to address questions that arise because of the Tax Act, any changes in accounting standards for U.S. federal income taxes or related interpretations in response to the Tax Act or any updates or changes to estimates the Company has utilized to calculate the impact. Future changes in tax law in the United States or the various jurisdictions in which the Company operates 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 fines or penalties, including, among others, under the European Union’s newly enacted General Data Privacy Regulation, disrupt the Company’s operations, damage its reputation and/or cause a loss of confidence in the Company’s products and services, which could adversely affect its business, financial condition and results of operations.

 

Item 1B. Unresolved Staff Comments

 

None.

 

9

 

 

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 the Netherlands (Papendrecht).

 

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:

 

Brisbane, Queensland, Australia

Guangzhou, China

Perth, Western Australia, Australia

Chennai, India

Gold Coast, Queensland, Australia

Coimbatore, India

Singapore

Saitama City, Japan

Shanghai, China

 

 

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.

 

10

 

 

Information About Our Executive Officers

 

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 31, 2019.

 

Name

Age

Position

John H. Batten

54

Chief Executive Officer 

James E. Feiertag

62

President, Chief Operating Officer

Jeffrey S. Knutson

54

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

Dean J. Bratel

55

Vice President – Sales and Applied Technology

Christopher D. Bridleman

41

Vice President – Global Operations

Michael B. Gee 52 Vice President – Engineering
Debbie A. Lange 61 Corporate Controller
Denise L. Wilcox 62 Vice President – Human Resources

 

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, Chief Executive Officer. Effective May 2019, Mr. Batten was named Chief Executive Officer. Prior to that, Mr. Batten served as President and Chief Executive Officer since July 2013, President and Chief Operations Officer since July 2008, Executive Vice President since October 2004, Vice President and General Manager – Marine Products since October 2001 and Commercial Manager – Marine since 1998. Mr. Batten joined Twin Disc in 1996 as an Application Engineer.

 

James E. Feiertag, President, Chief Operating Officer.  Mr. Feiertag was appointed to President and Chief Operating Officer effective May 1, 2019. Since 2014, Mr. Feiertag served as President and CEO of Bemis Manufacturing Company. Prior to that, Mr. Feiertag was employed at Twin Disc for fourteen years and held various roles, including Vice President - Manufacturing, and, most recently, Executive Vice President. Prior to joining Twin Disc, Mr. Feiertag was the Vice President of Manufacturing for the Drives and Systems Group of Rockwell Automation since 1999.

 

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).

 

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.

 

Christopher D. Bridleman, Vice President – Global Operations. Mr. Bridleman was named as Vice President – Global Operations effective November 12, 2018. Prior to joining the Company, Mr. Bridleman was Vice President, Operations of REV Group, Inc., a leading designer, manufacturer and distributor of specialty vehicles and related aftermarket parts and services, since May 2016. Prior to that, he was Vice President Operations at Double E Company, a multi-national manufacturing/engineering company that produces and sells high quality mechanical/electrical/industrial web handling products to the paper, film and foil industries, since January 2015. From December 2007 through December 2014, he had various roles at Rexnord Corporation, the most recent of which was Director of Operations from April through December 2014.

 

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.

 

11

 

 

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.

 

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.

 

 

PART II

 

Item 5. Market for the Registrant's Common Stock, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

The Company's common stock is traded on the NASDAQ Global Select Market under the symbol TWIN.

 

For information regarding the Company’s equity-based compensation plans, see the discussion under Item 12 of this report. As of August 22, 2019, shareholders of record numbered 415.

 

Recent Sales of Unregistered Securities

 

On May 13, 2019, the Company issued 139,347 shares of its common stock, valued at $1,991 ($14.29 per share), to settle its earn-out obligation under the June 13, 2018 Share 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 Holding B.V. The shares were issued pursuant to Section 4(a)(2) of the Securities Act of 1933, as amended, as the Share Purchase Agreement was a privately negotiated transaction that involved substantial due diligence on the part of all parties, and the shares were issued to three entities related to Het Komt Vast Goed B.V.

 

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

March 30, 2019 – April 26, 2019

0

NA

0

315,000

April 27, 2019 – May 31, 2019

0

NA

0

315,000

June 1, 2019 - June 30, 2019

5,302

NA

0

315,000

Total

5,302

NA

0

315,000

 

The amounts shown in Column (a) above represent shares of common stock delivered to the Company as payment of withholding taxes due on the vesting of restricted stock and performance share awards issued under the Twin Disc, Incorporated 2010 Long-Term Incentive Compensation Plan.

 

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 2018 and 2019. As of June 30, 2019, 315,000 shares remain authorized for purchase.

 

12

 

 

Item 6. Selected Financial Data

 

Financial Highlights

(in thousands, except per share amounts)

 

Fiscal Years Ended June 30,

 

Statement of Operations Data:

 

2019

   

2018

   

2017

   

2016

   

2015

 

Net sales

  $ 302,663     $ 240,733     $ 168,182     $ 166,282     $ 265,790  

Net income (loss)

    10,796       9,647       (6,115 )     (13,013 )     11,385  

Net income (loss) attributable to Twin Disc

    10,673       9,528       (6,294 )     (13,104 )     11,173  

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

    0.84       0.82       (0.56 )     (1.17 )     0.99  

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

    0.83       0.82       (0.56 )     (1.17 )     0.99  

Dividends per share

    -       -       -       0.18       0.36  

 

June 30,

 

Balance Sheet Data

 

2019

   

2018

   

2017

   

2016

   

2015

 

Total assets

  $ 346,870     $ 241,240     $ 210,898     $ 213,922     $ 249,862  

Total long-term debt

    42,491       4,824       6,323       8,501       10,231  

 

 

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.

 

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 changed 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 was effective on September 10, 2018, the Company’s first fiscal quarter of fiscal year 2019. 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 scaled some of its disclosures of financial and non-financial information in this annual 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.

 

13

 

 

Results of Operations

                               
                                 

(In thousands)

         

% of

           

% of

 
   

2019

   

Sales

   

2018

   

Sales

 

Net sales

  $ 302,663             $ 240,733          

Cost of goods sold

    213,022               160,092          

Gross profit

    89,641       29.6       80,641       33.5  
                                 

Marketing, engineering and administrative expenses

    71,541       23.6       61,095       25.4  

Restructuring expenses

    1,179       0.4       3,398       1.4  

Other operating income

    (1,577 )     (0.5 )     -       -  

Income from operations

  $ 18,498       6.1     $ 16,148       6.7  

 

 

Fiscal 2019 Compared to Fiscal 2018

 

Net Sales

 

Net sales for fiscal 2019 increased 25.7%, or $61.9 million, to $302.7 million from $240.7 million in fiscal 2018. The Veth Propulsion acquisition, which closed on July 2, 2018, was the primary contributor to this increase, accounting for $54.9 million of the improvement. Sales of the Company’s oil and gas related transmission products explain most of the remaining positive variance, as strong demand that began in late fiscal 2017 continued through much of fiscal 2019. While demand for oil and gas related products weakened in the fiscal fourth quarter, the Company is experiencing positive trends in many of its markets. In particular, global demand for commercial marine and industrial products has shown strong improvement, while pleasure craft demand remains steady. Currency translation had a $5.1 million unfavorable impact on fiscal 2019 sales.

