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TWIN > SEC Filings for TWIN > Form 10-Q on 20-Jun-2014All Recent SEC Filings

Show all filings for TWIN DISC INC

Form 10-Q for TWIN DISC INC


20-Jun-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 condensed consolidated financial statements included herein, and our consolidated fiscal 2013 financial statements and related notes included in the Company's Annual Report on Form 10-K for June 30, 2013.

In the course of closing the Company's books for April 2014, the Company discovered certain accounting irregularities relating to the quarter ended March 28, 2014, at its Belgian subsidiary, Twin Disc International S.A. ("TWINSA"). Specifically, the number of hours worked on manufacturing certain products included in TWINSA's inventory was artificially inflated. The value of those hours totaled $82,000, and have been properly reflected as cost of goods sold in the Company's statement of operations for the quarter ended March 28, 2014. Prior to the filing of this Form 10-Q, the Company's Audit Committee completed an investigation of the accounting irregularities. The investigation did not identify any additional irregularities requiring adjustment to the Company's current or prior financial statements. The Company has taken appropriate actions related to certain of the personnel involved, and is considering what further actions may be necessary, which will likely include additional training and controls.

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             Nine Months Ended
                   March 28,      March 29,      March 28,      March 29,
                  2014     %      2013     %     2014     %     2013     %

Net sales        $60,705         $68,232       $190,343       $209,351
Cost of goods     44,177          50,558        134,604        149,949
sold

Gross profit      16,528  27.2%   17,674 25.9%   55,739 29.3%   59,402 28.4%

Marketing,
engineering and
administrative    16,870  27.8%   17,405 25.5%   49,572 26.0%   50,795 24.3%
expenses
Restructuring of       0   0.0%        0  0.0%    1,094  0.6%        0  0.0%
operations

(Loss) earnings   ($342) (0.6%)     $269  0.4%   $5,073  2.7%   $8,607  4.1%
from operations

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

Net sales for the third quarter decreased 11.0%, or $7.5 million, to $60.7 million from $68.2 million in the same period a year ago. Compared to the third 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 $0.8 million versus the prior year, before eliminations. Lower levels of activity from North American and European customers continued to influence the Company's results. Additionally, the severe winter weather throughout most of the U.S. and Canada, while difficult to quantify, impacted the performance of the supply chain causing some shipments to be delayed, and there was a general low level of order activity for both new units and spares during the quarter. However, the Company continued to experience favorable demand trends from customers in Asia for both pressure pumping and commercial marine products as a result of overall economic growth in the region and market share gains. Towards the end of the quarter, demand for pressure pumping transmission systems began increasing in North America, and the Company is hopeful that these recent trends will continue as the excess field inventory situation continues to improve. Sales to customers serving the global mega yacht market remained near historical lows in the quarter.

Sales at our manufacturing segment were down 6.6%, or $3.7 million, versus the same period last year. Compared to the third 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 third quarter, our domestic manufacturing operation, the largest, experienced a 7% decrease in sales versus the third fiscal quarter of 2013. The primary driver for this decrease was lower sales of land-based transmission systems legacy military and Airport Rescue and Fire Fighting (ARFF) markets, and marine and propulsion systems for the global marine market, partially offset by increased aftermarket product 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 10% decrease in sales compared to the prior fiscal year's third quarter. 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 9% decrease in sales versus the prior fiscal year's third quarter, primarily driven by the continued softness in its markets. The Company's Swiss manufacturing operation, which supplies customized propellers for the global mega yacht and patrol boat markets, experienced a 33% 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 9%, or $2.8 million, compared to the third quarter of fiscal 2013. Compared to the third 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 $1.3 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 a 1% increase in sales compared to the prior fiscal year's third 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 11%. In the prior fiscal year's third quarter this operation experienced a 33% decrease in sales versus fiscal 2012's third 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 nine months of fiscal 2014. The Company's distribution operation in Italy, which provides boat accessories and propulsion systems for the pleasure craft market, saw sales more than double due to the timing of the shipment of propulsion products in the quarter. In fiscal 2013's fourth quarter, the Company committed to a plan to exit the third party distribution agreement of this operation and entered negotiations to sell the inventory back to the parent supplier. Those negotiations were completed in the third fiscal quarter of 2014. 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 14% from the prior year's third quarter.

