UNITED STATES

SECURITIES AND EXCHANGE COMMISSION     

WASHINGTON, D.C. 20549

Form 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarter ended March 25, 2016

 

Commission File Number 1-7635

 

 

TWIN DISC, INCORPORATED

(Exact name of registrant as specified in its charter)

 

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

 

1328 Racine Street, Racine, Wisconsin 53403

(Address of principal executive offices)

 

(262) 638-4000

(Registrant's telephone number, including area code)

 

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

Yes √           No          

 

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

 

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

 

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

                                

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

Yes               No √      

 

At April 29, 2016, the registrant had 11,350,174 shares of its common stock outstanding.

 

 

Part I.     FINANCIAL INFORMATION

 

Item 1.     Financial Statements

TWIN DISC, INCORPORATED

CONDENSED CONSOLIDATED BALANCE SHEETS

(IN THOUSANDS, EXCEPT SHARE AMOUNTS)

(UNAUDITED)

 

 

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

 

 

TWIN DISC, INCORPORATED

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

(IN THOUSANDS, EXCEPT PER SHARE DATA)

(UNAUDITED)

 

 

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

  

 

TWIN DISC, INCORPORATED

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(IN THOUSANDS)

(UNAUDITED)

 

 

 

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

  

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)

 

 

 

Item 2.     Management Discussion and Analysis

 

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

 

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

 

In addition to the assumptions and information referred to specifically in the forward-looking statements, other factors, including but not limited to those factors discussed under Item 1A, Risk Factors, of the Company’s Annual Report filed on Form 10-K for June 30, 2015 could cause actual results to be materially different from what is expressed or implied in any forward looking statement.

 

Results of Operations

 

(In thousands)
		Quarter Ended																Three Quarters Ended
		March 25, 2016					%			March 27, 2015					%			March 25, 2016					%			March 27, 2015					%
Net sales		$	41,434							$	60,941							$	123,635							$	198,456
Cost of goods sold			31,816								41,935								94,222								134,958
Gross profit			9,618				23.2	%			19,006				31.2	%			29,413				23.8	%			63,498				32.0	%
Marketing, engineering and administrative expenses			14,072				34.0	%			15,669				25.7	%			43,905				35.5	%			48,086				24.2	%
Restructuring of operations			272				0.7	%			0				0.0	%			787				0.6	%			0				0.0	%
Other operating expense (income)			0				0.0	%			0				0.0	%			(445	)			(0.4%	)			0				0.0	%
(Loss) earnings from operations		$	(4,726	)			(11.4%	)		$	3,337				5.5	%		$	(14,834	)			(12.0%	)		$	15,412				7.8	%

 

Comparison of the Third Quarter of FY 2016 with the Third Quarter of FY 2015

 

Net sales for the third quarter decreased 32.0%, or $19.5 million, to $41.4 million from $60.9 million in the same period a year ago. Currency translation had an unfavorable impact on fiscal 2016 sales compared to the prior year totaling $1.0 million due to the strengthening of the U.S. dollar against the euro and Asian currencies. The significant decline is the result of reduced demand for the Company’s oil and gas related products in both North America and Asia driven by the continued global decline in oil and natural gas prices, along with softening demand in Asia for the Company’s commercial marine products. Demand from customers in Europe remains weak, although improved slightly from the prior year, while overall demand in North America remains stable for the Company’s commercial marine and industrial products (excluding oil and gas applications). The sales decline was seen most heavily in Asia Pacific, as the percentage of sales to this region fell to 19% of total consolidated net sales in the third quarter of fiscal 2016 compared to 21% for the full year fiscal 2015 and 29% in the peak year of fiscal 2014. By comparison, the European region improved to 21% (from 17%).   

 

Sales at our manufacturing segment were down 32.4%, or $17.7 million, versus the same period last year. In the current fiscal year’s third quarter, our U.S. manufacturing operation, the largest, experienced a 44.1% decrease in sales versus the third fiscal quarter of 2015. The primary driver for this decrease was reduced shipments of pressure pumping transmissions and aftermarket components for the North American and Asian oil and gas markets, along with reduced demand for commercial marine product. The Company’s Italian manufacturing operations, which continue to be hampered by the softness in the European mega yacht and industrial markets, experienced an 18.0% decrease in sales compared to the prior fiscal year’s third quarter, partially due to an unfavorable currency impact (4.2%). The Company’s Belgian operation experienced a decline in the quarter (16.1%) on challenging European market conditions. The Company’s Swiss manufacturing operation, which supplies customized propellers for the global mega yacht and patrol boat markets, experienced a 24.8% decrease in sales, primarily due to softening demand for commercial and patrol craft applications along with an unfavorable currency impact (3.6%).