 

Sales at our manufacturing segment increased 29.6%, or $64.0 million, versus the same period last year. The largest contributor to this increase was the impact of the Veth Propulsion acquisition, as noted above, which contributed $54.9 million of additional revenue in fiscal 2019. The Company’s North American manufacturing operation experienced a 9.5% increase in sales compared to fiscal 2018. The primary driver for this increase was improved demand for the Company’s oil and gas related products, primarily new and replacement units, through the first half of the fiscal year. This operation also saw improving demand for its airport rescue and fire fighting (“ARFF”) transmission throughout the fiscal year. The Company’s Italian manufacturing operations were essentially flat, experiencing a currency driven decline of 3.7%. The Company’s Belgian manufacturing operation saw a 12.6% decrease in sales in fiscal 2019 on a significant currency impact (4.7%) and weaker demand in the marine markets served by this operation. The Company’s Swiss manufacturing operation, which supplies customized propellers for the global mega yacht and patrol boat markets, experienced a 10.8% decrease in sales, primarily due to currency and timing of projects in the global pleasure craft and patrol boat markets.

 

Sales at our distribution segment were up 25.7%, or $21.8 million, compared to fiscal 2018. The Company’s Asian distribution operation in Singapore, China and Japan experienced a 43.4% increase in sales due to a recovery in demand for the Company’s oil and gas, commercial marine and patrol craft products in the region. The Company’s distribution operation in the Northwest of the United States and Southwest of Canada experienced a decrease in sales of 42.3% primarily due to the sale of the Mill Log business in early March 2019. The Company’s European distribution operation, a newly established entity in 2019 to distribute the Company’s products in the European market, accounts for $12.8 million. 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 1.7%, driven by improved activity in the Australian pleasure craft market over the prior fiscal year, offset by a significant unfavorable currency impact (8.6%).

 

14

 

 

Net sales for the Company’s marine and propulsion systems were up 55.2% compared to the prior fiscal year. This increase primarily reflects the impact of the Veth Propulsion acquisition. In the land-based transmission market, the year-over-year increase of 5.2% can be attributed primarily to increased shipments of the Company’s pressure pumping transmission systems and components to the North American and Asian oil and gas market, along with improved shipments of the Company’s ARFF transmission products. The increase experienced in the Company’s industrial products of 10.2% was due to improving volume in agriculture, mining and general industrial markets, primarily in the North American and Italian regions. The Company is beginning to see the benefits of the new industrial products released over the past few years.

 

Geographically, sales to the U.S. and Canada declined 8% in fiscal 2019 compared to fiscal 2018, representing 47% of consolidated sales for fiscal 2019 compared to 64% in fiscal 2018. The reduction is primarily due to the reduced shipments of oil and gas related products into North America during the second half of fiscal 2019. Sales into China improved nearly 147% compared to fiscal 2018, driven by the combination of improving commercial marine activity and renewed oil and gas demand. Sales into China reached their highest level since fiscal 2014, representing 10% of 2019 consolidated net sales. Overall sales into the Asia Pacific market improved 58% compared to fiscal 2018 and represented approximately 18% of sales in fiscal 2019, compared to 15% in fiscal 2018. Sales into the European market improved approximately 112% from fiscal 2018 levels while accounting for 28% of consolidated net sales compared to 17% in fiscal 2018. The large increase is primarily the result of the Veth Propulsion acquisition, which has a high percentage of sales into the European market. See Note L, Business Segments and Foreign Operations, of the notes to the consolidated financial statements for more information on the Company’s business segments and foreign operations.

 

Gross Profit

 

In fiscal 2019, gross profit increased $9.0 million, or 11.2%, to $89.6 million on a sales increase of $61.9 million. Gross profit as a percentage of sales decreased 390 basis points in fiscal 2019 to 29.6%, compared to 33.5% in fiscal 2018. The table below summarizes the gross profit trend by quarter for fiscal years 2019 and 2018:

 

   

1st Qtr

   

2nd Qtr

   

3rd Qtr

   

4th Qtr

   

Year

 

Gross Profit:

                                       

($ millions)

                                       

2019

  $ 24.0     $ 26.1     $ 23.1     $ 16.4     $ 89.6  

2018

  $ 14.0     $ 18.2     $ 20.8     $ 27.6     $ 80.6  
                                         

2019

    32.1 %     33.4 %     29.9 %     22.7 %     29.6 %

2018

    31.0 %     32.2 %     31.9 %     37.4 %     33.5 %

 

There were a number of factors that impacted the Company’s overall gross profit rate in fiscal 2019. Gross profit for the year was primarily impacted by higher volumes, partially offset by a more challenging product mix. As the chart above shows, the product mix during the second half of fiscal 2019 was less profitable than the first half. This was driven by reduced sales of high-margin oil and gas transmissions and parts, along with increased sales of lower margin transmission units. Margin was also negatively impacted by a move to higher cost suppliers in order to meet production demands. In addition, there was purchase accounting inventory step-up to fair market value related to the Veth Propulsion acquisition that negatively impacted gross profit by $4.3 million in fiscal 2019. The Company estimates the net favorable impact of increased volumes on gross margin in fiscal 2019 was approximately $16.6 million. The unfavorable shift in product mix, primarily related to the reduced shipments of the Company’s high margin oil and gas transmission units and aftermarket products, had an estimated unfavorable impact of $3.0 million.

 

15

 

 

Marketing, Engineering and Administrative (ME&A) Expenses

 

Marketing, engineering, and administrative (ME&A) expenses of $71.5 million were up $10.4 million, or 17.1%, compared to the prior fiscal year. As a percentage of sales, ME&A expenses decreased to 23.6% of sales versus 25.4% of sales in fiscal 2018. The increase in fiscal 2019 ME&A expenses compared to the prior year was driven by the addition of Veth Propulsion expenses ($11.4 million), growth-related salary and travel expense ($0.9 million), increased marketing expenses ($0.8 million), higher stock-based compensation expense ($0.8 million) and other inflation and growth-related increases ($2.2 million). These increases were partially offset by reduced global bonus expense ($3.6 million), the elimination of Mill Log spending due to its divestiture in the third quarter ($1.1 million) and a foreign currency impact ($1.0 million).

 

Restructuring of Operations and Other Operating Income

 

During the course of fiscal 2019, the Company executed a series of targeted restructuring activities, resulting in a pre-tax restructuring charge of $1.2 million, or $0.09 per diluted share. These actions are a continuation of the Company’s efforts to reduce operating costs and improve efficiencies, and relate primarily to headcount reductions and structural changes at the Company’s Belgian operation.

 

During the course of fiscal 2019, as part of its ongoing initiative to focus resources on core manufacturing and product development activities, the Company completed the divestiture of its distribution entities in in the northwestern U.S. and western Canada territories (the “Mill Log business”). The Company received a total consideration of $7.7 million, consisting of cash of $5.2 million and a note receivable of $2.5 million from the buyer, who is a major distributor customer of the Company, in exchange for substantially all the assets and intangible rights of the Mill Log business, including distribution rights over the territory. The Company recognized a pre-tax gain on the sale of this business of $0.8 million.

