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TWIN > SEC Filings for TWIN > Form 10-Q on 7-Nov-2012All Recent SEC Filings

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Form 10-Q for TWIN DISC INC


7-Nov-2012

Quarterly Report


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 2012 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, 2012 could cause actual results to be materially different from what is presented here.

Results of Operations


(In thousands)
                                Three Months Ended
                           September 28,  September 30,
                            2012     %     2011     %
Net sales                  $68,793        $81,330
Cost of goods sold          49,377         50,562

Gross profit                19,416 28.2%   30,768 37.8%

Marketing, engineering and
administrative expenses     16,620 24.2%   15,909 19.6%

Earnings from operations    $2,796   4.1% $14,859  18.3%

Comparison of the First Quarter of FY 2013 with the First Quarter of FY 2012

Net sales for the first quarter decreased 15.4%, or $12.5 million, to $68.8 million from a record $81.3 million in the same period a year ago. Compared to the first quarter of fiscal 2012, on average, 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 $2.1 million versus the prior year, before eliminations. The decrease in sales was primarily the result of lower demand from customers in the pressure pumping sector of the North American oil and gas market. Offsetting the weakness in this market was higher demand from customers in the North American and Asian commercial marine markets. Sales to customers serving the global mega yacht market remained at historical lows in the quarter, while demand remained steady for equipment used in the industrial, airport rescue and fire fighting (ARFF), and military markets.

Sales at our manufacturing segment were down 17.9%, or $12.7 million, versus the same period last year. Compared to the first quarter of fiscal 2012, on average, the euro weakened against the U.S. dollar. The net translation effect of this on foreign manufacturing operations was to decrease revenues for the manufacturing segment by approximately $2.0 million versus the prior year, before eliminations. In the current fiscal year's first quarter, our domestic manufacturing operation experienced a 23% decrease in sales versus the first fiscal quarter of 2012. The primary driver for this decrease was lower sales of pressure pumping transmissions for the North American oil and gas markets. Partially offsetting this was increased shipments of marine transmission systems for the North American and Asian commercial marine markets. The Company's Italian manufacturing operations, which have been adversely impacted by the softness in the European mega yacht and industrial markets, experienced a 32% decrease in sales compared to the prior fiscal year's first quarter. The Company's Belgian manufacturing operation, which also continued to be adversely impacted by the softness in the global mega yacht market, saw a 26% increase in sales versus the prior fiscal year's first quarter, primarily driven by increased activity in the global commercial marine and patrol boat markets. The Company's Swiss manufacturing operation, which supplies customized propellers for the global mega yacht and patrol boat markets, experienced a 23% decrease in sales, primarily due to the timing of shipments for the global patrol boat and Italian mega yacht markets.

Our distribution segment, buoyed somewhat by continued growth in the Asian commercial marine, and oil and gas markets, experienced a decrease of 9%, or $3.1 million, in sales compared to the first quarter of fiscal 2012. Compared to the first quarter of fiscal 2012, on average, the Asian currencies weakened against the U.S. dollar. The net translation effect of this on foreign distribution operations was to decrease revenues for the distribution segment by approximately $0.3 million versus the prior year, before eliminations. The Company's distribution operation in Singapore, which continues to experience strong demand for marine transmission products for use in various commercial applications and pressure pumping transmissions for the Chinese oil and gas market, saw an 81% increase in sales compared to the prior fiscal year's first quarter. This operation acts as the Company's master distributor for Asia and continues to achieve record results as the Company's products gain greater acceptance in the market. The Company's distribution operation in the Northwest of the United States and Southwest of Canada experienced a sharp decline in sales of nearly 66% due to weakness in the Canadian oil and gas market as rig operators continued to adjust to the North American natural gas supply overhang and lower prices. The Company's distribution operation in Italy, which provides boat accessories and propulsion systems for the pleasure craft market, saw flat sales due to continued weakness in the global mega yacht market. The Company's distribution operation in Australia, which provides boat accessories, propulsion and marine transmission systems for the pleasure craft market, saw a decrease in sales of over 29% from the prior year's strong first quarter, due to continued softness in the Australian mega yacht market.