 

 

Our distribution segment experienced a 33.1%, or $8.7 million, decrease in sales compared to the third quarter of fiscal 2015. The Company’s distribution operation in Singapore, its largest Company-owned distribution operation, saw a 58.2% decrease in sales compared to the prior fiscal year’s third quarter. This decrease is due to a significant decline in shipments of pressure pumping and commercial marine transmissions for the Asian market, along with an unfavorable currency impact (1.3%). The Company’s distribution operation in the Northwest of the United States and Southwest of Canada experienced a decrease in sales of 44.1%. The year over year decrease was driven by reduced shipments of pressure pumping transmissions and aftermarket service and components for the Canadian oil and gas market. The Company’s distribution operation in Australia, which provides boat accessories, propulsion and marine transmission systems for the pleasure craft market, saw an increase in sales of 3.7% from the prior fiscal year’s third quarter despite an unfavorable currency impact (7.4%). This constant-currency increase was driven by improved shipments in the Australian pleasure craft market compared to the prior year.

 

The elimination for net inter/intra segment sales decreased $6.8 million, accounting for the remainder of the net change in sales versus the same period last year.

 

Gross profit as a percentage of sales decreased 800 basis points to 23.2% of sales, compared to 31.2% of sales for the same period last year. Gross profit for fiscal 2016’s third quarter was unfavorably impacted by the reduced volume ($8.9 million), a less profitable product mix (approximately $0.9 million) driven by lower sales of the Company’s oil and gas transmission products and an unfavorable currency impact ($0.2 million). These unfavorable items were partially offset by improved efficiencies and realization of recent cost savings initiatives ($0.7 million).

 

For the fiscal 2016 third quarter, marketing, engineering and administrative (ME&A) expenses, as a percentage of sales, were 34.0%, compared to 25.7% for the fiscal 2015 third quarter. ME&A expenses decreased $1.6 million or 10.2% versus the same period last fiscal year. The decrease in ME&A expenses for the quarter relates to a currency movement ($0.2 million), reduced bonus expense ($0.8 million) and the realization of recently enacted cost reduction initiatives ($1.7 million). These decreases were partially offset by increases related to pension expense ($0.6 million), stock based compensation expense ($0.3 million) and legal fees related to the amendment of revolving credit agreement ($0.2 million).

 

During the second fiscal quarter of fiscal 2016, the Company announced restructuring actions expected to generate $4.3 million in annualized savings through reductions in the base salaries of the Company’s corporate officers, the elimination of salaried positions, reductions in base salaries and wages of salaried and hourly employees at the Company’s headquarters and domestic manufacturing facilities, temporary layoffs at its Racine operation and headcount reductions at certain foreign subsidiaries. These actions resulted in a $0.5 million restructuring charge recorded in the Company’s second fiscal quarter, consisting of severance related to the aforementioned cost savings initiatives, and $0.3 million in the third fiscal quarter.

 

During the first quarter of fiscal 2016, the Company sold the distribution rights and assets of its distribution entity covering the southeast U.S. territory for approximately $4.1 million. As a result, a net operating gain of $0.4 million was recorded in the Company’s year-to-date results.

 

Interest expense of $156,000 for the quarter was up 27.9% versus last year’s third fiscal quarter. Total interest on the Company’s revolving credit facility under the Wells Fargo Agreement increased to $73,000 in fiscal 2016’s third quarter. The average borrowing on this loan, computed monthly, increased to $14.1 million in fiscal 2016’s third quarter, compared to $6.3 million in the same period a year ago. The interest rate increased from a range of 1.18% to 1.19% in the prior fiscal year’s third quarter to a range of 1.43% to 1.95% in the current year. The interest expense on the Company’s $25 million Senior Note decreased 50%, at a fixed rate of 6.05%, due to a lower remaining principal balance.