 

During the course of fiscal 2019, the contingent consideration related to the Veth Propulsion acquisition (see Note B, Acquisition of Veth Propulsion Holding B.V.) was settled through the issuance of 139,347 shares of Company common stock. The fair value of the shares of stock at settlement was lower than the fair value at which it was initially determined at opening balance sheet date. Under ASC 805, Business Combinations, any change 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. Accordingly, the Company recognized a pre-tax gain of $0.8 million.

 

Interest Expense

 

Interest expense of $1.9 million for fiscal 2019 was significantly higher than the prior year total of $0.3 million due to the additional borrowings required for the Veth Propulsion acquisition, which closed on July 2, 2018. The Company had an average term loan balance of $17.9 million in fiscal 2019, with an interest rate that ranged from 3.81% to 5.51%. The average borrowing on the revolver, computed monthly, increased to $32.1 million in fiscal 2019, compared to $7.3 million in the prior fiscal year. The interest rate on the revolver was a range of 2.98% to 4.25% in the prior fiscal year compared to a range of 1.25% to 4.75% in the current year.

 

Other Income (Expense), Net and Interest Income

 

In fiscal 2019, other expense, net, increased $0.6 million primarily due to the impact of currency movements related to the euro.

 

16

 

 

Income Taxes

 

The effective tax rate for the twelve months of fiscal 2019 was 25.6%, which was lower than the prior year rate of 33.1%. The lower fiscal 2019 rate was primarily the result of the full year impact of impact of the Tax Cuts and Jobs Act (the “Tax Act”), which was enacted in the middle of the Company’s prior fiscal year. The prior year was also impacted by two significant discrete adjustments. During the first quarter of fiscal 2018, the Company recorded a tax benefit of $3.8 million related to the reversal of a valuation allowance in a certain foreign jurisdiction that had been subject to a full valuation allowance. Improvement in operating results, along with a business reorganization which provided favorable tax planning opportunities, allowed for the reversal of this valuation allowance. During the second quarter of the prior fiscal year, in compliance with the Tax Act, the Company recorded a non-cash tax expense of $3.8 million, primarily due to a remeasurement of deferred tax assets and liabilities. In addition, a rate change in Belgium resulted in a $0.4 million non-cash tax expense due to remeasurement of deferred tax assets and liabilities. The mix of earnings by jurisdiction, smaller discrete adjustments and continued operational improvement explain the remaining movement in the Company’s effective tax rate.

 

The Company maintains valuation allowances when it is more likely than not that all or a portion of a deferred tax asset will not be realized. Changes in valuation allowances from period to period are included in the tax provision in the period of change. In determining whether a valuation allowance is required, the Company takes into account such factors as prior earnings history, expected future earnings, carry-back and carry-forward periods, and tax strategies that could potentially enhance the likelihood of realization of a deferred tax asset. 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 all of the deferred tax assets.

 

Order Rates

 

As of June 30, 2019, the Company’s backlog of orders scheduled for shipment during the next six months (six-month backlog) was $99.6 million, or approximately 13% lower than the six-month backlog of $115.0 million as of June 30, 2018. The reduced backlog is primarily attributable to a lower level of North American oil and gas transmission units on order, partially offset by the addition of the Veth Propulsion six month backlog.

 

Liquidity and Capital Resources

 

Fiscal Years 2019 and 2018

 

The net cash used by operating activities in fiscal 2019 totaled $5.5 million, a decline of $12.0 million from the prior fiscal year. While net income increased by $1.1 million from the prior year, this was more than offset by a $17.9 million increase in working capital, excluding the impact of the Veth Propulsion acquisition. The largest increase came in inventory ($22.2 million), as the Company ramped up to meet increasing demand for oil and gas related products. The movement of other components in working capital essentially offset, as reduced trade receivables (from lower fourth quarter sales) and reduced cash balance (from more aggressive global repatriation) were offset by lower trade payables (from reduced purchasing activity in the fourth quarter) and lower accruals (primarily bonus).

 

The acquisition of Veth Propulsion comprises $60.2 million of the total $66.9 million of cash used by investing activities. Spending on capital projects increased 89% to $12.0 million in fiscal 2019, as the Company accelerated investments in critical machine tools with improved technology to drive greater productivity, along with additional spending on new product development. This spending was partially offset by the proceeds from the sale of the Mill Log business during the third quarter of fiscal 2019 ($5.2 million).

 

In fiscal 2019, the net cash provided by financing activities is comprised of the proceeds from a follow-on public offering ($32.2 million) and net borrowings of long-term debt ($38.0 million). During fiscal 2019, 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.

 

17

 

 

Future Liquidity and Capital Resources

 

On June 29, 2018, the Company entered into 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 $35.0 million 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, $50.0 million (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.

 

The Credit Agreement provides that the Company may elect that the Term Loan and each Revolving Loan to be either “LIBOR Loans” or “Eurodollar Loans”, as defined, and bear interest at the applicable rate per the Credit Agreement. This rate as of June 30, 2019 was 3.68%. In addition to the monthly interest payments and any mandatory principal payments required by the Credit Agreement (if applicable), the Company is responsible for paying a quarterly Revolving Credit Commitment Fee and quarterly Letter of Credit Fees. The Company may prepay the Loans (or any one of the Loans), subject to certain limitations.

 

On March 4, 2019, the Company entered into a second amendment (the “Second Amendment”) to the June 29, 2018 Credit Agreement. The Second Amendment reduces the principal amount of the term loan commitment under the Credit Agreement from $35.0 million to $20.0 million. In connection with the Second Amendment, the Company issued an amended and restated term note in the amount of $20.0 million to the Bank, which amended the original $35.0 million note provided under the Credit Agreement.

 

Prior to entering into the Second Amendment, the outstanding principal amount of the term loan (the “Term Loan”) under the Credit Agreement was $10.8 million. On the date of the Second Amendment, the Bank made an additional advance on the Term Loan to the Company in the amount of $9.2 million. 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 $0.5 million 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 $100.0 million 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 $100.0 million figure had previously been $70.0 million).

 

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, Acquisition of Veth Propulsion Holding B.V., to the consolidated financial statements. To effect these security interests, the Company entered into various amendment and assignment agreements that consent to the assignment of certain agreements previously entered into between the Company and the Bank of Montreal in connection with the 2016 Credit Agreement. The Company also amended and assigned to BMO a Negative Pledge Agreement that it has previously entered into with Bank of Montreal, pursuant to which it agreed not to sell, lease or otherwise encumber real estate that it owns except as permitted by the Credit Agreement and the Negative Pledge Agreement.

 

18

 

 

Upon the occurrence of an Event of Default, BMO may take the following actions upon written notice to the Company: (1) terminate its remaining obligations under the Credit Agreement; (2) declare all amounts outstanding under the Credit Agreement to be immediately due and payable; and (3) demand the Company to immediately Cash Collateralize L/C Obligations in an amount equal to 105% of the aggregate L/C Obligations or a greater amount if BMO determines a greater amount is necessary. If such Event of Default is due to the Company’s bankruptcy, BMO may take the three actions listed above without notice to the Company.

