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TWIN > SEC Filings for TWIN > Form 10-K on 13-Sep-2013All Recent SEC Filings

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Form 10-K for TWIN DISC INC


13-Sep-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

Note on Forward-Looking Statements

Statements in this report (including but not limited to certain statements in Items 1, 3 and 7) and in other Company communications that are not historical facts are forward-looking statements, which are based on management's current expectations. These statements involve risks and uncertainties that could cause actual results to differ materially from what appears here.

Forward-looking statements include the Company's description of plans and objectives for future operations and assumptions behind those plans. The words "anticipates," "believes," "intends," "estimates," and "expects," or similar anticipatory expressions, usually identify forward-looking statements. In addition, goals established by the Company should not be viewed as guarantees or promises of future performance. There can be no assurance the Company will be successful in achieving its goals.

In addition to the assumptions and information referred to specifically in the forward-looking statements, other factors, including, but not limited to those factors discussed under Item 1A, Risk Factors, could cause actual results to be materially different from what is presented in any forward looking statements.

Results of Operations

(In thousands)

                   2013    %     2012    %     2011    %
Net sales        $285,282      $355,870      $310,393
Cost of goods     205,257       234,238       202,710
sold

Gross profit       80,025 28.1  121,632 34.2  107,683 34.7

Marketing,         67,899 23.8   73,091 20.5   72,967 23.5
engineering and
administrative
expenses
Restructuring of      708  0.2        -  0.0        -  0.0
operations
Impairment          1,405  0.5    3,670  1.0        -  0.0
charge

Earnings from     $10,013  3.5  $44,871 12.6  $34,716 11.2
operations

Note: Certain amounts in the fiscal 2012 and 2011 figures have been revised. See Note A of the Notes to the consolidated financial statements for further discussion.

Fiscal 2013 Compared to Fiscal 2012


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Net Sales

Net sales for fiscal 2013 decreased 19.8%, or $70.6 million, to $285.3 million from a record $355.9 million in fiscal 2012. Compared to fiscal 2012, on average, the euro and Swiss franc weakened against the U.S. dollar. The net translation effect of this on foreign operations was to decrease revenues by approximately $4.0 million versus the prior year, before eliminations. The decrease in sales continued to primarily be driven by lower demand from customers in the pressure pumping sector of the North American oil and gas market. Offsetting 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, while demand remained steady for equipment used in the airport rescue and fire fighting (ARFF), and military markets. Sales to customers in China increased approximately 46% in fiscal 2013 to $29.1 million, representing 10.2% of total fiscal 2013 sales.

In fiscal 2013, sales at our manufacturing segment were down 24.5% versus the prior fiscal year. Compared to fiscal 2012, on average, the euro and Swiss franc 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 $2.8 million versus the prior year, before eliminations. In fiscal 2013, our U.S. manufacturing operation saw a decrease of roughly 29% in sales versus fiscal 2012. The primary driver for this decrease was the decrease in shipments of transmissions and related products for the North American oil and gas markets. This was only partially offset by an increase in commercial marine transmission shipments. The Company's Italian manufacturing operations, which have been adversely impacted by the softness in the European mega yacht and industrial markets, experienced a 12.5% decrease compared to the prior fiscal year. Approximately one-third of this decrease can be attributed to unfavorable foreign currency translation, with the majority of the remaining decrease due to continued softness and timing of shipments to the Italian mega yacht market. The Company's Belgian manufacturing operation, which also continued to be adversely impacted by the softness in the global mega yacht market, saw an approximately 15% decrease in sales versus the prior fiscal year. The Company's Swiss manufacturing operation, which supplies customized propellers for the global mega yacht and patrol boat markets, experienced an 11.1% decrease in sales.

In fiscal 2013, our distribution segment experienced a slight increase of roughly 1% in sales compared to fiscal 2012. The Company's distribution operations in Singapore continued to experience record shipments for marine transmission products for use in various commercial applications. This operation saw a 33.1% increase in sales versus the prior fiscal year. In fiscal 2013, approximately 45% of this operation's sales were to customers in China. The Company's distribution operation in the Northwest of the United States and Southwest of Canada experienced a 46% decrease in sales due to continued softness in the Canadian oil and gas market. The Company's distribution operation in Italy, which provides boat accessories and propulsion systems for the pleasure craft market, continued to experience historic lows due to continued weakness in the global pleasure craft and mega yacht markets. 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 just over 16%.

