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 2009 financial statements and related notes.

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, 2009 could cause actual results to be materially different from what is presented here.

Results of Operations


(In thousands)
                                            Three Months Ended
                                   September 25,         September 26,
                                    2009       %          2008       %
Net sales                         $  47,057             $  72,671
Cost of goods sold                   37,310                52,599

Gross profit                          9,747   20.7 %       20,072   27.6 %

Marketing, engineering and
administrative expenses              12,778   27.2 %       16,318   22.5 %

(Loss) earnings from operations   $  (3,031 ) (6.4 )%   $   3,754    5.2 %

Comparison of the First Quarter of FY 2010 with the First Quarter of FY 2009

Net sales for the first quarter decreased 35.2%, or $25.6 million, to $47.1 million from $72.7 million in the same period a year ago. Compared to the first quarter of fiscal 2009, the Euro and Asian currencies weakened against the U.S. Dollar. The net translation effect of this on foreign operations was to decrease revenues by approximately $0.3 million versus the prior year, before eliminations. The decline in sales for the fiscal 2010 first quarter was due to the continued impact the global recession is having on the Company's markets, the seasonally weak first quarter and shutdowns at the Company's Italian, Belgian and Racine manufacturing facilities. Shipments to the mega yacht, industrial, and oil and gas markets remained weak during the fiscal 2010 first quarter, which was partially offset by good demand from the airport, rescue and fire fighting (ARFF) market and stable demand from land- and marine-based military, and Asian-Pacific commercial marine markets.

Sales at our manufacturing segment were down 45.8% versus the same period last year. As announced previously, the Company implemented temporary plant shutdowns along with government sponsored layoffs, in addition to normal seasonal actions, to adjust production levels to near term demand, which had a negative impact on volume. All global manufacturing operations were affected by these temporary shutdowns. Our domestic manufacturing operation saw a 40% decline in sales versus the first fiscal quarter of 2009. All product categories, except airport rescue and fire fighting, saw double digit declines versus the prior fiscal year. This was due to the continued effects of the global recession as well as the closure of Racine manufacturing operations for the month of July. The Company's Belgian and Italian manufacturing operations, which were adversely impacted by the softness in the European mega yacht and industrial markets, experienced decreases of nearly 50% and 60%, respectively, compared to the prior fiscal year's first quarter. The Company's Swiss manufacturing operation, which supplies customized propellers for the global mega yacht and patrol boat markets, experienced just over a 30% decrease in sales, as softness in the mega yacht market was partially offset by growth in the patrol boat market.

Our distribution segment, buoyed by continued growth in Asia, experienced a decrease of only 9% in sales compared to the first quarter of fiscal 2009. The Company's distribution operations in Singapore continued to experience strong demand for marine transmission products for use in various commercial applications. This operation saw a nearly 4% increase in sales versus the same period a year ago, and set a new sales record for its first fiscal quarter. The Company's distribution operation in the Northwest of the United States and Southwest of Canada experienced a double-digit decline in sales due to continued softness in the oil and gas, and marine transmission markets. The Company's distribution operation in Italy, which provides boat accessories and propulsion systems for the Italian pleasure craft market, also saw a double digit decrease in sales due to continued weakness in that market.

The elimination for net inter/intra segment sales decreased $4.9 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 nearly 700 basis points to 20.7% of sales, compared to 27.6% of sales for the same period last year. Profitability for fiscal 2010's first quarter was significantly impacted by lower volumes, unfavorable product mix, higher pension expenses and unfavorable plant absorption. The Company estimates that the majority of the deterioration was the result of unfavorable absorption due to the impact of lower volumes and the effect of the temporary plant shutdowns along with government sponsored layoffs, and normal seasonal actions, to adjust production levels to near term demand. In the first quarter of fiscal 2009, the Company recorded $0.2 million of pension expense for its domestic defined benefit pension plan, compared to pension expense of $0.6 million in the first quarter of fiscal 2010, for a net year over year increase in pension expense of $0.4 million. It is estimated that the fiscal year impact of the increase in pension expense to cost of goods sold will be $2.8 million.

Marketing, engineering, and administrative (ME&A) expenses decreased $3.5 million, or 21.7%, compared to last year's first fiscal quarter. As a percentage of sales, ME&A expenses increased to 27.2% of sales versus 22.5% of sales in the first quarter of fiscal 2009. The net $3.5 million decrease is a result of previously announced cost reduction initiatives across the Company's global operations, and lower bonus and stock based compensation expense, partially offset by higher pension expense. The decrease in domestic bonus and stock based compensation expense accounted for $0.7 million and $0.1 million, respectively, of the year over year decrease.

