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TWIN > SEC Filings for TWIN > Form 10-Q on 6-Nov-2013All Recent SEC Filings

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Form 10-Q for TWIN DISC INC


6-Nov-2013

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 2013 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, 2013 could cause actual results to be materially different from what is presented here.

Results of Operations


(In thousands)
                                 Three Months Ended
                            September 27,  September 28,
                             2013     %      2012     %
Net sales                   $66,426         $68,793
Cost of goods sold           45,759          49,377

Gross profit                 20,667 31.1%    19,416 28.2%

Marketing, engineering and
administrative expenses      15,517 23.4%    16,620 24.2%
Restructuring of Operations   1,094  1.6%         0  0.0%

Earnings from operations     $4,056   6.1%   $2,796  4.1%

Comparison of the First Quarter of FY 2014 with the First Quarter of FY 2013

Net sales for the first quarter decreased 3.4%, or $2.4 million, to $66.4 million from $68.8 million in the same period a year ago. Compared to the first quarter of fiscal 2013, on average, Asian currencies weakened against the U.S. dollar more than offsetting a strengthening euro against the U.S. dollar. The net translation effect of this on foreign operations was to decrease revenues by approximately $0.9 million versus the prior year, before eliminations. The decrease in sales was primarily the result of lower demand from the Company's customers in North America and Europe, offset by continued growth at record levels in Asia Pacific. While demand for pressure pumping transmissions for the North American market remained depressed, shipments of these transmission systems to China in the current fiscal quarter exceeded shipments for fiscal 2013's first quarter. 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, and airport rescue and fire fighting (ARFF) markets.

Sales at our manufacturing segment were down 8.6%, or $5.0 million, versus the same period last year. Compared to the first quarter of fiscal 2013, on average, the euro strengthened against the U.S. dollar. The net translation effect of this on foreign manufacturing operations was to increase revenues for the manufacturing segment by approximately $0.5 million versus the prior year, before eliminations. In the current fiscal year's first quarter, our domestic manufacturing operation, the largest, experienced a 6% decrease in sales versus the first fiscal quarter of 2013. The primary driver for this decrease was lower sales of marine and propulsion systems for the global marine market. This was partially offset by shipments of pressure pumping transmissions for the Asian oil and gas market. 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% 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, experienced a brief strike at its facility in July. This operation saw a 29% decrease in sales versus the prior fiscal year's first quarter, primarily driven by the continued softness in its markets and the temporary disruption experienced as a result of the strike. The Company's Swiss manufacturing operation, which supplies customized propellers for the global mega yacht and patrol boat markets, experienced a 29% decrease in sales, primarily due to the timing of shipments for the global patrol boat and Italian mega yacht markets.

Our distribution segment was essentially flat compared to the first quarter of fiscal 2013. Compared to the first quarter of fiscal 2013, 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 $1.4 million versus the prior year, before eliminations. The Company's distribution operation in Singapore, its largest Company-owned distribution operation, 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 16% 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 slight increase in sales of nearly 2%. However, in the prior fiscal year's first quarter this operation experienced a 66% decrease in sales versus fiscal 2012's first quarter 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 Canadian oil and gas market remained at depressed levels in the first quarter of fiscal 2014. The Company's distribution operation in Italy, which provides boat accessories and propulsion systems for the pleasure craft market, saw sales decline over 40% due to continued weakness in the global mega yacht market. In fiscal 2013's fourth quarter, the Company committed to a plan to exit the distribution agreement of this operation and entered negotiations to sell the inventory back to the parent supplier. Those negotiations continue. 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 almost 16% from the prior year's first quarter.

The elimination for net inter/intra segment sales decreased $2.6 million, accounting for the remainder of the net change in sales versus the same period last year.

Gross profit as a percentage of sales increased 290 basis points to 31.1% of sales, compared to 28.2% of sales for the same period last year. Gross profit for fiscal 2014's first quarter was favorably impacted by a more profitable product mix (approximately $1.7 million) driven by higher sales of the Company's oil and gas transmission products (approximately $1.2 million), along with reduced warranty expense ($0.5 million). The favorable mix and warranty impacts were partially offset by lower sales volume compared to the fiscal 2013 first quarter (approximately $1.0 million).