Net sales for the Company's largest product market, marine transmission and propulsion systems, were up 11.4% compared to the prior fiscal year. The majority of the growth was experienced in the first half of fiscal 2013 as the Company experienced increased demand in the global commercial marine market, which more than offset continued weakness in the global pleasure craft market. Sales of the Company's boat management systems manufactured at our Italian operation and servicing the global mega yacht market were down approximately 30% versus the prior fiscal year, as the European mega yacht market continued to experience softness in demand. In the off-highway transmission market, the year-over-year decrease of just over 50% can be attributed primarily to decreased North American sales of transmission systems for the oil and gas markets. In addition, demand for transmission systems for the military market and vehicular transmissions remained steady. The decrease experienced in the Company's industrial products of roughly 11% was due to decreased sales into the agriculture, mining and general industrial markets, primarily in the North American and Italian markets, as well as decreased activity related to oil field markets.


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Geographically, sales to the U.S. and Canada represented roughly 49% of consolidated sales for fiscal 2013 compared to 59% in fiscal 2012. This decrease was primarily driven by the softness of the North American pressure pumping market in fiscal 2013, only partially offset by growing demand in the U.S. gulf region for commercial marine transmission systems. Fiscal 2013 proved to be another milestone year for our global sales, as China became our second largest end market, after the U.S. Overall sales into the Asian Pacific market represented approximately 27% of sales in fiscal 2013, compared to just over 18% in fiscal 2012. See Note J of the Notes to the consolidated financial statements for more information on the Company's business segments and foreign operations.

The elimination for net intra-segment and inter-segment sales decreased $8.0 million, or 8.1%, from $98.7 million in fiscal 2012 to $90.7 million in fiscal 2013. Year-over-year changes in foreign exchange rates had a net unfavorable impact of $0.6 million on net intra-segment and inter-segment sales.

Gross Profit


In fiscal 2013, gross profit decreased $41.6 million, or 34.2%, to $80.0
million. Gross profit as a percentage of sales decreased 610 basis points in
fiscal 2013 to 28.1%, compared to 34.2% in fiscal 2012. The table below
summarizes the gross profit trend by quarter for fiscal years 2013 and 2012:

              1st Qtr 2nd Qtr 3rd Qtr 4th Qtr Year
Gross Profit:
($ millions)
  2013        $19.4   $22.3   $17.7   $20.6   $80.0
  2012        $30.8   $29.6   $33.1   $28.2   $121.6

% of Sales:
  2013        28.2%   30.8%   25.9%   27.2%   28.1%
  2012        37.8%   35.6%   34.6%   29.4%   34.2%

There were a number of factors that impacted the Company's overall gross margin rate in fiscal 2013. Gross margin for the year was unfavorably impacted by lower volumes, unfavorable product mix, higher domestic pension expense, higher warranty expense and unfavorable manufacturing absorption. The Company estimates the net unfavorable impact of lower volumes on gross margin in fiscal 2013 was approximately $33.7 million. The unfavorable shift in product mix related to the softening experienced in the Company's oil and gas transmission business had an estimated unfavorable impact of $7.6 million. Domestic pension expense included in cost of goods sold increased from $0.2 million in fiscal 2012 to $1.3 million in fiscal 2013. In addition, warranty expense increased by $1.3 million from $3.6 million in fiscal 2012 to $4.9 in fiscal 2013 (for additional information on the Company's warranty expense, see Note F of the Notes to the consolidated financial statements).

Marketing, Engineering and Administrative (ME&A) Expenses

Marketing, engineering, and administrative (ME&A) expenses decreased by $5.2 million, or 7%, to $67.9 million in fiscal 2013. As a percentage of sales, ME&A expenses increased by 330 basis points to 23.8% in fiscal 2013, compared to 20.5% in fiscal 2012. The table below summarizes significant changes in certain ME&A expenses for the fiscal year:

Fiscal Year Ended Increase/ $ thousands - (Income)/Expense June 30, 2013 June 30, 2012 (Decrease)

Stock-Based Compensation           $  2,681      $  1,642        $   1,039
Domestic Pension Expense               596           121              475
Incentive/Bonus Expense                493          5,013          (4,520)
                                                                   (3,006)
                                Foreign Currency Translation         (913)
                                                                   (3,919)
                                              All Other, Net       (1,273)
                                                                 $  (5,192)

The year-over-year net remaining decrease in ME&A expenses of $1.3 million for the year primarily relates to efforts to control global ME&A expenses in light of the current softness in demand experienced in certain of the Company's markets.