Interest expense of $0.6 million for the quarter was up 3.7% versus last year's first fiscal quarter. For the first quarter of fiscal 2009, the interest rate on the Company's revolving credit facility was in the range of 3.71% to 3.74%, whereas for the first quarter of fiscal 2010 the rate was 4.0%. The average balance of the Company's revolving credit facility increased less than 1% and the total interest on the revolver increased nearly 21% to $0.2 million. The interest expense on the Company's $25 million Senior Note was flat year over year, at a fixed rate of 6.05%, at $0.4 million.

Other income, net of $0.1 million for the quarter was down roughly $0.9 million from the prior year primarily due to a swing from exchange gains in the prior fiscal year to exchange losses in the current fiscal year at the Company's Belgian manufacturing and Japanese joint venture caused by the strengthening of the U.S. Dollar in the first quarter of fiscal 2010.

The consolidated income tax rate for the first fiscal quarter of 2010 was 37.7%, compared to 34.0% for the same period a year ago. The increase is primarily the result of the magnified impact of foreign permanent items on a lower income base, as well as the reduced impact of certain tax credits.

Financial Condition, Liquidity and Capital Resources

Comparison between September 25, 2009 and June 30, 2009

As of September 25, 2009, the Company had net working capital of $103.1 million, which represents a decrease of $0.6 million, or 0.5%, from the net working capital of $103.7 million as of June 30, 2009.

Cash increased $3.8 million to $17.1 million as of September 25, 2009, versus $13.3 million as of June 30, 2009. The majority of the cash as of September 25, 2009 are at our overseas operations in Europe and Asia-Pacific.

Trade receivables of $42.3 million were down $11.1 million, or nearly 21%, when compared to last fiscal year-end. The impact of foreign currency translation was to increase accounts receivables by $0.6 million versus June 30, 2009. The net decrease is consistent with the sales volume decline experienced from the fourth quarter of the prior fiscal year to the first quarter of fiscal 2009 as well as the continued focus on the collection of any past due receivables balances.

Net inventory decreased by $2.8 million versus June 30, 2009 to $89.5 million. The impact of foreign currency translation was to increase net inventory by $1.8 million versus June 30, 2009. After adjusting for the impact of foreign currency translation, the net decrease of $4.6 million came at the Company's European manufacturing and Asian distribution locations offset by an increase at the Company's domestic manufacturing operation as it amped back up production after its July shutdown. The overall decrease reflects lower sales volumes and a continued emphasis on inventory management and reduction in fiscal 2010. On a consolidated basis, as of September 25, 2009, the Company's backlog of orders to be shipped over the next six months approximates $62.5 million, compared to $60.6 million at June 30, 2009 and $118.6 million at September 26, 2008.Net property, plant and equipment (PP&E) decreased $0.5 million versus June 30, 2009. This includes the addition of $1.0 million in capital expenditures, primarily at the Company's Racine-based manufacturing operation, which was more than offset by depreciation of $2.2 million. The net remaining decrease is due to foreign currency translation effects. In total, the Company expects to invest between $7 and $10 million in capital assets in fiscal 2010. 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. In addition, the quoted lead times on certain manufacturing equipment purchases may push some of the capital expenditures into the next fiscal year. This compares to $8.9 million and $15.0 million in capital expenditures in fiscal 2009 and fiscal 2008, respectively. The Company's capital program is focusing on modernizing key core manufacturing, assembly and testing processes at its facilities around the world as well as the implementation of a global ERP system.

Accounts payable as of September 25, 2009 of $21.4 million were down $3.4 million, or 13.8%, from June 30, 2009. The decrease in accounts payable was consistent with the overall decrease in inventory in the quarter as well as the decrease in production levels due to the previously announced temporary plant shutdowns and layoff programs at the Company's domestic and European manufacturing operations.

Total borrowings and long-term debt as of September 25, 2009 decreased by $1.8 million, or over 3%, to $49.0 million versus June 30, 2009. This decrease was driven by the overall increase in operating cash flow primarily driven by a decrease in inventory and receivables levels.

Total equity remained flat at $107.8 million. Retained earnings decreased by $3.2 million. The net decrease in retained earnings included $2.4 million in net losses reported year-to-date and $0.8 million in dividend payments. Net favorable foreign currency translation of $2.9 million was reported. The remaining movement of $0.9 million represents an adjustment for the amortization of net actuarial loss and prior service cost on the Company's defined benefit pension plans.