 

The Company’s balance sheet remains strong, there are no material off-balance-sheet arrangements, and the Company continues to have sufficient liquidity for near-term needs. The Company had approximately $24.7 million of available borrowings under the Credit Agreement as of June 30, 2019. 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, 2019, the Company also had cash of $12.4 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 2020, the Company expects to contribute $1.9 million to its defined benefit pension plans, the minimum contribution required.

 

Net working capital increased $32.4 million, or 33.4%, during fiscal 2019 and the current ratio (calculated as total current assets divided by total current liabilities) increased from 2.6 at June 30, 2018 to 2.8 at June 30, 2019. The increase in net working capital was primarily driven by the acquisition of Veth Propulsion in July 2018 and demand-related increases to inventory.

 

The Company expects capital expenditures to be approximately $12 million - $14 million in fiscal 2020. These anticipated expenditures reflect the Company’s plans to ramp up investment in modern equipment to meet volume demands and 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

 

The Company had no off-balance sheet arrangements as of June 30, 2019 and 2018.

 

Other Matters

 

Critical Accounting Policies and Estimates

 

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, Basis of Presentation and Significant Accounting Policies, of the notes 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 its customers and adjusts credit limits based on payment history and the customer’s credit-worthiness as determined by review of current credit information. The Company continuously monitors collections and payments from its customers and maintains a provision for estimated credit losses based upon its 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 the Company’s accounts receivable are dispersed among a large customer base, a significant change in the liquidity or financial position of any one of its largest customers could have a material adverse impact on the collectibility of its accounts receivable and future operating results.

 

19

 

 

Inventory

 

Inventories are valued at the lower of cost or net realizable value. 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.

 

In determining the fair value of the Company’s 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 test completed as of the end of June 30, 2019, goodwill was not impaired and no impairment charge was necessary for fiscal 2019. See discussion in Note F, Goodwill and Other Intangibles, of 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.

 

20

 

 

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 the Company’s 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 the Company believes that 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.

 

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, 2019 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-2018 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.

 

21

 

 

Recently Issued Accounting Standards

 

See Note A, Basis of Presentation and Significant Accounting Policies, of the notes 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 electing not to provide this disclosure due to its status as a Smaller Reporting Company.

 

 

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)

 

2019

 

1st Qtr.

   

2nd Qtr.

   

3rd Qtr.

   

4th Qtr.

   

Year

 
                                         

Net sales

  $ 74,689     $ 78,107     $ 77,420     $ 72,447     $ 302,663  

Gross profit

    23,985       26,088       23,117       16,451       89,641  

Restructuring expenses

    173       434       131       441       1,179  

Net income (loss)

    2,903       4,079       4,587       (773 )     10,796  

Net income (loss) attributable to Twin Disc

    2,862       4,073       4,560       (822 )     10,673  

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

    0.24       0.31       0.35       (0.06 )     0.84  

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

    0.24       0.31       0.34       (0.06 )     0.83  

Dividends per share

    -       -       -       -       -  
                                         

2018

                                       
                                         

Net sales

  $ 45,064     $ 56,546     $ 65,349     $ 73,774     $ 240,733  

Gross profit

    13,992       18,223       20,822       27,604       80,641  

Restructuring expenses

    1,218       831       452       897       3,398  

Net income (loss)

    3,405       (4,050 )     4,336       5,956       9,647  

Net income (loss) attributable to Twin Disc

    3,392       (4,113 )     4,308       5,941       9,528  

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

    0.29       (0.36 )     0.37       0.51       0.82  

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

    0.29       (0.36 )     0.37       0.51       0.82  

Dividends per share

    -       -       -       -       -  

 

 

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

 

None.

 

22

 

 

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 its 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, the Company’s management concluded that its internal control over financial reporting was effective as of June 30, 2019.

 

For purposes of evaluating the Company’s internal control over financial reporting, management’s assessment of and conclusion on the effectiveness of internal control over financial reporting did not include the internal controls of Veth Propulsion Holding B.V. and Veth Propulsion B.V. (collectively “Veth Propulsion”), which the Company acquired on July 2, 2018, and which are included in the consolidated balance sheets of the Company as of June 30, 2019, and the related consolidated statements of operations and comprehensive income, cash flows, and changes in shareholders’ equity, for the year then ended. Veth Propulsion constituted 28% of total assets as of June 30, 2019, and 18% and 7% of net sales and income from operations, respectively, for the year then ended.

 

RSM US LLP, an independent registered public accounting firm, has audited the Company’s internal control over financial reporting as of June 30, 2019, as stated in their report which appears herein.

 

23

 

 

Changes in Internal Control Over Financial Reporting

 

During the fourth quarter of fiscal 2019, 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.

 

 

 

PART III

 

Item 10.  Directors, Executive Officers and Corporate Governance

 

For information with respect to the executive officers of the Registrant, see "Information About Our Executive Officers" 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 31, 2019, 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 31, 2019, 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 31, 2019, 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 31, 2019, 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 31, 2019, 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 31, 2019, which is incorporated into this report by reference.

 

24

 

 

Item 11. Executive Compensation

 

The information set forth under the captions "Executive Compensation" and "Director Compensation" in the Proxy Statement for the Annual Meeting of Shareholders to be held on October 31, 2019, is incorporated into this report by reference.

 

 

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

For information regarding security ownership of certain beneficial owners and management, see the Proxy Statement for the Annual Meeting of Shareholders to be held on October 31, 2019 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 31, 2019, 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 31, 2019, 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 31, 2019, 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 31, 2019 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.

 

25

 

 

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND

FINANCIAL STATEMENT SCHEDULE

 

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

Page

   

Report of Independent Registered Public Accounting Firm

27-28

   

Consolidated Balance Sheets as of June 30, 2019 and 2018

29

   

Consolidated Statements of Operations and Comprehensive Income for the years ended June 30, 2019 and 2018

30
   

Consolidated Statements of Cash Flows for the years ended June 30, 2019 and 2018

31

   

Consolidated Statements of Changes in Equity for the years ended June 30, 2019 and 2018

32

   

Notes to Consolidated Financial Statements

33-66

   
   

INDEX TO FINANCIAL STATEMENT SCHEDULE

 
   

Schedule II - Valuation and Qualifying Accounts

67

 

 

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.

 

26

 

 

Report of Independent Registered Public Accounting Firm

  

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

  

Opinion on the Internal Control Over Financial Reporting

We have audited Twin Disc, Incorporated's (the Company) internal control over financial reporting as of June 30, 2019, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of June 30, 2019, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013.

 

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the financial statements of the Company and our report dated August 29, 2019 expressed an unqualified opinion.

 

As described in Management’s Report on Internal Control Over Financial Reporting in Item 9A. Controls and Procedures, management has excluded Veth Propulsion Holding B.V. and Veth Propulsion B.V. (collectively “Veth Propulsion”) from its assessment of internal control over financial reporting as of June 30, 2019, because it was acquired by the Company in a purchase business combination in the first quarter of fiscal 2019. We have also excluded Veth Propulsion from our audit of internal control over financial reporting. Veth Propulsion is a wholly owned subsidiary whose total assets and net income represent approximately 28 percent and (17) percent, respectively, of the related consolidated financial statement amounts as of and for the year ended June 30, 2019.

