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TWIN > SEC Filings for TWIN > Form 10-Q on 5-Feb-2014All Recent SEC Filings

Show all filings for TWIN DISC INC

Form 10-Q for TWIN DISC INC


5-Feb-2014

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                                  Six Months Ended
                       December 27,             December 28,             December 27,              December 28,
                     2013          %          2012          %          2013           %          2012           %

Net sales          $ 63,212                 $ 72,325                 $ 129,638                 $ 141,118
Cost of goods
sold                 44,668                   50,014                    90,427                    99,391

Gross profit         18,544        29.3 %     22,311        30.8 %      39,211        30.2 %      41,727        29.6 %

Marketing,
engineering and
administrative
expenses             17,185        27.2 %     16,770        23.2 %      32,702        25.2 %      33,390        23.7 %
Restructuring of
operations                0         0.0 %          0         0.0 %       1,094         0.8 %           0         0.0 %

Earnings from
operations         $  1,359         2.1 %   $  5,541         7.7 %   $   5,415         4.2 %   $   8,337         5.9 %

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

Net sales for the second quarter decreased 12.6%, or $9.1 million, to $63.2 million from $72.3 million in the same period a year ago. Compared to the second 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 $1.0 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, while sales to customers in Asia Pacific remained strong. Coming off a record year in fiscal 2013, commercial marine transmission system shipments are down in the first half of fiscal 2014. However, the Company experienced strong order activity in the second fiscal quarter and the six-month backlog of orders for commercial marine transmission systems is up significantly both sequentially and versus the end of the prior fiscal year's second quarter. 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 second quarter. Sales to customers serving the global mega yacht market remained near historical lows in the quarter.

Sales at our manufacturing segment were down 14.8%, or $9.9 million, versus the same period last year. Compared to the second 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 $0.7 million versus the prior year, before eliminations. In the current fiscal year's second quarter, our domestic manufacturing operation, the largest, experienced a 20% decrease in sales versus the second fiscal quarter of 2013. The primary driver for this decrease was lower sales of pressure-pumping transmissions for the oil and gas market, and marine and propulsion systems for the global marine market. The Company's Italian manufacturing operations, which have been adversely impacted by the softness in the European mega yacht and industrial markets, experienced flat sales compared to the prior fiscal year's second 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 the first fiscal quarter. This operation saw an 18% decrease in sales versus the prior fiscal year's second quarter, primarily driven by the continued softness in its markets and the temporary disruption experienced as a result of the strike in the first fiscal quarter. The Company's Swiss manufacturing operation, which supplies customized propellers for the global mega yacht and patrol boat markets, experienced a 5% increase in sales, primarily due to the timing of shipments for the global patrol boat and Italian mega yacht markets.

Sales at our distribution segment were down just over 9%, or $3.2 million, compared to the second quarter of fiscal 2013. Compared to the second 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 $1.7 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, experienced flat sales compared to the prior fiscal year's second 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 decrease in sales of nearly 14%. In the prior fiscal year's second quarter this operation experienced a 40% decrease in sales versus fiscal 2012's second 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 half 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 25% 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 a decrease in sales of almost 8% from the prior year's second quarter, driven by both softness in the mega yacht and industrial markets in Australia.

The elimination for net inter/intra segment sales decreased $4.0 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 150 basis points to 29.3% of sales, compared to 30.8% of sales for the same period last year. Gross profit for fiscal 2014's second quarter was unfavorably impacted by lower sales volume compared to the fiscal 2013 second quarter (approximately $4.3 million). The unfavorable volume impact was somewhat offset by a more profitable product mix (approximately $0.5 million) and reduced warranty expense ($0.3 million).

Marketing, engineering, and administrative (ME&A) expenses of $17.2 million were up $0.4 million compared to last year's second fiscal quarter. As a percentage of sales, ME&A expenses increased to 27.2% of sales versus 23.2% of sales in the second quarter of fiscal 2013. The increase in ME&A expenses for the quarter relates to increased spending in the Company's growing Asian operations, a slight increase in stock based compensation expense in the quarter and increased spending on corporate projects, partially offset by a continued focus on controlled spending at the Company's global operations.

Interest expense of $0.2 million for the quarter was down 32.2% versus last year's second fiscal quarter. Total interest on the Company's $40 million revolving credit facility ("revolver") decreased nearly 50% to $0.06 million in fiscal 2014's second quarter. The average borrowing on the revolver, computed monthly, decreased to $11.4 million in fiscal 2014's second quarter, compared to $22.5 million in the same period a year ago. The interest rate on the revolver increased slightly from a range of 1.71% to 1.73% in the prior fiscal year's second quarter to a range of 1.82% to 1.83% 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, Japanese yen and Indian rupee.