The elimination for net inter/intra segment sales increased $1.0 million, accounting for the remainder of the net change in sales versus the same period last year.

Gross profit as a percentage of sales increased 130 basis points to 27.2% of sales, compared to 25.9% of sales for the same period last year, primarily due to an improved product mix. Gross profit for fiscal 2014's third quarter was unfavorably impacted by lower sales volume compared to the fiscal 2013 third quarter (approximately $3.1 million). The unfavorable volume impact was somewhat offset by a more profitable product mix (approximately $1.3 million) and reduced warranty expense ($0.2 million).

Marketing, engineering, and administrative (ME&A) expenses of $16.9 million were down $0.5 million, or 3.1%, compared to last year's third fiscal quarter. As a percentage of sales, ME&A expenses increased to 27.8% of sales versus 25.5% of sales in the third quarter of fiscal 2013. Compared to the prior fiscal year's third quarter, stock based compensation expense decreased $1.2 million, from $1.5 million to $0.3 million. The net decrease in ME&A expenses relates to a continued focus on controlled spending at the Company's European and North American operations and the noted decrease in stock based compensation expense this fiscal year compared to fiscal 2013 partially offset by increased spending in the Company's growing Asian operations and increased spending on corporate activities, including engineering and corporate development projects.

Interest expense of $0.2 million for the quarter was down nearly 40% versus last year's third fiscal quarter. Total interest on the Company's $40 million revolving credit facility ("revolver") decreased 45% to $0.05 million in fiscal 2014's third quarter. The average borrowing on the revolver, computed monthly, decreased to $11.7 million in fiscal 2014's third quarter, compared to $20.5 million in the same period a year ago. The interest rate on the revolver increased slightly from a range of 1.70% to 1.71% in the prior fiscal year's third quarter to a range of 1.81% to 1.82% 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. On April 10, 2014, the latest quarterly payment of $3.6 million was made.

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, Japanese yen and Indian rupee.

The fiscal 2014 third quarter tax benefit on near break-even, pre-tax results was impacted by a reduced effective rate driven by a change in the jurisdictional mix of earnings along with provision to return adjustments for the federal and various state tax returns filed in the quarter. The fiscal 2013 third quarter tax expense was primarily impacted by foreign tax credits following final settlement of an IRS audit and the completion of the fiscal 2012 federal tax return. The year-to-date effective tax rate for fiscal 2014 is 66.6%, which is significantly higher than the prior year rate of 46.6%. However, the effective rates in both years are impacted by the non-deductibility of operating losses in a certain foreign jurisdiction that is subject to a full valuation allowance. Adjusting both fiscal years for the non-deductible losses, the fiscal 2014 year-to-date rate would have been 33.3% compared to 37.6% for the same period in fiscal 2013. The fiscal 2014 rate was favorably impacted by a change in the jurisdictional mix of earnings, along with favorable provision to return adjustments recorded in the fiscal 2014 third quarter.

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

Net sales for the first nine months decreased 9.1%, or $19.0 million, to $190.3 million from $209.4 million in the same period a year ago. Compared to the first nine 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 $2.6 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. Additionally, the severe winter weather throughout most of the U.S. and Canada, while difficult to quantify, impacted the performance of the supply chain causing some shipments to be delayed, and there was a general low level of order activity for both new units and spares during the cold winter months. Coming off a record year in fiscal 2013, commercial marine transmission system shipments are down in the first nine months of fiscal 2014. However, the Company continued to experience favorable demand trends from customers in Asia for both pressure pumping and commercial marine products as a result of overall economic growth in the region and market share gains. Towards the end of the third fiscal quarter, demand for pressure pumping transmission systems began increasing in North America, and the Company is hopeful that these recent trends will continue as the excess field inventory situation continues to improve. Sales to customers serving the global mega yacht market remained near historical lows.