 

Basis for Opinion

The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit 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 audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

 

Definition and Limitations of Internal Control Over Financial Reporting

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 (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets 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 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/ RSM US LLP

 

Milwaukee, Wisconsin

August 29, 2019

 

27

 

 

Report of Independent Registered Public Accounting Firm

 

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

 

Opinion on the Financial Statements

We have audited the accompanying consolidated balance sheets of Twin Disc, Incorporated (the Company) as of June 30, 2019 and 2018, the related consolidated statements of operations comprehensive income, changes in equity and cash flows for each of the two years in the period ended June 30, 2019, and the related notes to the consolidated financial statements and schedule (collectively, the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of June 30, 2019 and 2018, and the results of its operations and its cash flows for each of the two years in the period ended June 30, 2019, in conformity with accounting principles generally accepted in the United States of America.

 

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of June 30, 2019, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013, and our report dated August 29, 2019 expressed an unqualified opinion on the effectiveness of the Company's internal control over financial reporting.

 

Basis for Opinion

These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

 

/s/ RSM US LLP

 

We have served as the Company's auditor since 2018.

 

Milwaukee, Wisconsin

August 29, 2019

 

28

 

 

 

TWIN DISC, INCORPORATED AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

June 30, 2019 and 2018

(In thousands, except share amounts)

 

   

2019

   

2018

 
                 

ASSETS

               

Current assets:

               

Cash

  $ 12,362     $ 15,171  

Accounts receivable, net

    44,013       45,422  

Inventories

    125,893       84,001  

Prepaid expenses

    11,681       8,423  

Other

    8,420       6,252  

Total current assets

    202,369       159,269  
                 

Property, plant and equipment, net

    71,258       55,467  

Goodwill, net

    25,954       2,692  

Deferred income taxes

    18,178       18,056  

Intangible assets, net

    25,353       1,906  

Other assets

    3,758       3,850  
                 

Total assets

  $ 346,870     $ 241,240  
                 

LIABILITIES AND EQUITY

               

Current liabilities:

               

Short-term borrowings and current maturities of long-term debt

  $ 2,000     $ -  

Accounts payable

    31,468       29,368  

Accrued liabilities

    39,609       32,976  

Total current liabilities

    73,077       62,344  
                 

Long-term debt

    40,491       4,824  

Lease obligations

    14,683       6,527  

Accrued retirement benefits

    25,878       21,068  

Deferred income taxes

    7,429       1,203  

Other long-term liabilities

    2,494       1,658  
                 

Total liabilities

    164,052       97,624  
                 

Commitments and contingencies (Note Q)

               
                 

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 13,099,468, respectively; no par value

    45,047       11,570  

Retained earnings

    196,472       178,896  

Accumulated other comprehensive loss

    (37,971 )     (23,792 )
      203,548       166,674  

Less treasury stock, at cost (1,392,524 and 1,545,783 shares, respectively)

    21,332       23,677  
                 

Total Twin Disc shareholders' equity

    182,216       142,997  
                 

Noncontrolling interest

    602       619  
                 

Total equity

    182,818       143,616  
                 

Total liabilities and equity

  $ 346,870     $ 241,240  

 

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

 

29

 

 

 

TWIN DISC, INCORPORATED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME

For the years ended June 30, 2019 and 2018

(In thousands, except per share amounts)

 

   

2019

   

2018

 
                 

Net sales

  $ 302,663     $ 240,733  

Cost of goods sold

    213,022       160,092  

Gross profit

    89,641       80,641  
                 

Marketing, engineering and administrative expenses

    71,541       61,095  

Restructuring expenses

    1,179       3,398  

Other operating income

    (1,577 )     -  

Income from operations

    18,498       16,148  
                 

Other income (expense):

               

Interest income

    43       55  

Interest expense

    (1,927 )     (282 )

Other income (expense), net

    (2,107 )     (1,501 )
      (3,991 )     (1,728 )
                 

Income before income taxes and noncontrolling interest

    14,507       14,420  
                 

Income tax expense

    3,711       4,773  
                 

Net income

    10,796       9,647  
                 

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

    (123 )     (119 )
                 

Net income attributable to Twin Disc

  $ 10,673     $ 9,528  
                 

Income per share data:

               
                 

Basic income per share attributable to Twin Disc common shareholders

  $ 0.84     $ 0.82  
                 

Diluted income per share attributable to Twin Disc common shareholders

  $ 0.83     $ 0.82  
                 

Weighted average shares outstanding data:

               

Basic shares outstanding

    12,571       11,295  

Dilutive stock awards

    111       100  
                 

Diluted shares outstanding

    12,682       11,395  
                 

Comprehensive income:

               

Net income

  $ 10,796     $ 9,647  

Foreign currency translation adjustment

    (2,671 )     981  

Benefit plan adjustments, net of income taxes of ($1,242) and $3,207, respectively

    (4,121 )     7,924  

Unrealized loss on cash flow hedge, net of income taxes of $156 and $0

    (509 )     -  

Comprehensive income

    3,495       18,552  

Less: Comprehensive income attributable to noncontrolling interest

    (98 )     (145 )
                 

Comprehensive income attributable to Twin Disc

  $ 3,397     $ 18,407  

 

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

 

30

 

 

 

TWIN DISC, INCORPORATED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the years ended June 30, 2019 and 2018

(In thousands)

 

   

2019

   

2018

 

Cash flows from operating activities:

               

Net income

  $ 10,796     $ 9,647  

Adjustments to reconcile net income to net cash (used) provided by operating activities:

               

Depreciation and amortization

    9,335       6,464  

Amortization of inventory fair value step-up

    4,277       -  

Stock compensation expense

    2,591       2,062  

Restructuring of operations

    -       238  

Gain on sale of Mill Log Business

    (768 )     -  

Gain on contingent consideration of Veth Propulsion acquisition

    (809 )     -  

Provision for deferred income taxes

    6,846       3,004  

Other, net

    84       (63 )

Changes in operating assets and liabilities

               

Trade accounts receivable

    11,177       (13,774 )

Inventories

    (27,671 )     (17,460 )

Other assets

    (10,159 )     1,537  

Accounts payable

    (1,013 )     6,844  

Accrued liabilities

    (9,896 )     10,096  

Accrued/prepaid retirement benefits

    (251 )     (2,084 )
                 

Net cash (used) provided by operating activities

    (5,461 )     6,511  
                 

Cash flows from investing activities, net of acquired business:

               

Capital expenditures

    (11,979 )     (6,328 )

Acquisition of Veth Propulsion, less cash acquired

    (60,195 )     -  

Proceeds from sale of plant assets

    239       152  

Proceeds from sale of Mill Log business (see Note R)

    5,158       -  

Proceeds from life insurance policy

    101       -  

Other, net

    (233 )     (128 )
                 

Net cash used by investing activities

    (66,909 )     (6,304 )
                 

Cash flows from financing activities:

               

Proceeds from issuance of common stock, net

    32,210       -  

Borrowings under long-term debt agreement

    44,480       -  

Borrowings under revolving loan agreement

    147,854       80,642  

Repayments under revolving loan agreement

    (129,548 )     (82,143 )

Repayments of long-term borrowings

    (24,752 )     -  

Payments of withholding taxes on stock compensation

    (1,005 )     (422 )