Marketing, engineering, and administrative (ME&A) expenses of $15.5 million were down $1.1 million compared to last year's first fiscal quarter. As a percentage of sales, ME&A expenses decreased to 23.4% of sales versus 24.2% of sales in the first quarter of fiscal 2013. The decrease in ME&A expenses for the quarter relates to lower stock-based and incentive compensation expenses, and controlled spending in the Company's global operations. The table below summarizes significant changes in certain ME&A expenses for the first fiscal quarter:

Three Months Ended Increase/ $ thousands - (Income)/Expense Sept. 27, 2013 Sept. 28, 2012 (Decrease)

Stock Based Compensation Exp.      $    319      $    745        $   (426)
                                Foreign Currency Translation          (28)
                                                                 $   (454)
                                              All Other, Net         (649)
                                                                 $  (1,103)

The net remaining $0.6 million decrease primarily relates to lower ME&A spending at most of the Company's global operations only partially offset by increased spending in the Company's growing Asian operations.

The Company recorded a restructuring charge of $1.1 million, or $0.10 per diluted share, in the fiscal 2014 first quarter representing the incremental cost above the minimum legal indemnity for a targeted workforce reduction at the Company's Belgian operation, following finalization of negotiations with the local labor union. The minimum legal indemnity of $0.7 million was recorded in the fourth quarter of fiscal 2013, upon announcement of the intended restructuring action. During the first quarter of fiscal 2014, the Company made cash payments of $0.8 million, resulting in an accrual balance at September 27, 2013 of $0.9 million.

Interest expense of $0.3 million for the quarter was down 17.0% versus last year's first fiscal quarter. Total interest on the Company's $40 million revolving credit facility ("revolver") decreased 9.8% to $0.1 million in fiscal 2014's first quarter. The average borrowing on the revolver, computed monthly, decreased to $14.6 million in fiscal 2014's first quarter, compared to $18.2 million in the same period a year ago. The interest rate on the revolver increased slightly from a range of 1.73% to 1.75% in the prior fiscal year's first quarter to a range of 1.83% to 1.85% in the current year. The interest expense on the Company's $25 million Senior Note decreased 25%, at a fixed rate of 6.05%, to $0.2 million, due to a lower remaining principal balance.

The favorable 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 quarter of fiscal 2014 was 64.4%, which is significantly higher than the prior year rate of 46.4%. Both years were significantly impacted by non-deductible losses in certain foreign jurisdictions that are subject to a full valuation allowance. Adjusting for these non-deductible losses, the fiscal 2014 rate would have been 39.7% compared to 36.9% for the fiscal 2013 first quarter. The increase in the fiscal 2014 rate was primarily driven by adjustments to tax on foreign earnings (Canada and Italy) recorded in the quarter.

Net earnings for the first quarter of fiscal 2014 includes out-of-period adjustments related to the correction of errors deemed immaterial to all periods impacted, which have the effect of increasing net earnings $69,000 ($437,000 pre-tax). See Note A of the Notes to the Condensed Consolidated Financial Statements for further discussion.

Financial Condition, Liquidity and Capital Resources

Comparison between September 27, 2013 and June 30, 2013

As of September 27, 2013, the Company had net working capital of $127.5 million, which represents an increase of $2.5 million, or 2.0%, from the net working capital of $125.0 million as of June 30, 2013.

Cash increased $3.3 million, or 16.1%, to $24.1 million as of September 27, 2013, versus $20.7 million as of June 30, 2013. The majority of the cash as of September 27, 2013 is at our overseas operations in Europe ($13.6 million) and Asia-Pacific ($9.3 million).

Trade receivables of $37.5 million were down $8.9 million, or just over 19%, when compared to last fiscal year-end. The impact of foreign currency translation was to increase accounts receivable by $0.4 million versus June 30, 2013. The net remaining decrease is consistent with the sales volume decrease of just under 13% from the fourth quarter of fiscal 2013 compared to the first fiscal quarter of fiscal 2014.