Restructuring of Operations

During the fourth quarter of fiscal 2013, the Company recorded a pre-tax restructuring charge of $0.7 million related to a workforce reduction at its Belgian operation and the elimination of a Corporate officer position. The Belgian charge consisted of the minimum legal indemnity for 22 manufacturing employees, as negotiations with the workforce were ongoing as of June 30, 2013. Subsequently, negotiations were completed in July 2013, resulting in an additional restructuring charge of approximately $1.1 million to be recorded in the first quarter of fiscal 2014. During fiscal 2013, the Company made no cash payments, resulting in an accrual balance at June 30, 2013 of $0.7 million.

Impairment Charge

In connection with preparing its financial statements for fiscal 2013, the Company recorded an impairment charge of $1.4 million, or $0.12 per diluted share, which represents the remaining intangibles and fixed assets of its Italian distribution entity for which the Company committed to a plan to exit the distribution agreement and entered negotiations to sell the inventory back to the parent supplier. This decision triggered an impairment review of the long lived assets at this entity, resulting in the impairment charge of $1.4 million representing a complete impairment of the remaining intangibles ($1.3 million) and fixed assets ($0.1 million) for this entity. In the prior year, the Company took an impairment charge of $3.7 million, or $0.32 per diluted share, for the write-down of goodwill at an Italian manufacturing operation due to softness in the Italian mega yacht market.

Interest Expense

Interest expense of $1.4 million for the fiscal 2013 was down slightly versus fiscal 2012. Total interest on the Company's $40 million revolving credit facility ("revolver") decreased 6% to $0.4 million in fiscal 2013. The decrease can be attributed to an overall decrease in the average borrowings year-over-year and a lower interest rate on the revolver. The average borrowing on the revolver, computed monthly, decreased to $19.8 million in fiscal 2013, compared to $20.4 million in the prior fiscal year. The interest rate on the revolver decreased from a range of 1.74% to 2.09% in the prior fiscal year to a range of 1.70% to 1.84% in the current year. The interest expense on the Company's $25 million Senior Note decreased $0.2 million, or 21%, at a fixed rate of 6.05%, to $0.8 million, due to a lower remaining principal balance.

Other, Net

For the fiscal 2013 full year, Other, net declined by $0.7 million due primarily to unfavorable exchange movements related to the Euro, Canadian dollar and Swiss franc.

Income Taxes

The effective tax rate for the twelve months of fiscal 2013 was 54.0 percent, which is significantly higher than the


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prior year rate of 39.8 percent. Both years were impacted by non-deductible losses in certain foreign jurisdictions that are subject to a valuation allowance, as well as non-deductible impairment charges. Adjusting for these non-deductible items, the fiscal 2013 rate would have been 35.0 percent compared to 33.3 percent for fiscal 2012. The effective rate for the fiscal 2013 fourth quarter was 89.2 percent compared to 76.6 percent for the same period last fiscal year. Adjusting both for these non-deductible items results in rates of 30.0 percent for the fiscal 2013 fourth quarter and 37.8 percent for the fiscal 2012 fourth quarter. The fiscal 2013 fourth quarter rate was favorably impacted by a favorable change in Italian tax law of $0.4 million.

The Company maintains valuation allowances when it is more likely than not that all or a portion of a deferred tax asset will not be realized. Changes in valuation allowances from period to period are included in the tax provision in the period of change. In determining whether a valuation allowance is required, the Company takes into account such factors as prior earnings history, expected future earnings, carry-back and carry-forward periods, and tax strategies that could potentially enhance the likelihood of realization of a deferred tax asset. During fiscal 2013, the Company continued to incur operating losses in certain foreign jurisdictions where the loss carryforward period is unlimited. The Company has evaluated the realizability of the net deferred tax assets related to these jurisdictions and concluded that based primarily upon recent losses in these jurisdictions and failure to achieve targeted levels of improvement, a full valuation allowance continues to be necessary. Therefore, the company recorded a net reduction in valuation allowance of $0.1 million. Management believes that it is more likely than not that the results of future operations will generate sufficient taxable income and foreign source income to realize the remaining deferred tax assets.

Order Rates

As of June 30, 2013, the Company's backlog of orders scheduled for shipment during the next six months (six-month backlog) was $66.8 million, or approximately 32% lower than the six-month backlog of $98.7 million as of June 30, 2012. The decrease in backlog is primarily a result of decreased orders by North American oil and gas customers for the Company's 8500 series transmission as rig operators adjust to the natural gas supply overhang and lower prices.