Dividends paid to noncontrolling interest

    (115 )     (172 )

Proceeds from exercise of stock options

    36       29  
                 

Net cash provided (used) by financing activities

    69,160       (2,066 )
                 

Effect of exchange rate changes on cash

    401       663  
                 

Net change in cash

    (2,809 )     (1,196 )
                 

Cash:

               

Beginning of year

    15,171       16,367  
                 

End of year

  $ 12,362     $ 15,171  
                 

Supplemental cash flow information:

               

Cash paid (received) during the year for:

               

Interest

  $ 1,906     $ 304  

Income taxes

    1,927       (7 )

 

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

 

31

 

 

 

TWIN DISC, INCORPORATED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

For the years ended June 30, 2019 and 2018

(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, 2017

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

Net income

            9,528                       119       9,647  

Translation adjustments

                    955               26       981  

Benefit plan adjustments, net of tax

                    7,924                       7,924  

Cash dividends

            -                       (172 )     (172 )

Compensation expense

    2,062                                       2,062  

Shares (acquired) issued, net

    (921 )                     528               (393 )
                                                 

Balance at June 30, 2018

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

Net income

            10,673                       123       10,796  

Translation adjustments

                    (2,646 )             (25 )     (2,671 )

Benefit plan adjustments, net of tax

                    (4,121 )                     (4,121 )

Unrealized loss on cash flow hedge, net of tax

                    (509 )                     (509 )

Release stranded tax effects

            6,903       (6,903 )                     -  

Cash dividends

                                    (115 )     (115 )

Compensation expense

    2,591                                       2,591  

Shares issued, net

    30,886                       2,345               33,231  
                                                 

Balance at June 30, 2019

  $ 45,047     $ 196,472     $ (37,971 )   $ (21,332 )   $ 602     $ 182,818  

 

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

 

32

 

 

TWIN DISC, INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

 

 

 

A. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

 

Basis of Presentation

 

The consolidated financial statements and information included in this Annual Report on Form 10-K (“Form 10-K”) include the financial results of Veth Propulsion Holding B.V. (“Veth Propulsion”) for the period beginning July 2, 2018 through June 30, 2019. The financial results included in this Form 10-K related to the acquisition method accounting for the Veth Propulsion acquisition have been finalized. See Note B, Acquisition of Veth Propulsion Holding B.V., for further information about the acquisition and related transactions and the acquisition accounting.

 

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 of ($681) and ($198) in fiscal 2019 and 2018, 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 $1,582 and $1,478 at June 30, 2019 and 2018, respectively. The Company records an allowance for doubtful accounts 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 its 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.

 

33

 

 

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 defined in Note O, Pension and Other Postretirement Benefit Plans. 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, 2019. The Company’s term loan borrowing, which is LIBOR-based, approximates fair value at June 30, 2019. 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.

 

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 derivative financial instruments to manage certain financial risks. The Company enters into forward contracts to reduce the earnings and cash flow impact of non-functional currency denominated receivables and payables. The Company uses interest rate swap contracts to reduce the exposure to variability in interest rates on floating debt borrowings. The Company designates certain financial instruments as cash flow hedges for accounting purposes. See Note T, Derivative Financial Instruments, for additional information.

 

Inventories--Inventories are valued at the lower of cost or net realizable value. 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 during the Company’s fourth fiscal quarter 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.

 

Goodwill impairment charges are recorded using a simplified 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.

 

34

 

 

In fiscal 2018 and prior years, the annual testing date was the last day of the fiscal year. In fiscal 2019, the Company changed its annual testing date to the first day of the Company’s fourth fiscal quarter in order to provide the Company more time and better information to perform the analyses. The Company does not believe that this change constitutes a material change to the method in applying an accounting principle.

 

The Company conducted interim qualitative assessments throughout the year, and its annual assessment for goodwill impairment as of March 30, 2019 and June 30, 2018 using updated inputs, including appropriate risk-based, country and company specific weighted average discount rates for the Company’s reporting units.

 

The fair value of the Company’s other intangible assets with indefinite lives, primarily tradenames, is estimated using the relief-from-royalty method, which requires assumptions related to projected revenues; assumed royalty rates that could be payable if the Company did not own the asset; and a discount rate. The Company completed the impairment testing of indefinite-lived intangibles as of June 30, 2019 and concluded there were no impairments.

 

Changes in circumstances, existing at the measurement date or at other times in the future, or in the numerous estimates associated with management’s judgments, assumptions and estimates made in assessing the fair value of goodwill and other indefinite-lived intangibles, could result in an impairment charge in the future. The Company will continue to monitor all significant estimates and impairment indicators, and will perform interim impairment reviews as necessary.

 

Any cost incurred to extend or renew the term of an indefinite lived intangible asset are expensed as incurred.

 

Income Taxes--The Company recognizes deferred tax assets and liabilities for the expected future income tax consequences of events that have been recognized in the Company’s financial statements. Under this method, deferred tax assets and liabilities are determined based on the temporary differences between the financial statement carrying amounts and the tax bases of assets and liabilities using enacted tax rates in effect in the years in which temporary differences are expected to reverse. Valuation allowances are provided for deferred tax assets where it is considered more likely than not that the Company will not realize the benefit of such assets. The Company evaluates its uncertain tax positions as new information becomes available. Tax benefits are recognized to the extent a position is more likely than not to be sustained upon examination by the taxing authority.

 

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.

 

Goods sold to third party distributors are subject to an annual return policy, for which a provision is made at the time of shipment based upon historical experience.

 

Shipping and Handling Fees and Costs--The Company records revenue from shipping and handling costs in net sales. The cost associated with shipping and handling of products is reflected in cost of goods sold.

  

35

 

 

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. 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.

 

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 consolidated statement of operations and comprehensive income or consolidated statement of cash flows for the year ended June 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 income (expense), net in the condensed consolidated statements of operations and comprehensive income. As a result, prior period amounts impacted have been revised accordingly. There was no impact to net income.

 

36

 

 

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 year ended June 30, 2018:

 

 

 

For the Year Ended

 
   

June 30, 2018

   

Adoption

   

June 30, 2018

 
   

As Reported

   

Impact

   

Restated

 

Cost of goods sold

  $ 160,497     $ (405 )   $ 160,092  

Gross profit

    80,236       405       80,641  

Marketing, engineering and administrative expenses

    61,909       (814 )     61,095  

Income from operations

    14,929       1,219       16,148  

Other income (expense), net

    (282 )     (1,219 )     (1,501 )

 

 

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 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 Company elected to early adopt this standard during the fourth quarter of fiscal 2019. The adoption of this guidance did not have a material impact on the Company’s financial statements and disclosures.

 

 

h.

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

 

 

a.

In June 2018, the FASB issued guidance (ASU 2018-07) intended to simplify the accounting for share based payments granted to nonemployees. Under the amendments in this guidance, payments to nonemployees would be aligned with the requirements for share based payments granted to employees. The amendments in this guidance are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018, (the Company’s fiscal 2020), including interim periods within that fiscal year. The Company is currently evaluating the potential impact of this guidance on the Company’s financial statements and disclosures.

 

 

b.

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.

 

 

c.

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.