Net inventory increased slightly by $0.3 million versus June 30, 2013 to $103.1 million. The impact of foreign currency translation was to increase net inventory by $1.2 million versus June 30, 2013. After adjusting for the impact of foreign currency translation, the net decrease of $0.9 million primarily came at the Company's Asian distribution location. On a consolidated basis, as of September 27, 2013, the Company's backlog of orders to be shipped over the next six months approximates $58.1 million, compared to $66.8 million at June 30, 2013 and $82.4 million at September 28, 2012. 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, and commercial marine markets. As a percentage of six month backlog, inventory has increased from 154% at June 30, 2013 to 178% at September 27, 2013.

Net property, plant and equipment (PP&E) decreased $1.2 million versus June 30, 2013. This includes the addition of $0.9 million in capital expenditures, primarily at the Company's Racine-based manufacturing operation, which was more than 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 2014. 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 2013, the Company spent $6.6 million for capital expenditures, down from $13.7 million in fiscal 2012. 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 27, 2013 of $17.3 million were down $3.3 million, or 16.0%, from June 30, 2013. The impact of foreign currency translation was to decrease accounts payable by $0.1 million versus June 30, 2013. This decrease is consistent with the Company's lower six month backlog levels and continued focus on lowering inventories.

Total borrowings and long-term debt as of September 27, 2013 decreased by $2.3 million, or roughly 9%, to $24.8 million versus June 30, 2013. This decrease was driven by the strong operating cash flow in the first fiscal quarter ($9.7 million). During the quarter, the Company generated free cash flow of $8.9 million and ended the quarter with total debt, net of cash, of $0.8 million, compared to $6.4 million at June 30, 2013.

Total equity increased $0.8 million, or less than 1%, to $144.4 million as of September 27, 2013. 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 $1.9 million was reported. The net remaining decrease in equity of $1.4 million primarily represents the issuance and vesting of stock awards and noncontrolling interest dividends, partially offset by an adjustment for the amortization of net actuarial loss and prior service cost on the Company's defined benefit pension plans.

The Company has a $40,000,000 revolving loan agreement with BMO Harris Bank, N.A. ("BMO"). The Company originally entered into this revolving loan agreement in December 2002 with M&I Marshall & Ilsley Bank, predecessor to BMO. At that time, the revolving loan agreement was for $20,000,000 and had an 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 at September 27, 2013, and a maximum total funded debt to EBITDA ratio of 3.0 at September 27, 2013. As of September 27, 2013, the Company was in compliance with these covenants with a four quarter EBITDA total of $22,481,000 and a funded debt to EBITDA ratio of 1.10. 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 27, 2013 the minimum equity requirement was $119,837,000 compared to an actual result of $177,770,000 after all required adjustments. The outstanding balance of $14,000,000 and $16,330,000 at September 27, 2013 and June 30, 2013, 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 1.83% and 1.84% at September 27, 2013 and June 30, 2013, 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 $10,714,286 at September 27, 2013 and June 30, 2013, respectively. Of the outstanding balance, $3,571,429 was classified as a current maturity of long-term debt at September 27, 2013 and June 30, 2013, respectively. The remaining $7,142,857 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.