 

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

 

The fiscal 2016 third quarter tax rate was 81.6%, compared to the fiscal 2015 third quarter rate of 18.8%. Both periods were impacted by non-deductible operating results in a certain foreign jurisdiction that is subject to a full valuation allowance. Adjusting both periods for the non-deductible results, the fiscal 2016 third quarter rate would have been 71.4%, compared to 27.3% for the fiscal 2015 third quarter. The fiscal 2016 third quarter effective tax rate was favorably impacted by a tax strategy which resulted in the recognition of foreign tax credits associated with the repatriation of $9.7 million in cash from our European operations ($2.4 million). Adjusting for this non-recurring benefit, the fiscal 2016 third quarter effective tax rate would have been 34.3%.

  

 

Comparison of the First Three Quarters of FY 2016 with the First Three Quarters of FY 2015

 

Net sales for the first three quarters decreased 37.7%, or $74.8 million, to $123.6 million from $198.5 million in the same period a year ago. Currency translation had an unfavorable impact on fiscal 2016 sales compared to the prior year totaling $7.9 million due to the strengthening of the U.S. dollar against the euro and Asian currencies. The significant decline is the result of reduced demand for the Company’s oil and gas related products in both North America and Asia driven by the continued global decline in oil and natural gas prices, along with softening demand in Asia for the Company’s commercial marine products. Demand from customers in Europe remains weak, while overall demand in North America remains stable for the Company’s commercial marine and industrial products (excluding oil and gas applications). The sales decline was seen most heavily in North America, driven by the reduced demand for oil and gas related products, as the percentage of sales to this region fell to 52% of total consolidated net sales in the first three quarters of fiscal 2016 compared to 55% for the full year fiscal 2015. By comparison, the European region improved to 20% (from 17%), while Asia Pacific fell slightly to 20% (compared to 21% for fiscal 2015).   

 

Sales at our manufacturing segment were down 40.6%, or $72.2 million, versus the same period last year. In the current fiscal year’s first three quarters, our U.S. manufacturing operation, the largest, experienced a 51.9% decrease in sales versus the first three quarters of 2015. The primary driver for this decrease remains the reduced shipments of pressure pumping transmissions and aftermarket components for the North American and Asian oil and gas markets, along with reduced demand in Asia for commercial marine product. The Company’s Italian manufacturing operations, which continue to be hampered by the softness in the European mega yacht and industrial markets, experienced a 26.0% decrease in sales compared to the prior fiscal year’s first three quarters, partially due to an unfavorable currency impact (10.1%). The Company’s Belgian manufacturing operation experienced a volume decline of 8.4%, including an unfavorable currency impact (5.8%), on continued challenges in the European market. The Company’s Swiss manufacturing operation, which supplies customized propellers for the global mega yacht and patrol boat markets, experienced an 18.4% decrease in sales, partially due to currency impact (4.0%) and the softening demand for commercial and patrol craft applications.

 

Our distribution segment experienced a 31.4%, or $24.9 million, decrease in sales compared to the first three quarters of fiscal 2015. The Company’s distribution operation in Singapore, its largest Company-owned distribution operation, saw a 55.7% decrease in sales compared to the prior fiscal year’s first three quarters. This significant decrease is due to a significant decline in shipments of pressure pumping and commercial marine transmissions for the Chinese market, along with an unfavorable currency impact (3.5%). The Company’s distribution operation in the Northwest of the United States and Southwest of Canada experienced a decrease in sales of 50.3%. The year over year decrease was driven by reduced shipments of pressure pumping transmissions and aftermarket service and components for the Canadian oil and gas market. The Company’s distribution operation in Australia, which provides boat accessories, propulsion and marine transmission systems for the pleasure craft market, saw an increase in sales of just over 9% from the prior fiscal year’s first three quarters, after adjusting for an unfavorable currency impact (15.5%). This constant-currency increase was driven by improved shipments in the Australian pleasure craft market compared to the prior year.

 

The elimination for net inter/intra segment sales decreased $22.3 million, accounting for the remainder of the net change in sales versus the same period last year.