 

37

 

 

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 changed 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 was effective on September 10, 2018, the Company’s first fiscal quarter of fiscal year 2019. 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 scaled some of its disclosures of financial and non-financial information in this annual 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 B.V.

 

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 Propulsion 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 $59,407 in cash, and $1,991 in shares of common stock on May 13, 2019, which represents the fair value of 139,347 shares. The shares of stock were issued in settlement of the earn-out, a contingent consideration, after Veth Propulsion demonstrated that it achieved the profitability target (earnings before interest, tax, depreciation and amortization or “EBITDA”) under the terms of the Purchase Agreement. The difference between the fair value at settlement and the initial fair value assigned to the earn-out at acquisition date of $2,921 is recognized in the income statement. The maximum earn-out at acquisition was $3,300. The fair value at acquisition was determined by using a discounted probability weighted approach. See Note R, Restructuring of Operations and Other Operating Income.

 

The total consideration transferred at acquisition date was:

 

Cash, paid at closing and after agreed-upon working capital adjustments

  $ 59,407  

Fair value of contingent consideration at acquisition date

    2,921  

Total

  $ 62,328  

 

38

 

 

Fair value of assets acquired and liabilities assumed at acquisition date:

 

Fair Value of Assets Acquired

       

Cash, including restricted cash

  $ 1,078  

Accounts receivable and other current assets

    10,437  

Inventories

    26,862  

Property, plant and equipment

    2,661  

Intangibles (a)

    26,500  

Accounts payable and accrued liabilities

    (21,208 )

Deferred tax liability

    (8,001 )

Total net assets acquired

    38,329  

Goodwill (b)

    23,999  

Total consideration

  $ 62,328  

 

 

(a)

Intangibles consist of customer relationships, technology and know-how and tradenames, with estimated useful lives 12 years, 7 years, and 10 years, respectively, and weighted average remaining useful life of approximately 9 years. The amounts acquired are presented in Note F, Goodwill and Other Intangibles.

 

 

(b)

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

 

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 I, Debt.

 

Summary Pro Forma Financial Information

 

The following table presents financial information for Veth Propulsion that is included in the Company’s consolidated statement of operations for the year ended June 30, 2019:

 

   

Year Ended

 
   

June 30, 2019

 

Net sales

  $ 54,909  

Gross profit (a)

    10,085  

Operating loss (b)

    (1,281 )

Net loss attributable to Twin Disc

    (1,849 )

 

 

(a)

Gross profit includes the non-recurring purchase accounting charge for the step-up of inventories acquired of $4,277 for the year.

 

 

(b)

In addition to (a), operating loss includes the depreciation of property, plant and equipment and amortization of intangible assets acquired of $2,636 for the year. Operating loss also includes one-time transaction charges related to the acquisition of $461 for the year.

 

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

 

    Year Ended  

Year Ended

 
    June 30, 2019  

June 30, 2018

 

Net sales

$ 302,663   $ 296,556  

Gross profit (a)

  93,918     92,158  

Net income attributable to Twin Disc (b)

  14,227     5,277  
             

Basic income per share attributable to Twin Disc common shareholders

$ 1.13   $ 0.47  

Diluted income per share attributable to Twin Disc common shareholders

$ 1.12   $ 0.46  
             
Weighted average number of common shares outstanding:            

Basic

  12,571     11,295  

Diluted

  12,682     11,395  

 

 

(a)

Gross profit includes the amortization of the step-up of inventories of $4,715 for the year ended June 30, 2018. For the year ended, June 30, 2019, the amortization of the step-up of inventories of $4,277 is excluded.

 

 

(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 $4,542 before tax, for the year ended June 30, 2018, as well as $1,768 related to one-time transaction charges. For the year ended June 30, 2019, this excludes one-time transaction charges related to the acquisition of $461.

 

39

 

 

 

C. REVENUE RECOGNITION

 

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’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 obligations primarily consist of product delivery and certain service obligations such as technical commissioning, repair services, installation reviews, and shift development.

 

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 practice of billing for repairs, overhaul, and other product service related time incurred by its technicians.

 

Recognize revenue:

 

Revenue is recognized as each performance obligation is satisfied which is typically at a point in time. For technical commissioning, repairs, installation review, and shift development 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 year ended June 30, 2019.

 

Net sales by product group for year ended June 30, 2019 is summarized as follows:

 

                   

Elimination of

         
   

Manufacturing

   

Distribution

   

Intercompany Sales

   

Total

 

Industrial

  $ 30,393     $ 8,079     $ (4,430 )   $ 34,042  

Land-based transmissions

    111,260       30,483       (28,950 )     112,793  

Marine and propulsion systems

    138,704       62,329       (50,796 )     150,237  

Other

    71       5,590       (70 )     5,591  

Total

  $ 280,428     $ 106,481     $ (84,246 )   $ 302,663  

 

Contract assets/liabilities:

 

There are no significant balances of contract assets or liabilities as of June 30, 2019.

 

40

 

 

 

D. INVENTORIES

 

The major classes of inventories at June 30 were as follows:

 

   

2019

       2018  

Finished parts

  $ 57,682     $ 49,332  

Work in process

    23,812       13,183  

Raw materials

    44,399       21,486  
    $ 125,893       84,001  

 

Inventories stated on a LIFO basis represent approximately 52% and 48% of total inventories at June 30, 2019 and 2018, respectively. The approximate current cost of the LIFO inventories exceeded the LIFO cost by $25,709 and $24,630 at June 30, 2019 and 2018, respectively. The Company had reserves for inventory obsolescence of $10,463 and $8,427 at June 30, 2019 and 2018, respectively.

 

 

 

E. PROPERTY, PLANT AND EQUIPMENT

 

Property, plant and equipment at June 30 were as follows:

 

   

2019

       2018  

Land

  $ 6,479     $ 6,525  

Buildings

    47,627       46,473  

Machinery and equipment

    158,183        144,457  
      212,289       197,455   

Less: accumulated depreciation

    (141,031 )     (141,988
    $ 71,258     $ 55,467  

 

Depreciation expense for the years ended June 30, 2019 and 2018 was $6,682 and $6,315, respectively.

 

 

 

F. GOODWILL AND OTHER INTANGIBLES

 

Goodwill

 

The Company reviews goodwill for impairment on a reporting unit basis annually as of the first day of the Company’s fourth fiscal quarter, and whenever events or changes in circumstances (“triggering events”) indicate that the carrying value of goodwill may not be recoverable.

 

In fiscal 2018 and prior years, the annual testing date was the last day of the fiscal year. In fiscal 2019, the Company changed its annual testing date to the first day of the Company’s fourth fiscal quarter in order to provide the Company more time and better information to perform the analyses. The Company does not believe that this change constitutes a material change to the method in applying an accounting principle.

 

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

 

41

 

 

On July 2, 2018, as discussed in Note B, Acquisition of Veth Propulsion Holding B.V., the Company acquired goodwill in the amount of $23,999 and intangible assets in the amount of $26,500 consisting of customer relationships, technology and know-how, and trade names as part of the acquisition of Veth Propulsion. As of June 30, 2019, these amounts are final. The Company, in coordination with an independent valuation firm, completed its fair value measurements and has recorded all purchase accounting entries in its financial statements for the year ended June 30, 2019. Veth Propulsion is reported as part of the Company's manufacturing segment and European Propulsion reporting unit.