Fiscal 2012 Compared to Fiscal 2011

Net Sales

Net sales increased $45.5 million, or 14.7%, in fiscal 2012. The year-over-year movement in foreign exchange rates resulted in a net favorable translation effect on sales of $0.4 million in fiscal 2012 compared to fiscal 2011.

In fiscal 2012, sales for our worldwide manufacturing operations, before eliminating intra-segment and inter-segment sales, were higher by $57.5 million, or 21.5%, than in the prior fiscal year. Year-over-year changes in foreign exchange rates had a net unfavorable impact on sales of $0.6 million. In fiscal 2012, our domestic manufacturing operation saw continued growth, with a 25.9% increase in sales versus fiscal 2011. The primary driver for this increase was the sale of transmissions and related products for the North American and Asian oil and gas markets as well as increased commercial marine transmission shipments. The Company's Italian manufacturing operations, which continued to be adversely impacted by the softness in the European mega yacht market in fiscal 2012, experienced a 4.1% decrease in sales compared to the prior fiscal year. The Company's Belgian manufacturing operation saw a 28.4% increase in sales versus the prior year, although it continued to be adversely impacted by the softness in the global mega yacht market. The Company's Swiss manufacturing operation, which supplies customized propellers for the global mega yacht and patrol boat markets, experienced a 10.7% decrease in sales compared to the prior fiscal year, primarily due to the impact of continued softness in the global mega yacht market as well as the timing of shipments for the patrol boat market.

Our distribution segment, buoyed by strong demand in Asia and the global oil and gas markets, experienced a slight


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increase of $0.9 million, or 0.7%, in sales in fiscal 2012 compared to fiscal 2011's record results. Compared to fiscal 2011, on average, the Asian currencies strengthened against the U.S. Dollar. The net translation effect of this on foreign distribution operations was to increase revenues for the distribution segment by approximately $1.5 million versus the prior year, before eliminations. The Company's distribution operations in Singapore continued to experience strong demand for marine transmission products for use in various commercial applications as well as growing demand in the Asia pressure pumping market. This operation saw a 3.2% increase in sales versus the same period a year ago, and set a new sales record. The Company's distribution operation in the Northwest of the United States and Southwest of Canada experienced a 1% decline from fiscal 2011's record levels, and continued to benefit from the strength in the Canadian oil and gas market through most of fiscal 2012. The Company's distribution operation in Italy, which provides boat accessories and propulsion systems for the pleasure craft market, saw an increase in sales of 41.3% after several years of decline due to continued weakness in the Italian 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 an increase in sales of 6.3%, due to improving market conditions, including sales of components parts for the Company's new Express Joystick SystemŽ that were shipped in fiscal 2012. The Company's joint venture in Japan, which sells large marine transmissions for commercial applications throughout Asia, experienced a decrease of nearly 25% in sales in fiscal 2012 compared to fiscal 2011. As reported in the Company's second fiscal quarter's results, this decrease was primarily a result of the impact of the Japanese tsunami on this operation, as our joint venture partner's production facility was impacted by power shortages as well as delayed shipments from suppliers. These issues were substantially resolved in the second fiscal quarter.

Net sales for the Company's largest product market, marine transmission and propulsion systems, were up 8% compared to the prior fiscal year. The majority of the growth was experienced in the second half of fiscal 2012 as the Company experienced increased demand in the global commercial marine market, which more than offset continued weakness in the global pleasure craft market. Sales of the Company's boat management systems manufactured at our Italian operation and servicing the global mega yacht market, were down approximately 14% versus the prior fiscal year, as the European mega yacht market continued to experience softness in demand. In the off-highway transmission market, the year-over-year increase of just over 20% can be attributed primarily to increased sales of the 8500 and 7500 series transmission systems for the oil and gas markets. In addition, sales of transmission systems for the military market and vehicular transmissions were up double-digit percentages versus the prior fiscal year. The increase experienced in the Company's industrial products of roughly 34% was due to increased sales into the agriculture, mining and general industrial markets, primarily in the North American and Italian markets, as well as increased activity related to oil field markets.

Geographically, sales to the U.S. and Canada represented roughly 59% of consolidated sales for fiscal 2012 compared to 55% in fiscal 2011. This growth was primarily driven by the strength of the North American pressure pumping market through the first three fiscal quarters of fiscal 2012 as well as growing demand in the U.S. gulf region for commercial marine transmission systems in the second half of the fiscal year. Fiscal 2012 proved to be a milestone year for our global sales, as Asia became our second largest end market, surpassing Europe. In particular, the Company experienced triple-digit growth in sales to the Chinese market. See Note J for more information on the Company's business segments and foreign operations.