 

Gross profit as a percentage of sales decreased 820 basis points to 23.8% of sales, compared to 32.0% of sales for the same period last year. Gross profit for fiscal 2016’s first three quarters was unfavorably impacted by the reduced volume ($32.1 million), a less profitable product mix (approximately $3.4 million) driven by lower sales of the Company’s oil and gas transmission products and an unfavorable currency impact ($1.0 million). These unfavorable items were partially offset by improved efficiencies and realization of recent cost savings initiatives ($2.5 million).

 

For the fiscal 2016 first three quarters, marketing, engineering and administrative (ME&A) expenses, as a percentage of sales, were 35.5%, compared to 24.2% for the fiscal 2015 comparable period. ME&A expenses decreased $4.2 million or 8.7% versus the same period last fiscal year. The decrease in ME&A expenses for the first three quarters relates to a currency movement ($1.7 million), reduced bonus expense ($2.0 million) and the realization of recently enacted cost reduction initiatives ($3.4 million). These decreases were partially offset by increases related to pension expense ($1.3 million), stock based compensation ($0.7 million), legal fees related to the amended bank agreement ($0.2 million) and corporate development activities ($0.7 million).

  

 

During the second fiscal quarter, the Company announced restructuring actions expected to generate $4.3 million in annualized savings through reductions in the base salaries of the Company’s corporate officers, the elimination of salaried positions, reductions in base salaries and wages of salaried and hourly employees at the Company’s headquarters and domestic manufacturing facilities, temporary layoffs at its Racine operation and headcount reductions at certain foreign subsidiaries. These actions resulted in a $0.8 million restructuring charge recorded in the Company’s second and third fiscal quarters.

 

During the first quarter of fiscal 2016, the Company sold the distribution rights and assets of its distribution entity covering the southeast U.S. territory for approximately $4.1 million. As a result, a net operating gain of $0.4 million was recorded in the Company’s year-to-date results.

 

Interest expense of $356,000 for the first three quarters was down 18.3% versus last year’s comparable period. Total interest on the Company’s revolving credit facility under the Wells Fargo Agreement increased 50.5% to $157,400 in fiscal 2016’s first three quarters. The average borrowing on this loan, computed monthly, increased 27.2% to $13.3 million in fiscal 2016’s first three quarters, compared to $10.5 million in the same period a year ago. The interest rate increased from a range of 1.16% to 1.19% in the prior fiscal year’s first three quarters to a range of 1.20% to 1.95% in the current year. The interest expense on the Company’s $25 million Senior Note decreased 50% to $162,000 at a fixed rate of 6.05%, due to a lower remaining principal balance.

 

The unfavorable movement in other expense (income) compared to the prior year is primarily due to the impact of currency movements related to the euro, Chinese yuan, Japanese yen and Australian dollar.

 

The fiscal 2016 tax rate for the first three quarters was 51.5%, compared to the fiscal 2015 rate of 31.8% for the comparable period. The fiscal 2016 rate was significantly impacted by a tax strategy implemented which resulted in a net tax benefit of $2.4 million recorded to reflect foreign tax credits associated with the repatriation of cash from various European entities ($9.7 million). Adjusting for this non-recurring benefit, the fiscal 2016 effective tax rate would have been 36.0%.    

 

Financial Condition, Liquidity and Capital Resources

 

Comparison between March 25, 2016 and June 30, 2015

 

As of March 25, 2016, the Company had net working capital of $92.3 million, which represents a decrease of $20.5 million, or 18.2%, from the net working capital of $112.8 million as of June 30, 2015.

 

Cash decreased $9.5 million to $13.4 million as of March 25, 2016, versus $22.9 million as of June 30, 2015. The decrease is the result of a $9.7 million repatriation of cash from various European entities during the Company’s third fiscal quarter, which was used to pay down debt. The majority of the cash as of March 25, 2016 is at overseas operations in Europe ($3.6 million) and Asia-Pacific ($9.2 million).

 

Trade receivables of $32.6 million were down $11.2 million, or approximately 25.6%, when compared to last fiscal year-end. The impact of foreign currency translation was to decrease accounts receivable by $0.2 million versus June 30, 2015. The net remaining decrease is driven by the sales volume decrease of just over 38% from the fourth quarter of fiscal 2015 compared to the third fiscal quarter of fiscal 2016.