The elimination for net inter/intra segment sales decreased $3.3 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 960 basis points to 28.2% of sales, compared to a record 37.8% of sales for the same period last year. Gross profit for fiscal 2013's first quarter was significantly impacted by lower sales volumes, primarily due to lower shipments to the Company's North American pressure pumping transmission customers (approximately $6.3 million), a less profitable mix of business related to the Company's oil and gas transmission business (approximately $1.7 million), and unfavorable manufacturing efficiency and absorption due to lower volumes. Partially offsetting these was a decrease in warranty expenses from $1.5 million in fiscal 2012's first quarter to $0.9 million in fiscal 2013's first quarter, as well as a decrease in incentive compensation expense booked to cost of goods sold by $0.3 million.

Marketing, engineering, and administrative (ME&A) expenses of $16.6 million were up $0.7 million compared to last year's first fiscal quarter. As a percentage of sales, ME&A expenses increased to 24.2% of sales versus 19.6% of sales in the first quarter of fiscal 2012. Compared to the first quarter of fiscal 2012, the U.S. dollar strengthened against the euro and Asian currencies. The net translation effect of this was to decrease ME&A expenses by approximately $0.6 million versus the prior year, before eliminations. The table below summarizes significant changes in certain ME&A Expenses for the first fiscal quarter:

Three Months Ended Increase/ $ thousands - (Income)/Expense Sept. 28, 2012 Sept. 30, 2011 (Decrease)

Domestic Bonus/Incentive Exp.      $    -        $    877        $   (877)
Stock Based Compensation Exp.          745           (188)            933
                                                                 $     56
                                Foreign Currency Translation         (646)
                                                                 $   (590)
                                              All Other, Net        1,301
                                                                 $    711

The net remaining $1.3 million increase primarily relates to increased research and development activities, wage inflation and additional headcount, primarily in the Company's growing Asian operations.

Interest expense of $0.3 million for the quarter was down 14.8% versus last year's first fiscal quarter. Total interest on the Company's $40 million revolving credit facility ("revolver") remained flat at $0.1 million in fiscal 2013's first quarter. The average borrowing on the revolver, computed monthly, increased to $18.2 million in fiscal 2013's first quarter, compared to $15.0 million in the same period a year ago. The interest rate on the revolver decreased from a range of 2.09% to 2.12% in the prior fiscal year's first quarter to a range of 1.73% to 1.75% in the current year. The interest expense on the Company's $25 million Senior Note decreased 20%, at a fixed rate of 6.05%, to $0.2 million, due to a lower remaining principal balance.

For the quarter ended September 28, 2012, the Company recorded other expense of $0.1 million, compared to other income of $0.4 million for the quarter ended September 30, 2011. 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, Canadian dollar, Japanese yen and Swiss franc.

The effective tax rate for the first three months of fiscal 2013 is 45.6%, which is higher than the prior year's 35.3%. The most significant factors impacting changes in the effective tax rate for the three months ended September 28, 2012 were the magnified impact of the valuation allowance on a reduced earnings base, decreased domestic sales which were offset by a limited Section 199 credit, the expiration of the credit for research and development activities and a change in the mixture of foreign and domestic earnings resulting in increased net foreign earnings.

Financial Condition, Liquidity and Capital Resources

Comparison between September 28, 2012 and June 30, 2012

As of September 28, 2012, the Company had net working capital of $136.9 million, which represents an increase of $6.4 million, or 4.9%, from the net working capital of $130.5 million as of June 30, 2012.

Cash increased $5.8 million to $21.5 million as of September 28, 2012, versus $15.7 million as of June 30, 2012. The majority of the cash as of September 28, 2012 is at our overseas operations in Europe and Asia-Pacific.

Trade receivables of $47.1 million were down $16.3 million, or just under 26%, when compared to last fiscal year-end. The impact of foreign currency translation was to increase accounts receivable by $0.3 million versus June 30, 2012. The net remaining decrease is consistent with the sales volume decrease of just over 28% from the fourth quarter of fiscal 2012 compared to the first fiscal quarter of fiscal 2013.

Net inventory increased by $9.6 million versus June 30, 2012 to $112.8 million. The impact of foreign currency translation was to increase net inventory by $1.0 million versus June 30, 2012. After adjusting for the impact of foreign currency translation, the net increase of $8.6 million primarily came at the Company's domestic manufacturing and Asian distribution locations, and was primarily driven by an elevated level of oil and gas transmissions inventory that has yet to work its way through sales. On a consolidated basis, as of September 28, 2012, the Company's backlog of orders to be shipped over the next six months approximates $82.4 million, compared to $98.7 million at June 30, 2012 and $164.5 million at September 30, 2011. The majority of the decrease is being experienced at the Company's domestic manufacturing location due to lower demand from customers in the pressure pumping sector of the North American oil and gas market. As a percentage of six month backlog, inventory has increased from 104% at June 30, 2012 to 137% at September 28, 2012.