On November 19, 2012, the Company and its wholly-owned subsidiary Twin Disc International, S.A. entered into a multi-currency revolving Credit Agreement with Wells Fargo Bank, National Association. Pursuant to the Credit Agreement, the Company may, from time to time, enter into revolving credit loans in amounts not to exceed, in the aggregate, Wells Fargo's revolving credit commitment of $15,000,000. In general, outstanding revolving credit loans (other than foreign currency loans) will bear interest at one of the following rates, as selected by the Company: (1) a "Base Rate," which is equal to the highest of (i) the prime rate; (ii) the federal funds rate plus 0.50%; or (iii) LIBOR plus 1.00%; or (2) a "LIBOR Rate" (which is equal to LIBOR divided by the difference between 1.00 and the Eurodollar Reserve Percentage (as defined in the Credit Agreement)) plus 1.50%. Outstanding revolving credit loans that are foreign currency loans will bear interest at the LIBOR Rate plus 1.50%, plus an additional "Mandatory Cost," which is designed to compensate Wells Fargo for the cost of compliance with the requirements of the Bank of England and/or the Financial Services Authority, or the requirements of the European Central Bank. In addition to principal and interest payments, the Borrowers will be responsible for paying monthly commitment fees equal to .25% of the unused revolving credit commitment. The Company has the option of making additional prepayments subject to certain limitations. The Credit Agreement includes financial covenants regarding minimum 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 3.0:1. The Credit Agreement also includes certain restrictive covenants that limit, among other things, certain investments, acquisitions and indebtedness. The Credit Agreement provides that it shall automatically include any covenants or events of default not previously included in the Credit 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. The Credit Agreement also includes customary events of default, including events of default under the BMO agreement or the Prudential Note Agreement. Following an event of default, Wells Fargo may accelerate all amounts outstanding under any revolving credit notes or the Credit Agreement. The Credit Agreement is scheduled to expire on May 31, 2015. As of September 27, 2013 and June 30, 2013, respectively, there were no borrowings under the Credit Agreement.

Four quarter EBITDA, total funded debt, and adjusted net worth 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, total funded debt to four quarter EBITDA ratio, and adjusted net worth covenants described above. In accordance with the Company's revolving loan agreements 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.

"Adjusted net worth" means the Company's reported shareholder equity, excluding adjustments that result from (i) changes to the assumptions used by the Company in determining its pension liabilities or (ii) changes in the market value of plan assets up to an aggregate amount of adjustments equal to $34,000,000 ("Permitted Benefit Plan Adjustments") for purposes of computing net worth at any time.

The Company's total funded debt as of September 27, 2013 and June 30, 2013 was equal to the total debt reported on the Company's September 27, 2013 and June 30, 2013 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 27, 2013:

Four Quarter EBITDA Reconciliation
Net Earnings Attributable to Twin Disc    $  3,928,000
Depreciation & Amortization                 10,809,000
Interest Expense                             1,383,000
Income Taxes                                 6,361,000
Four Quarter EBITDA                       $ 22,481,000

Total Funded Debt to Four Quarter EBITDA
Total Funded Debt                         $ 24,835,000
Divided by: Four Quarter EBITDA             22,481,000
 Total Funded Debt to Four Quarter EBITDA        1.10

The following table sets forth the reconciliation of the Company's reported shareholders' equity to the calculation of adjusted net worth for the quarter ended September 27, 2013:

Total Twin Disc Shareholders' Equity $143,770,000 Permitted Benefit Plan Adjustments 34,000,000 Adjusted Net Worth $177,770,000

As of September 27, 2013, the Company was in compliance with all of the covenants described above. As of September 27, 2013, the Company's backlog of orders scheduled for shipment during the next six months (six-month backlog) was $58.1 million, or approximately 13% lower than the six-month backlog of $66.8 million as of June 30, 2013. In spite of the decrease in order backlog driven primarily by the 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 2014. 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 not expected to decrease significantly. Based on its annual financial plan, the Company believes it is well positioned to generate sufficient EBITDA levels throughout fiscal 2014 in order to maintain compliance with the above covenants. However, as with all forward-looking information, there can be no assurance that the Company will achieve the planned results in future periods due to the uncertainties in certain of its markets. Please see the factors discussed under Item 1A, Risk Factors, of this Form 10-K 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 $26.0 million of available borrowings on its $40 million revolving loan agreement as of September 27, 2013 as well as $15 million available under its multi-currency revolver agreement with Wells Fargo Bank. The Company expects to continue to generate enough cash from operations to meet our operating and investing needs. In the first fiscal quarter, the Company generated $9.7 million of cash from operating activities. As of September 27, 2013, the Company also had cash of $24.1 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 2014, the Company expects to contribute $2.6 million to its defined benefit pension plans, the minimum contributions required. However, if the Company elects to make voluntary contributions in fiscal 2014, it intends to do so using cash from operations and, if necessary, from available borrowings under existing credit facilities.

As of September 27, 2013, 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):

. . .

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