 

Net inventory decreased by $10.7 million, or 13.4%, versus June 30, 2015 to $69.5 million. The impact of foreign currency translation was to decrease net inventory by $0.7 million versus June 30, 2015. After adjusting for the impact of foreign currency translation, the net decrease of $10.0 million is primarily the result of the sale of the inventories of Twin Disc Southeast, a Company-owned distributor in the southeast U.S., to a third party distributor ($3.3 million), along with reductions at our Racine manufacturing operation ($1.3 million) and Singapore distribution operation ($3.2 million). On a consolidated basis, as of March 25, 2016, the Company’s backlog of orders to be shipped over the next six months approximates $40.0 million, compared to $34.4 million at June 30, 2015 and $47.8 million at March 27, 2015. As a percentage of six month backlog, inventory has improved from 233% at June 30, 2015 to 174% at March 25, 2016.

 

Net property, plant and equipment (PP&E) decreased $3.2 million versus June 30, 2015. This includes the addition of $3.6 million in capital expenditures, primarily at the Company’s Racine-based manufacturing operation, which was more than offset by depreciation of $6.6 million. The net remaining decrease is due to foreign currency translation effects and asset disposals. In total, the Company expects to invest between $5 and $7 million in capital assets in fiscal 2016. These anticipated expenditures reflect the Company’s plans to conserve capital while continuing to invest in modern equipment and facilities, its global sourcing program and new products. The Company continues to review its capital plans based on overall market conditions and availability of capital, and may make changes to its capital plans accordingly. The Company’s capital program is focused on modernizing key core manufacturing, assembly and testing processes and expanding capacity at its facilities around the world.

  

 

Due to recent volatility in the Company’s stock price, the Company’s market capitalization has fallen below its book value at times over the past two quarters. The Company evaluated this decline, as well its unfavorable operating results and the downward industry macroeconomic trends, in light of possible goodwill impairments, and concluded that the decline in the Company’s market capitalization during the second and third fiscal quarters of 2016 was not indicative that the fair value of the Company’s reporting units had more likely than not declined to below their carrying values. See Footnote I of this quarterly report for further discussion.

 

Accounts payable as of March 25, 2016 of $15.1 million were down $5.6 million, or 26.9%, from June 30, 2015. The impact of foreign currency translation was to decrease accounts payable by $0.1 million versus June 30, 2015. This decrease is consistent with the timing of certain payments, the Company’s lower six month backlog levels and the reduction in purchasing activity during the first three quarters resulting from reduced sales levels compared to the fourth quarter of fiscal 2015.

 

Total borrowings and long-term debt as of March 25, 2016 decreased by $2.0 million, or 14.5%, to $11.8 million versus June 30, 2015. This decrease was driven by debt repayments primarily through the use of $9.7 million in cash repatriated from foreign jurisdictions in the Company’s fiscal third quarter, the use of $4.1 million of proceeds from the sale of the assets of Twin Disc Southeast and the use of $2.0 million from life insurance proceeds, partially offset by borrowings used to support operating cash flows and make bonus, dividend and severance payments. During the first three quarters, the Company generated negative free cash flow (defined as operating cash flow less acquisitions of fixed assets and dividends paid to shareholders) of ($10.9) million and ended the quarter with total debt, net of cash, of ($1.6) million, compared to ($9.1) million at June 30, 2015, for a net change of $7.5 million.

 

Total equity decreased $9.2 million, or 6.5%, to $131.0 million as of March 25, 2016. Retained earnings decreased by $9.6 million. The net decrease in retained earnings included $7.6 million in net loss for the first fiscal three quarters, along with $2.0 million in dividend payments. Net unfavorable foreign currency translation of $2.2 million was reported. The net remaining increase in equity of $2.6 million primarily represents the amortization of net actuarial loss and prior service cost on the Company’s defined benefit pension plans.

 

As of March 25, 2016, the Company’s borrowings consisted of loans under (a) the revolving loan agreement with Wells Fargo Bank, National Association (the “Wells Fargo Agreement”) and (b) the Amended and Restated Note Purchase and Private Shelf Agreement (the “Prudential Agreement”).

 

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

 

Borrowings under the amended Wells Fargo Agreement were secured by substantially all of the Company’s personal property, including accounts receivable, inventory, certain machinery and equipment, and intellectual property, and the personal property of Mill-Log Equipment Co., Inc. (“Mill-Log”), a wholly-owned domestic subsidiary of the Company. The Company had also pledged 65% of its equity interests in certain foreign subsidiaries. The Company and Mill-Log had entered into a Security Agreement with Wells Fargo, under which Wells Fargo had been granted a security interest in these assets and holdings as collateral agent for itself and for the Noteholders under the Prudential Agreement.