Net property, plant and equipment (PP&E) decreased $1.0 million versus June 30, 2012. This includes the addition of $1.3 million in capital expenditures, primarily at the Company's Racine-based manufacturing operation, which was partially offset by depreciation of $2.5 million. The net remaining increase is due to foreign currency translation effects. In total, the Company expects to invest between $10 and $15 million in capital assets in fiscal 2013. These anticipated expenditures reflect the Company's plans to continue investing in modern equipment and facilities, its global sourcing program and new products as well as expanding capacities at facilities around the world. 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. In fiscal 2012, the Company spent $13.7 million for capital expenditures. In fiscal 2011, the Company spent $12.0 million for capital expenditures, up from $4.5 million and $8.9 million in fiscal years 2010 and 2009, respectively. 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.

Accounts payable as of September 28, 2012 of $25.9 million were up $2.4 million, or 10.1%, from June 30, 2012. The impact of foreign currency translation was to increase accounts payable by $0.3 million versus June 30, 2012. The net remaining increase in accounts payable was consistent with the increase in inventory levels experienced in the quarter.

Total borrowings and long-term debt as of September 28, 2012 increased by $6.8 million, or roughly 21%, to $39.0 million versus June 30, 2012. This increase was driven by the overall increase in working capital levels, primarily driven by an increase in inventory and a net decrease in accrued liabilities. In addition, the Company made payments for its annual incentive program in the first fiscal quarter of 2013 based on the achievement of fiscal 2012 targets.

Total equity increased $2.3 million, or 2%, to $139.6 million as of September 28, 2012. Retained earnings increased by $0.2 million. The net increase in retained earnings included $1.3 million in net earnings for the first fiscal quarter offset by $1.0 million in dividend payments. Net favorable foreign currency translation of $1.3 million was reported. The net remaining movement of $0.7 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. Through a series of amendments, the last of which was agreed to during the fourth quarter of fiscal 2011, the total commitment was increased to $40,000,000 and the term was extended to May 31, 2015. 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, and a maximum total funded debt to EBITDA ratio of
3.0. As of September 28, 2012, the Company was in compliance with these covenants with a four quarter EBITDA total of $44,283,000 and a funded debt to EBITDA ratio of 0.88. 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 28, 2012, the minimum equity requirement was $118,004,000 compared to an actual result of $172,696,000 after all required adjustments. The outstanding balance of $24,450,000 and $17,550,000 at September 28, 2012 and June 30, 2012, respectively, is classified as long-term debt. In accordance with the loan agreement as amended, the Company can borrow at LIBOR plus an additional "Add-On," between 1.5% and 2.5%, depending on the Company's Total Funded Debt to EBITDA ratio. The rate was 1.73% and 1.74% at September 28, 2012 and June 30, 2012, 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 outstanding balance was $14,285,714 at September 28, 2012 and June 30, 2012, respectively. Of the outstanding balance, $3,571,429 was classified as a current maturity of long-term debt at September 28, 2012 and June 30, 2012, respectively. The remaining $10,714,286 is classified as long-term debt. 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.

Four quarter EBITDA and total funded debt are non-GAAP measures, and are included herein for the purpose of disclosing the status of the Company's compliance with the four quarter EBITDA covenant and the total funded debt to four quarter EBITDA ratio covenant described above. In accordance with the Company's revolving loan agreement with M&I and the Note Agreement:

"Four quarter EBITDA" is defined as "the sum of (i) Net Income plus, to the extent deducted in the calculation of Net Income, (ii) interest expense, (iii) depreciation and amortization expense, and (iv) income tax expense;" and

"Total funded debt" is defined as "(i) all Indebtedness for borrowed money (including without limitation, Indebtedness evidenced by promissory notes, bonds, debentures and similar interest-bearing instruments), plus (ii) all purchase money Indebtedness, plus (iii) the principal portion of capital lease obligations, plus (iv) the maximum amount which is available to be drawn under letters of credit then outstanding, all as determined for the Company and its consolidated Subsidiaries as of the date of determination, without duplication, and in accordance with generally accepted accounting principles applied on a consistent basis."