 

During the 2019 fiscal year, the Company determined that there were no triggering events to warrant an interim goodwill impairment test. The Company conducted its annual assessment for goodwill impairment on March 30, 2019, the first day of its fourth fiscal quarter, its measurement date, using current assumptions, including updated forecasted cash flows and reporting unit specific discount rates of 13.0% and 14.0% for its European Propulsion and European Industrial reporting units, respectively, and concluded that goodwill is not impaired. As of June 30, 2019, goodwill in the amounts of $23,371 and $2,583 is carried in the European Propulsion and European Industrial reporting units, respectively. The fair values exceeded their carrying value by 118% and 41% for the European Propulsion and European Industrial reporting units, respectively, and therefore no impairment charge was required for these reporting units.

 

The changes in the carrying amount of goodwill are summarized as follows:

 

   

Net Book Value Rollforward

   

Net Book Value By

Reporting Unit

 
   

Gross Carrying Amount

   

Accumulated Impairment

   

Net Book

Value

   

European

Industrial

   

European

Propulsion

 

Balance at June 30, 2017

  $ 16,407     $ (13,822 )   $ 2,585     $ 2,585     $ -  

Translation adjustment

    107       -       107       107       -  

Balance at June 30, 2018

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

Acquisition

    23,999       -       23,999       -       23,999  

Translation adjustment

    (737 )     -       (737 )     (109 )     (628 )

Balance at June 30, 2019

  $ 39,776     $ (13,822 )   $ 25,954     $ 2,583     $ 23,371  

 

Other Intangibles

 

At June 30, 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

   

Customer Relationships

   

Technology Know-how

   

Trade Name

   

Other

 

Balance at June 30, 2017

  $ 13,436     $ (11,632 )   $ 1,804     $ -     $ -     $ 1,319     $ 485  

Addition

    19       -       19       -       -       -       19  

Amortization

    -       (149 )     (149 )     -       -       (84 )     (65 )

Translation adjustment

    30       -       30       -       -       53       (23 )

Balance at June 30, 2018

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

Addition

    236       -       236       -       -       -       236  

Acquistion

    26,500       -       26,500       16,300       8,400       1,800       -  

Amortization

    -       (2,653 )     (2,653 )     (1,123 )     (1,172 )     (261 )     (97 )

Translation adjustment

    (634 )     -       (634 )     (334 )     (203 )     (94 )     (3 )

Balance at June 30, 2019

  $ 39,587     $ (14,434 )   $ 25,153     $ 14,843     $ 7,025     $ 2,733     $ 552  

 

Other intangibles consist of certain proprietary technology, computer software, patents and licensing agreements.

 

The weighted average remaining useful life of the intangible assets included in the table above is approximately 9 years.

 

42

 

 

Intangible amortization expense for the years ended June 30, 2019 and 2018 was $2,653 and $149, respectively. Estimated intangible amortization expense for each of the next five fiscal years is as follows:

 

Fiscal Year

       
2020   $ 2,904  

2021

    2,890  

2022

    2,874  

2023

    2,888  

2024

    2,789  

Thereafter

    10,808  

 

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

 

 

 

G. ACCRUED LIABILITIES

 

Accrued liabilities at June 30 were as follows:

 

   

2019

   

2018

 

Customer deposits

  $ 14,924     $ 5,426  

Salaries and wages

    6,982       10,311  

Warranty

    3,034       3,952  

Accrued professional fees

    1,843       3,501  

Other

    12,826       9,786  
    $ 39,609     $ 32,976  

 

 

 

H. WARRANTY

 

The Company warrants all assembled products, parts (except component products or parts on which written warranties are issued by the respective manufacturers thereof and are furnished to the original customer, as to which the Company makes no warranty and assumes no liability) and service against defective materials or workmanship. Such warranty generally extends from periods ranging from 12 months to 24 months. 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 the Company’s 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 the Company believes that 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 during the years ended June 30:

 

   

2019

   

2018

 
                 

Reserve balance, July 1

  $ 4,407     $ 2,062  

Current period expense and adjustments

    2,766       4,998  

Payments or credits to customers

    (3,953 )     (2,671 )

Acquisition

    557       -  

Translation adjustment

    (41 )     18  

Reserve balance, June 30

  $ 3,736     $ 4,407  

 

The current portion of the warranty accrual ($3,034 and $3,952 for fiscal 2019 and 2018, respectively) is reflected in accrued liabilities, while the long-term portion ($702 and $455 for fiscal 2019 and 2018, respectively) is included in other long-term liabilities on the consolidated balance sheets.

 

43

 

 

 

I. DEBT

 

Long-term Debt:

 

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, Acquisition of Veth Propulsion Holding B.V., 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 K, Shareholders’ Equity) 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 BMO 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, Acquisition of Veth Propulsion Holding B.V..

 

Upon the occurrence of an event of default, BMO may take the following actions upon written notice to the Company: (1) terminate its remaining obligations under the Credit Agreement; (2) declare all amounts outstanding under the Credit Agreement to be immediately due and payable; and (3) demand the Company to immediately cash collateralize letter of credit obligations in an amount equal to 105% of the aggregate letter of credit obligations or a greater amount if BMO determines a greater amount is necessary. If such event of default is due to the Company’s bankruptcy, BMO may take the three actions listed above without notice to the Company.

 

44

 

 

In addition to the monthly interest payments and any mandatory principal payments required by the Credit Agreement (if applicable), the Company is responsible for paying a quarterly Revolving Credit Commitment Fee and quarterly Letter of Credit Fees. The Revolving Credit Commitment Fee is paid at an annual rate equal to the Applicable Margin on the average daily unused portion of the Revolving Credit Commitment. The Letter of Credit Fee is paid at the Applicable Margin for Revolving Loans that are Eurodollar Loans on the daily average face amount of Letters of Credit outstanding during the preceding calendar quarter. The Company may prepay the Loans (or any one of the Loans), subject to certain limitations. 

 

Long-term debt consisted of the following at June 30:

 

   

2019

   

2018

 

Revolving loan agreement

  $ 22,666     $ 4,787  

Term loan (due March 2026)

    19,500       -  

Other

    325       37  

Subtotal

    42,491       4,824  

Less: current maturities

    (2,000 )     -  

Total long-term debt

  $ 40,491     $ 4,824  

 

Other long-term debt pertains mainly to a financing arrangement in Europe. During 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 $329 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 $28 in principal was paid on these liabilities during the current fiscal year.

 

During fiscal year 2019, the average interest rate was 4.71% on the Term Loan, and 2.99% on the Revolving Loans.

 

As of June 30, 2019, the Company’s borrowing capacity under the terms of the Credit Agreement was approximately $47,324 and the Company had approximately $24,658 of available borrowings.

 

The Company’s borrowings described above approximates fair value at June 30, 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. This swap is included in the disclosures in Note T, Derivative Financial Instruments.

 

The aggregate scheduled maturities of outstanding long-term debt obligations in subsequent years are as follows:

 

Fiscal Year

       

2020

  $ 2,000  

2021

    2,161  

2022

    2,081  

2023

    24,709  

2024