In December 2002, the Company entered into a $20,000,000 revolving loan agreement with M&I Marshall & Ilsley Bank ("M&I"), which had an original expiration date of October 31, 2005. In September 2004, the revolving loan agreement was amended to increase the commitment to $35,000,000 and the termination date of the agreement was extended to October 31, 2007. During the first quarter of fiscal 2007, the term was extended by an additional two years to October 31, 2009. An additional amendment was agreed to in the first quarter of fiscal 2008 to extend the term by an additional year to October 31, 2010, and eliminate the covenants limiting capital expenditures and restricted payments (dividend payments and stock repurchases). During the fourth quarter of fiscal 2009, the term was further extended to May 31, 2012 and the funded debt to EBITDA maximum was increased from 2.5 to 3.0. This agreement contains certain covenants, including restrictions on investments, acquisitions and indebtedness. Financial covenants include a minimum consolidated net worth, minimum EBITDA for the most recent four fiscal quarters of $11,000,000 at September 25, 2009, and a maximum total funded debt to EBITDA ratio of 3.0 at September 25, 2009. As of September 25, 2009, the Company was in compliance with these covenants with a rolling four quarter EBITDA total of $22,398,000 and a funded debt to EBITDA ratio of 2.19. The minimum net worth covenant fluctuates based upon actual earnings and is subject to adjustment for certain pension accounting adjustments to equity. As of September 25, 2009 the minimum equity requirement was $100,614,000 compared to an actual result of $141,012,000 after all required adjustments. The outstanding balance of $21,150,000 and $22,450,000 at September 25, 2009 and June 30, 2009, respectively, is classified as long-term debt. In accordance with the loan agreement as amended, the Company has the option of borrowing at the prime interest rate or LIBOR plus an additional "Add-On," between 2% and 3.5%, depending on the Company's Total Funded Debt to EBITDA ratio, subject to a minimum interest rate of 4%. The rate was 4.0% at September 25, 2009 and June 30, 2009, respectively.

On April 10, 2006, the Company entered into a Note Agreement (the "Note Agreement") with The Prudential Insurance Company of America and certain other entities (collectively, "Purchasers"). Pursuant to the Note Agreement, Purchasers acquired, in the aggregate, $25,000,000 in 6.05% Senior Notes due April 10, 2016 (the "Notes"). The Notes mature and become due and payable in full on April 10, 2016 (the "Payment Date"). Prior to the Payment Date, the Company is obligated to make quarterly payments of interest during the term of the Notes, plus prepayments of principal of $3,571,429 on April 10 of each year from 2010 to 2015, inclusive. The Company also has the option of making additional prepayments subject to certain limitations, including the payment of a Yield-Maintenance Amount as defined in the Note Agreement. In addition, the Company will be required to make an offer to purchase the Notes upon a Change of Control, and any such offer must include the payment of a Yield-Maintenance Amount. The Note Agreement includes certain financial covenants which are identical to those associated with the revolving loan agreement discussed above. The Note Agreement also includes certain restrictive covenants that limit, among other things, the incurrence of additional indebtedness and the disposition of assets outside the ordinary course of business. The Note Agreement provides that it shall automatically include any covenants or events of default not previously included in the Note Agreement to the extent such covenants or events of default are granted to any other lender of an amount in excess of $1,000,000. Following an Event of Default, each Purchaser may accelerate all amounts outstanding under the Notes held by such party. As of September 25, 2009, the Company was in compliance with these covenants.

The Company's balance sheet remains very strong, there are no off-balance-sheet arrangements other than the operating leases listed below, and we continue to have sufficient liquidity for near-term needs. The Company had $13.8 million of available borrowings on our $35 million revolving loan agreement as of September 25, 2009, and continues to generate enough cash from operations to meet our operating and investing needs. For the quarter ended September 25, 2009, the Company generated net cash from operating activities of $8.5 million. As of September 25, 2009, the Company also had cash of $17.1 million, primarily at its overseas operations. These funds, with limited restrictions, are available for repatriation as deemed necessary by the Company. In fiscal 2010, the Company expects to contribute $455,000 to its defined benefit plans, the minimum contributions required. However, if the Company elects to make voluntary contributions in fiscal 2010, it intends to do so using cash from operations and, if necessary, from available borrowings under existing credit facilities. In the fourth fiscal quarter of 2009, the Company announced $25 million of cost avoidance and savings actions in light of softening that was anticipated in many of its key markets. Based on its annual financial plan, which reflects these actions and the softening forecast, the Company does not expect to violate any of its financial covenants in fiscal 2010.