The elimination for net intra-segment and inter-segment sales increased $12.9 million, or 15.1%, from $85.8 million in fiscal 2011 to $98.7 million in fiscal 2012. Year-over-year changes in foreign exchange rates had a net unfavorable impact of $0.5 million on net intra-segment and inter-segment sales.

Gross Profit

In fiscal 2012, gross profit increased $13.9 million, or 13.0%, to $121.6 million. Gross profit as a percentage of sales decreased 50 basis points in fiscal 2012 to 34.2%, compared to 34.7% in fiscal 2011. The table below summarizes the gross profit trend by quarter for fiscal years 2012 and 2011:


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1st Qtr 2nd Qtr 3rd Qtr 4th Qtr Year
Gross Profit:
($ millions)
  2012        $30.8   $29.6   $33.1   $28.2   $121.6
  2011        $20.0   $23.8   $27.8   $36.1   $107.7

% of Sales:
  2012        37.8%   35.6%   34.6%   29.4%   34.2%
  2011        32.6%   31.6%   36.3%   37.1%   34.7%

There were a number of factors that impacted the Company's overall gross margin rate in fiscal 2012. Gross margin for the year was favorably impacted by higher volumes, favorable product mix and lower domestic pension expense, partially offset by higher material costs and surcharges, and unfavorable manufacturing absorption primarily in the fiscal fourth quarter. The Company estimates the net favorable impact of higher volumes on gross margin in fiscal 2012 was approximately $21.7 million. The favorable shift in product mix related to the Company's oil and gas transmission business had an estimated impact of $2.0 million. Domestic pension expense included in cost of goods sold decreased from $1.9 million in fiscal 2011 to $0.2 million in fiscal 2012. In addition, warranty expense as a percentage of sales decreased from 1.27% in fiscal 2011 to 1.02% in fiscal 2012 (for additional information on the Company's warranty expense, see Note F of the Notes to the Consolidated Financial Statements). The decrease in warranty expense as a percentage of sales can be attributed to an increase in volume and an overall reduction in specific warranty campaigns. In addition, the year-over-year movement in foreign exchange rates, primarily driven by movements in the Euro and Asian currencies, resulted in a net favorable translation effect on gross profit of $0.8 million in fiscal 2012 compared to fiscal 2011.

Marketing, Engineering and Administrative (ME&A) Expenses

Marketing, engineering, and administrative (ME&A) expenses remained relatively flat at $73.1 million in fiscal 2012. As a percentage of sales, ME&A expenses decreased by 300 basis points to 20.5% in fiscal 2012, compared to 23.5% in fiscal 2011. The table below summarizes significant changes in certain ME&A expenses for the fiscal year:

Fiscal Year Ended Increase/ $ thousands - (Income)/Expense June 30, 2012 June 30, 2011 (Decrease)

Stock-Based Compensation           $  1,642      $  6,148        $  (4,506)
Severance                              684             -              684
Domestic Pension Expense               121           975             (854)
Incentive/Bonus Expense               5,013         4,964              49
                                                                   (4,627)
                                Foreign Currency Translation          342
                                                                   (4,285)
                                              All Other, Net        4,409
                                                                 $    124

The net remaining increase in ME&A expenses for the year of $4.4 million was primarily driven by wage inflation and additional headcount, higher benefit costs, increased travel, higher project related expenses and a continued emphasis on the Company's product development program.

Impairment Charge

The Company conducted its annual assessment for goodwill impairment in the fourth quarter of fiscal 2012 by


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applying a fair value based test using discounted cash flow analyses, in accordance with ASC 350-10, "Intangibles - Goodwill and Other." The result of this assessment identified that one of the Company's reporting units goodwill was fully impaired, necessitating a charge of $3.7 million. The impairment was due to a declining outlook in the global pleasure craft/megayacht market, the continued weakened European economy and few signs of significant near-term recovery in the markets served by this reporting unit. These factors were identified as the Company conducted its annual budget review process during the fourth fiscal quarter, and the Company concluded that the impairment charge was necessary in connection with the preparation of the year end financial statements during the fourth fiscal quarter. This impairment charge was not deductible for tax purposes. The fair value of the goodwill for the remaining . . .

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