 

Loans under the Wells Fargo Agreement were generally charged interest at the LIBOR Rate plus (a) 1.00% if the Company’s adjusted four-quarter EBITDA (as defined) was at least $11 million, or (b) 1.50% if the Company’s adjusted four-quarter EBITDA (as defined) was less than $11 million. The rate was 1.94% at March 25, 2016.

  

 

On April 22, 2016, the Company entered into a revolving Credit Agreement (the “BMO Agreement”) with Bank of Montreal (“BMO”). This agreement permitted the Company to enter into loans up to $40 million. This maximum may be increased under the BMO Agreement by an additional $10 million so long as there exists no default and certain other conditions specified in the BMO Agreement are satisfied. On the day of the closing of the BMO Agreement, the Company used proceeds to pay off the loan balance under the Wells Fargo Agreement. The new agreement demonstrated that the Company had both the intent and ability to refinance its debt obligation as of March 25, 2016, and the secured agreement allows for the Company to borrow up to the specified borrowing base criteria over the next twelve months. As a result the Company has classified the outstanding balance under the Wells Fargo Agreement as of March 25, 2016, as a long-term obligation.

 

In general, each revolving loan under the BMO Agreement will bear interest at a Eurodollar Rate, as defined. This rate as of April 22, 2016 was 2.18%

 

In addition to monthly interest payments, the Company will be responsible for paying a quarterly unused fee equal to 0.15% of the average daily unused portion of the revolving credit commitment. The Company may prepay loans subject to certain limitations.

 

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

 

The Prudential Agreement was entered into on June 30, 2014. Among other things, the Prudential Agreement: (a) amended and restated the note agreement between the Company and Purchasers dated as of April 10, 2006, as it had been amended from time to time; and (b) set forth the terms of the potential sale and purchase of up to $50 million in shelf notes by the Company to Prudential. The notes bear interest on the outstanding principal balance at a fixed rate of 6.05% per annum, payable quarterly. The principal was payable in annual installments of $3.6 million, and matured and became due and payable in full on April 10, 2016. The outstanding balance was $3.6 million at March 25, 2016 and June 30, 2015, respectively. The entire outstanding balance was classified as a current maturity of long-term debt at March 25, 2016 and June 30, 2015, respectively.

 

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

 

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

 

As of March 25, 2016, the Company’s backlog of orders scheduled for shipment during the next six months (six-month backlog) was $40.0 million, or approximately 16% greater than the six-month backlog of $34.4 million as of June 30, 2015, but down 16% from the end of the third fiscal quarter of 2015. Please see the factors discussed under Item 1A, Risk Factors, of the Company’s Annual Report filed on Form 10-K for June 30, 2015, as supplemented in this report, which could cause actual results to be materially different from what is expressed or implied in any forward looking statement.

  

 

The Company’s balance sheet remains strong, there are no material off-balance-sheet arrangements, and we continue to have sufficient liquidity for near-term needs. The Company had approximately $15.5 million of available borrowings on the new Credit Agreement with Bank of Montreal as of April 22, 2016. 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 March 25, 2016, the Company also had cash of $13.4 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 2016, the Company expects to contribute $2.2 million to its defined benefit pension plans, the minimum contributions required. As of March 25, 2016, $2.2 million in contributions have been made.

 

Net working capital decreased $20.5 million, or 18.2%, in fiscal 2016’s first three quarters, and the current ratio increased from 3.0 at June 30, 2015 to 3.3 at March 25, 2016. The decrease in net working capital was primarily driven by a decrease in accounts receivable and inventory, partially offset by a decrease in accounts payable and accrued liabilities due to the impact of reduced volume and the payment of severance and bonus obligations.

 

The Company expects capital expenditures to be approximately $5 million - $7 million in fiscal 2016. These anticipated expenditures reflect the Company’s plans to continue conserve capital while investing in modern equipment and facilities, its global sourcing program and new products.

 

Management believes that available cash, the BMO credit facility, 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.