As of September 25, 2009, the Company has obligations under non-cancelable operating lease contracts and loan and senior note agreements for certain future payments. A summary of those commitments follows (in thousands):

                                Less than   1-3     3-5   After 5
Contractual Obligations  Total   1 year    Years   Years   Years
Revolver borrowing      $21,150           $21,150
Long-term debt          $27,863    $4,038  $8,134  $8,515  $7,176
Operating leases         $9,847    $3,501  $4,314  $1,822    $210
Total obligations       $58,860    $7,539 $33,598 $10,337  $7,386

The table above does not include tax liabilities related to uncertain income tax positions totaling $797,000, excluding related interest and penalties, as the timing of their resolution can not be estimated. 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 Pension Committee to manage the operations and administration of the defined benefit plans. The Company estimates that fiscal 2010 contributions to all defined benefit plans will total $455,000.

New Accounting Releases

In August 2009, the Financial Accounting Standards Board ("FASB") issued a clarification on fair value measurements. This clarification provides that in circumstances in which a quoted price in an active market for the identical liability is not available, a reporting entity is required to measure fair value using one or more of the techniques provided for in this update. This clarification was effective in the first reporting period following issuance (the Company's first quarter of fiscal 2010), and did not have a material impact on the Company's financial statements.

In June 2009, the FASB issued the FASB Accounting Standards Codification ("Codification"). The Codification is the single source of authoritative US generally accepted accounting principles recognized by the FASB, and is to be applied for financial statements issued for interim and annual periods ending after September 15, 2009. The Codification is not intended to change GAAP and did not have an affect on our financial position, results or liquidity.

In June 2009, the FASB issued an amendment changing how a reporting entity determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. New disclosures will be required regarding involvement with variable interest entities and any significant changes in risk exposure due to that involvement. This change will be effective for the start of the first fiscal year beginning after November 15, 2009 (July 1, 2010 for the Company) and is not expected to have a material impact on the Company's financial statements.

In June 2009, the FASB issued a revision which will require more information about transfers of financial assets, including securitization transactions, and where entities have continuing exposure to the risks related to transferred financial assets. It eliminates the concept of a "qualifying special-purpose entity," and changes the requirements for derecognizing financial assets, and requires additional disclosures. This change will be effective for the start of the first fiscal year beginning after November 15, 2009 (July 1, 2010 for the Company) and is not expected to have a material impact on the Company's financial statements.

In April 2009, the FASB issued an update that requires disclosure about the fair value of financial instruments whenever summarized financial information for interim periods is issued, and requires disclosure of the fair value of all financial instruments (where practicable) in the body or accompanying notes of interim and annual financial statements. This update was effective for the Company's first quarter of fiscal 2010, with no material impact on the financial statements.

In March 2009, the FASB concluded that vested share-based payment awards that entitle holders to receive nonforfeitable dividends declared on common stock are participating securities. Accordingly, those awards should be considered in the calculation of earnings per share using the two class method. This guidance is effective for fiscal years beginning after December 15, 2008. The Company implemented this provision in the first fiscal quarter of 2010, with no material impact to the financial statements.

In December 2008, the FASB issued additional guidance on an employer's disclosures regarding plan assets of a defined benefit pension or other postretirement plan. The objectives of the disclosures required under this guidance are to provide users of financial statements with an understanding of:
a) How investment allocation decisions are made;

b) The major categories of plan assets;

c) The inputs and valuation techniques used to measure the fair value of plan assets;

d) The effect of fair value measurements using significant unobservable inputs on changes in plan assets for the period; and

e) Significant concentrations of risk within plan assets.

These disclosures about plan assets are required for fiscal years ending after December 15, 2009, and earlier application is permitted.

In April 2008, the FASB issued an update that amends the factors to be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset. The intent of this update is to improve the consistency between the useful life of a recognized intangible asset and the period of expected cash flows used to measure the fair value of the asset. This change was effective for the Company's first quarter of fiscal 2010, and had no material impact on the Company's financial statements.

In December 2007, the FASB established new accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary, and includes expanded disclosure requirements regarding the interests of the parent and its noncontrolling interest. This new guidance is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. The Company implemented this new standard in the first fiscal quarter of 2010, with minimal impact to the presentation of the financial statements.

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, 2009. There have been no significant changes to those accounting policies subsequent to June 30, 2009.