The effective tax rate for the second quarter of fiscal 2014 was 54.9%, which is significantly higher than the prior year rate of 34.7%. Both years were significantly impacted by non-deductible losses in a certain foreign jurisdiction that are subject to a full valuation allowance. Adjusting for these non-deductible losses, the fiscal 2014 rate would have been 29.8% compared to 31.2% for the fiscal 2013 second quarter. The increase in the fiscal 2014 adjusted rate was primarily driven by adjustments to tax on foreign earnings (Canada and Italy) recorded in the first quarter.

Comparison of the First Six Months of FY 2014 with the First Six Months of FY 2013

Net sales for the first six months decreased 8.1%, or $11.5 million, to $129.6 million from $141.1 million in the same period a year ago. Compared to the first six months 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 $1.9 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, while sales to customers in Asia Pacific remained strong. Coming off a record year in fiscal 2013, commercial marine transmission system shipments are down in the first half of fiscal 2014. However, the Company experienced strong order activity in the second fiscal quarter and the six-month backlog of orders for commercial marine transmission systems is up significantly both sequentially and versus the end of the prior fiscal year's second quarter. While demand for pressure pumping transmissions for the North American market remained depressed, shipments of these transmission systems to China in the current fiscal years' first half exceeded shipments for fiscal 2013's first half. Sales to customers serving the global mega yacht market remained near historical lows.

Sales at our manufacturing segment were down 11.9%, or $14.9 million, versus the same period last year. Compared to the first half 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 $1.3 million versus the prior year, before eliminations. In the current fiscal year's first half, our domestic manufacturing operation, the largest, experienced a 14% decrease in sales versus the first six months of 2013. The primary driver for this decrease was lower sales of pressure-pumping transmissions for the oil and gas market, and marine and propulsion systems for the global marine market. The Company's Italian manufacturing operations, which have been adversely impacted by the softness in the European mega yacht and industrial markets, experienced flat sales compared to the prior fiscal year's first six months. 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 the first fiscal quarter. This operation saw a nearly 24% decrease in sales versus the prior fiscal year's first six months, primarily driven by the continued softness in its markets and the temporary disruption experienced as a result of the strike in the first fiscal quarter. The Company's Swiss manufacturing operation, which supplies customized propellers for the global mega yacht and patrol boat markets, experienced a 13% decrease in sales, primarily due to the timing of shipments for the global patrol boat and Italian mega yacht markets.

Sales at our distribution segment were down nearly 5%, or $3.2 million, compared to the first half of fiscal 2013. Compared to the first six months 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 $3.1 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, experienced an over 7% increase in sales compared to the prior fiscal year's first six months. 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 decrease in sales of nearly 7%. In the prior fiscal year's first six months, this operation experienced a 56% decrease in sales versus fiscal 2012's first six months 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 half 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 34% 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 just over 2% from the prior year's first six months, driven by strong shipments in the first fiscal quarter of 2014. This operation experienced weaker sales in both the mega yacht and industrial markets in Australia in the second fiscal quarter of 2014.

The elimination for net inter/intra segment sales decreased $6.6 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 60 basis points to 30.2% of sales, compared to 29.6% of sales for the same period last year. Gross profit for fiscal 2014's first six months was unfavorably impacted by lower sales volume compared to the fiscal 2013 first half (approximately $5.3 million). The unfavorable volume impact was only partially offset by a more profitable product mix (approximately $1.8 million) driven by higher sales of the Company's oil and gas transmission products (approximately $0.9 million) and reduced warranty expense ($0.8 million).

Marketing, engineering, and administrative (ME&A) expenses of $32.7 million were down $0.7 million compared to last year's first six months. As a percentage of sales, ME&A expenses increased to 25.2% of sales versus 23.7% of sales in the first six months of fiscal 2013. The decrease in ME&A expenses for the first half relates to increased spending in the Company's growing Asian operations and increased spending on corporate projects, more than offset by a continued focus on controlled spending at the Company's global operations and a decrease in stock based compensation expense for the first six months of this fiscal year compared to the same period in fiscal 2013.

Interest expense of $0.5 million for the quarter was down 24.9% versus the prior fiscal year's first six months. Total interest on the Company's $40 million revolving credit facility ("revolver") decreased 32% to $0.13 million in fiscal 2014's second quarter. The average borrowing on the revolver, computed monthly, decreased to $12.9 million in fiscal 2014's first half, compared to $19.7 million in the same period a year ago. The interest rate on the revolver increased slightly from a range of 1.71% to 1.75% in the prior fiscal year's first six months to a range of 1.82% to 1.85% in the current fiscal year. The interest expense on the Company's $25 million Senior Note decreased 25%, at a fixed rate of 6.05%, to $0.3 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, Japanese yen and Indian rupee.