 

The Company has approximately $0.8 million of unrecognized tax benefits, including related interest and penalties, as of March 25, 2016, which, if recognized, would favorably impact the effective tax rate. See Note H of the Condensed Consolidated Financial Statements for disclosures surrounding uncertain income tax positions.

 

The Company maintains defined benefit pension plans for some of its operations in the United States and Europe. The Company has established the Benefits Committee to manage the operations and administration of the defined benefit plans. As mentioned above, the Company estimates that fiscal 2016 contributions to all defined benefit plans will total $2.2 million. As of March 25, 2016, $2.2 million in contributions have been made.

 

New Accounting Releases

 

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

 

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

 

In November 2015, the Financial Accounting Standards Board (“FASB”) issued guidance intended to simplify current presentation guidance by requiring that deferred income tax assets and liabilities, by jurisdiction, be presented in the balance sheet as noncurrent. The amendments in this guidance are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016 (the Company’s fiscal 2018), with early adoption permitted. The Company is currently evaluating the potential impact of this guidance on the Company’s financial statements and disclosures.

 

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

  

 

In July 2015, the FASB issued guidance to reduce complexity in employee benefit plan accounting, which is consistent with its Simplification Initiative of improving areas of generally accepted accounting principles (GAAP) for which cost and complexity can be reduced while maintaining or improving the usefulness of the information provided to users of financial statements. This guidance update consists of several parts that affect the reporting of defined benefit pension plans, defined contribution pension plans, and their fair value measurements, among others. This guidance is effective for fiscal years beginning after December 15, 2015 (the Company’s fiscal 2017). The adoption of this guidance is not expected to have a material impact on the Company’s financial disclosures.

 

In April 2015, the FASB issued guidance intended to amend current presentation guidance by requiring that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of the debt liability, consistent with debt discounts. The amendments in this guidance are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015 (the Company’s fiscal 2017). The adoption of this guidance is not expected to have a material impact on the Company’s financial statements and disclosures.

 

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

 

In June 2014, the FASB issued stock compensation guidance requiring that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. The amendments in this guidance are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015 (the Company’s fiscal 2017). The adoption of this guidance is not expected to have a material impact on the Company’s financial statements and disclosures.

 

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

 

Critical Accounting Policies

 

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

 

Twin Disc’s critical accounting policies are described in Item 7 of the Company’s Annual Report filed on Form 10-K for June 30, 2015. There have been no significant changes to those accounting policies subsequent to June 30, 2015.

  

 

Item 3.     Quantitative and Qualitative Disclosure About Market Risk

 

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

 

Interest rate risk - The Company’s earnings exposure related to adverse movements of interest rates is primarily derived from outstanding floating rate debt instruments that are indexed to a Eurodollar Rate. In accordance with BMO Agreement expiring April 22, 2021, the Company has the option of borrowing at a Eurodollar Rate plus an additional “Add-On” of 1.75%. Due to the relative stability of interest rates, the Company did not utilize any financial instruments at March 25, 2016 to manage interest rate risk exposure. A 10 percent increase or decrease in the applicable interest rate would result in a change in pretax interest expense of approximately $18,000.

 

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

 

Currency risk - The Company has exposure to foreign currency exchange fluctuations. Approximately 27% of the Company’s revenues in the quarter ended March 25, 2016 were denominated in currencies other than the U.S. dollar. Of that total, approximately 60% was denominated in euros with the balance composed of Japanese yen, the Swiss franc, Indian rupee and the Australian and Singapore dollars. The Company does not hedge the translation exposure represented by the net assets of its foreign subsidiaries. Foreign currency translation adjustments are recorded as a component of shareholders’ equity. Forward foreign exchange contracts are occasionally used to hedge the currency fluctuations on significant transactions denominated in foreign currencies.

 

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

 

The Company primarily enters into forward exchange contracts to reduce the earnings and cash flow impact of non-functional currency denominated receivables and payables. These contracts are highly effective in hedging the cash flows attributable to changes in currency exchange rates. Gains and losses resulting from these contracts offset the foreign exchange gains or losses on the underlying assets and liabilities being hedged. The maturities of the forward exchange contracts generally coincide with the settlement dates of the related transactions. Gains and losses on these contracts are recorded in Other expense, net in the Condensed Consolidated Statement of Operations as the changes in the fair value of the contracts are recognized and generally offset the gains and losses on the hedged items in the same period. The primary currency to which the Company was exposed in fiscal 2016 and 2015 was the euro. At March 25, 2016, the Company had three outstanding forward exchange contracts to purchase U.S. dollars in the notional value of $950,000 with a weighted average maturity of 52 days. The fair value of the Company’s contracts was a loss of $54,000 at March 25, 2016. The Company had no outstanding forward exchange contracts at June 30, 2015.