"Total funded debt to four quarter EBITDA" is defined as the ratio of total funded debt to four quarter EBITDA calculated in accordance with the above definitions.

The Company's total funded debt as of September 28, 2012 and June 30, 2012 was equal to the total debt reported on the Company's September 28, 2012 and June 30, 2012 Condensed Consolidated Balance Sheet, and therefore no reconciliation is included herein. The following table sets forth the reconciliation of the Company's reported Net Earnings to the calculation of four quarter EBITDA for the four quarters ended September 28, 2012:

Four Quarter EBITDA Reconciliation
Net Earnings                              $17,782,000
Depreciation & Amortization                10,815,000
Interest Expense                            1,422,000
Income Taxes                               14,264,000
Four Quarter EBITDA                       $44,283,000

Total Funded Debt to Four Quarter EBITDA
Total Debt                                $38,994,000
Divided by: Four Quarter EBITDA            44,283,000
 Total Funded Debt to Four Quarter EBITDA        0.88

As of September 28, 2012, the Company was in compliance with all of the covenants described above. As of September 28, 2012, the Company's backlog of orders scheduled for shipment during the next six months (six-month backlog) was $82.4 million, or approximately 17% lower than the six-month backlog of $98.7 million as of June 30, 2012. In spite of the decrease in order backlog driven primarily by the recent decline in the North American oil and gas market, as rig operators adjust to the natural gas supply overhang and lower prices, the Company does not expect to violate any of its financial covenants in fiscal 2013. The current margin surrounding ongoing compliance with the above covenants, in particular, minimum EBITDA for the most recent four fiscal quarters and total funded debt to EBITDA, are expected to continue to decrease but remain in compliance in fiscal 2013. Please see the factors discussed under Item 1A, Risk Factors, of the Company's Annual Report filed on Form 10-K for June 30, 2012 for further discussion of this topic.

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 $15.6 million of available borrowings on our $40 million revolving loan agreement as of September 28, 2012, and expects to continue to generate enough cash from operations to meet our operating and investing needs. As of September 28, 2012, the Company also had cash of $21.5 million, primarily at its overseas operations. These funds, with limited restrictions, are available for repatriation as deemed necessary by the Company. In fiscal 2013, the Company expects to contribute $4.4 million to its defined benefit pension plans, the minimum contributions required. However, if the Company elects to make voluntary contributions in fiscal 2013, it intends to do so using cash from operations and, if necessary, from available borrowings under existing credit facilities. As of September 28, 2012, $3.8 million in contributions have been made.

As of September 28, 2012, 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      $24,450           $24,450
Long-term debt          $14,544  $3,656   $7,290  $3,572   $26
Operating leases        $5,954   $2,920   $2,666   $368
Total obligations       $44,948  $6,576   $34,406 $3,940   $26

The table above does not include tax liabilities related to uncertain income tax positions totaling $635,000, 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 2013 contributions to all defined benefit plans will total $4.4 million. As of September 28, 2012, $3.5 million in contributions have been made.

New Accounting Releases

In July 2012, the Financial Accounting Standards Board ("FASB") issued amended guidance that simplifies how entities test indefinite-lived intangible assets other than goodwill for impairment. After an assessment of certain qualitative factors, if it is determined to be more likely than not that an indefinite-lived asset is impaired, entities must perform the quantitative impairment test. Otherwise, the quantitative test is optional. The amended guidance is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012, with early adoption permitted. The adoption of this guidance is not expected to have a material impact on the Company's financial results.

In September 2011, the FASB issued a standards update that is intended to simplify how entities test goodwill for impairment. This update permits an entity to first assess qualitative factors to determine whether it is "more likely than not" that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test described in Topic 350 "Intangibles-Goodwill and Other." This update is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011 (the Company's fiscal 2013). This standards update is not expected to have a material impact on the Company's financial statements.

In June 2011, FASB issued a standards update that will allow an entity the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. This standards update eliminates the option of presenting the components of other comprehensive income as part of the statement of changes in stockholders' equity. This update is effective for this quarter. This standards update did not have a material impact on the Company's 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, 2012. There have been no significant changes to those accounting policies subsequent to June 30, 2012.

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