The effective tax rate for the first half of fiscal 2014 was 62.1%, which is significantly higher than the prior year rate of 38.3%. Both years were significantly impacted by non-deductible losses in a certain foreign jurisdiction that are subject to a full valuation allowance. Adjusting for these non-deductible losses, the fiscal 2014 rate would have been 37.0% compared to 33.1% for fiscal 2013. The increase in the fiscal 2014 adjusted rate was primarily driven by adjustments to tax on foreign earnings (Canada and Italy) recorded in the first quarter.

Financial Condition, Liquidity and Capital Resources

Comparison between December 27, 2013 and June 30, 2013

As of December 27, 2013, the Company had net working capital of $123.4 million, which represents a decrease of $1.6 million, or 1.3%, from the net working capital of $125.0 million as of June 30, 2013.

Cash increased $6.4 million, or 30.9%, to $27.1 million as of December 27, 2013, versus $20.7 million as of June 30, 2013. The majority of the cash as of December 27, 2013 is at our overseas operations in Europe ($15.5 million) and Asia-Pacific ($10.5 million). As of December 27, 2013, the Company was in a net cash position of $6.06 million (net cash is defined as total cash ($27.12 million) less total debt ($21.06 million)).

Trade receivables of $34.9 million were down $11.4 million, or nearly 25%, when compared to last fiscal year-end. The impact of foreign currency translation was to increase accounts receivable by $0.6 million versus June 30, 2013. The net remaining decrease is consistent with the sales volume decrease of just under 17% from the fourth quarter of fiscal 2013 compared to the second fiscal quarter of fiscal 2014.

Net inventory decreased slightly by $0.2 million versus June 30, 2013 to $102.6 million. The impact of foreign currency translation was to increase net inventory by $1.5 million versus June 30, 2013. After adjusting for the impact of foreign currency translation, the net decrease of $1.7 million primarily came at the Company's U.S. manufacturing location. On a consolidated basis, as of December 27, 2013, the Company's backlog of orders to be shipped over the next six months approximates $56.2 million, compared to $66.8 million at June 30, 2013 and $68.2 million at December 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 183% at December 27, 2013.

Net property, plant and equipment (PP&E) decreased $1.2 million versus June 30, 2013. This includes the addition of $3.0 million in capital expenditures, primarily at the Company's Racine-based manufacturing operation, which was more than offset by depreciation of $5.1 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 December 27, 2013 of $19.9 million were down $0.8 million, or 3.7%, from June 30, 2013. The impact of foreign currency translation was to increase accounts payable by $0.3 million versus June 30, 2013. This decrease is consistent with the Company's lower six month backlog levels, continued focus on lowering inventories and the timing of certain payments.

Total borrowings and long-term debt as of December 27, 2013 decreased by $6.1 million, or roughly 22%, to $21.1 million versus June 30, 2013. This decrease was driven by the strong operating cash flow in the first half of the fiscal year ($19.6 million). During the first six months of the fiscal year, the Company generated free cash flow (defined as operating cash flow less acquisitions of fixed assets) of $16.6 million and ended the quarter with total debt, net of cash, of $(6.1) million, compared to $6.4 million at June 30, 2013, for a net change of $12.5 million.

Total equity increased $2.4 million, or less than 2%, to $145.9 million as of December 27, 2013. Retained earnings decreased by $0.2 million. The net decrease in retained earnings included $1.8 million in net earnings for the first six months of the fiscal year offset by $2.0 million in dividend payments. Net favorable foreign currency translation of $3.0 million was reported. The net remaining decrease in equity of $0.4 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 December 27, 2013, and a maximum total funded debt to EBITDA ratio of 3.0 at December 27, 2013. As of December 27, 2013, the Company was in compliance with these covenants with a four quarter EBITDA total of $18,289,000 and a funded debt to EBITDA ratio of 1.15. The minimum net worth covenant fluctuates based upon actual earnings and is subject to adjustment for certain pension accounting adjustments to equity. As of December 27, 2013 the minimum equity requirement was $120,018,000 compared to an actual result of $179,265,000 after all required adjustments. The outstanding balance of $10,250,000 and $16,330,000 at December 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 1.82% and 1.84% at December 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 December 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 December 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 . . .

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