 

Item 4.     Controls and Procedures

 

(a)     Evaluation of Disclosure Controls and Procedures

 

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

 

(b)     Changes in Internal Control Over Financial Reporting

 

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

 

 

Part II.     OTHER INFORMATION

 

Item 1.     Legal Proceedings

 

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

 

Item 1A.     Risk Factors

 

There have been no material changes to the risk factors previously disclosed in response to Item 1A to Part I of our 2015 Annual Report on Form 10-K.

 

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

 

(a)	Unregistered Sales of Equity Securities

 

There were no securities of the Company sold by the Company during the quarter ended March 25, 2016, which were not registered under the Securities Act of 1933, in reliance upon an exemption from registration provided by Section 4 (2) of the Act.

 

(b)	Use of Proceeds

 

Not applicable.

 

(c)	Issuer Purchases of Equity Securities

 

Issuer Purchases of Equity Securities

 

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
Dec. 26, 2015 – Jan. 29, 2016	0	NA	0	315,000
Jan. 30, 2016 – Feb. 26, 2016	0	NA	0	315,000
Feb. 27, 2016 – Mar. 25, 2016	0	NA	0	315,000
Total	0	NA	0	315,000

 

The Company did not purchase any shares of Common Stock during the quarter ended March 25, 2016, pursuant to our publicly announced program (described below).

 

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.

 

 

Item 3.     Defaults Upon Senior Securities

 

None.

 

Item 5.     Other Information

 

None.

 

Item 6.     Exhibits

 

31a	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31b	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32a	Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32b	Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
10.1	Credit Agreement Between Twin Disc, Incorporated and Bank of Montreal, dated April 22, 2016 (Incorporated by reference to Exhibit 10.1 of the Company’s Form 8-K dated April 26, 2016).
10.2	Security Agreement Between Twin Disc, Incorporated, Mill-Log Equipment Co., Inc., and Bank of Montreal, dated April 22, 2016 (Incorporated by reference to Exhibit 10.2 of the Company’s Form 8-K dated April 26, 2016).
10.3	IP Security Agreement Between Twin Disc, Incorporated and Bank of Montreal, dated April 22, 2016 (Incorporated by reference to Exhibit 10.3 of the Company’s Form 8-K dated April 26, 2016).
10.4	Pledge Agreement Between Twin Disc, Incorporated, Mill-Log Equipment Co., Inc. and Bank of Montreal, dated April 22, 2016 (Incorporated by reference to Exhibit 10.4 of the Company’s Form 8-K dated April 26, 2016).
10.5	Guaranty Agreement Between Mill-Log Equipment Co., Inc. and Bank of Montreal, dated April 22, 2016 (Incorporated by reference to Exhibit 10.5 of the Company’s Form 8-K dated April 26, 2016).
10.6	Guarantor Security Agreement Between Mill-Log Equipment Co., Inc. and Bank of Montreal, dated April 22, 2016 (Incorporated by reference to Exhibit 10.6 of the Company’s Form 8-K dated April 26, 2016).
10.7	Negative Pledge Agreement Between Twin Disc, Incorporated and Bank of Montreal, dated April 22, 2016 (Incorporated by reference to Exhibit 10.7 of the Company’s Form 8-K dated April 26, 2016).
101.INS	XBRL Instance Document
101.SCH	XBRL Schema
101.CAL	XBRL Calculation Linkbase
101.DEF	XBRL Definition Linkbase
101.LAB	XBRL Label Linkbase
101.PRE	XBRL Presentation Linkbase

 

 

SIGNATURE

 

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

 

 

	TWIN DISC, INCORPORATED
	(Registrant)
Date: May 4, 2016	/s/ DEBBIE A. LANGE
	Debbie A. Lange
	Corporate Controller
	Chief Accounting Officer

 

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