Sales at our manufacturing segment were down 10.3%, or $18.7 million, versus the same period last year. Compared to the first nine months 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 $1.8 million versus the prior year, before eliminations. In the current fiscal year's first nine months, our domestic manufacturing operation, the largest, experienced a 12% decrease in sales versus the first nine months of 2013. The primary drivers for this decrease were lower sales of legacy military and ARFF transmission systems, and marine and propulsion systems for the global markets, only partially offset by increased shipments of aftermarket products. The Company's Italian manufacturing operations, which have been adversely impacted by the softness in the European mega yacht and industrial markets, experienced a sales decrease of 3.9% compared to the prior fiscal year's first nine 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 18% decrease in sales versus the prior fiscal year's first nine 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 2.5% 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 6.2%, or $6.0 million, compared to the first nine months of fiscal 2013. Compared to the first nine 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 $4.4 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, experienced an over 5% increase in sales compared to the prior fiscal year's first nine 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 8.2%. In the prior fiscal year's first nine months, this operation experienced a nearly 50% decrease in sales versus fiscal 2012's first nine 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 nine months of fiscal 2014. The Company's distribution operation in Italy, which provides boat accessories and propulsion systems for the pleasure craft market, saw sales increase slightly despite continued weakness in the global mega yacht market. In fiscal 2013's fourth quarter, the Company committed to a plan to exit the third party distribution agreement of this operation and entered negotiations to sell the inventory back to the parent supplier. Those negotiations were completed in the third fiscal quarter. 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 under 6% from the prior year's first nine months, driven by improved shipments over the prior fiscal year.

The elimination for net inter/intra segment sales decreased $5.6 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 90 basis points to 29.3% of sales, compared to 28.4% of sales for the same period last year, primarily due to an improved product mix. Gross profit for fiscal 2014's first nine months was unfavorably impacted by lower sales volume compared to the fiscal 2013 first nine months (approximately $8.4 million). The unfavorable volume impact was only partially offset by a more profitable product mix (approximately $3.1 million) driven by higher sales of the Company's oil and gas transmission products (approximately $0.8 million) and reduced warranty expense ($1.0 million).

Marketing, engineering, and administrative (ME&A) expenses of $49.6 million were down $1.2 million, or 2.4%, compared to last fiscal year's first nine months. As a percentage of sales, ME&A expenses increased to 26.0% of sales versus 24.3% of sales in the first nine months of fiscal 2013. Compared to the prior fiscal year's first nine months, stock based compensation expense decreased $1.5 million, from $2.4 million to $0.9 million. The net decrease in ME&A expenses relates to a continued focus on controlled spending at the Company's European and North American operations and the noted decrease in stock based compensation expense this fiscal year compared to fiscal 2013 partially offset by increased spending in the Company's growing Asian operations and increased spending on corporate activities, including engineering and corporate development projects.

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 $0.5 million was recorded in the fourth quarter of fiscal 2013, upon announcement of the intended restructuring action. During the first nine months of fiscal 2014, the Company made cash payments of $0.8 million, resulting in an accrual balance at March 28, 2014 of $0.9 million.

Interest expense of $0.7 million was down 30.4% versus the prior fiscal year's first nine months. Total interest on the Company's $40 million revolving credit facility ("revolver") decreased 37% to $0.18 million in fiscal 2014's third quarter. The average borrowing on the revolver, computed monthly, decreased to $12.6 million in fiscal 2014's first nine months, compared to $20.0 million in the same period a year ago. The interest rate on the revolver increased slightly from a range of 1.70% to 1.75% in the prior fiscal year's first nine months to a range of 1.81% 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 $0.5 million, due to a lower remaining principal balance. On April 10, 2014, the latest quarterly payment of $3.6 million was made.

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 nine months of fiscal 2014 is 66.6%, which is higher than the prior year's 46.6%. However, the effective rates in both years are impacted by the non-deductibility of operating losses in a certain foreign jurisdiction that is subject to a full valuation allowance. Adjusting both fiscal years for the non-deductible losses, the fiscal 2014 year-to-date rate would have been 33.3% compared to 37.6% for the same period in fiscal 2013. The fiscal 2014 rate was favorably impacted by a change in the jurisdictional mix of earnings, along with favorable provision to return adjustments recorded in the fiscal 2014 third quarter.

Financial Condition, Liquidity and Capital Resources

Comparison between March 28, 2014 and June 30, 2013

As of March 28, 2014, the Company had net working capital of $127.4 million, which represents an increase of $2.4 million, or 1.9%, from the net working capital of $125.0 million as of June 30, 2013.

Cash increased $5.6 million, or 27.2%, to $26.4 million as of March 28, 2014, versus $20.7 million as of June 30, 2013. The majority of the cash as of March 28, 2014 is at our overseas operations in Europe ($14.4 million) and Asia-Pacific ($11.0 million). As of March 28, 2014, the Company was in a net cash position of $1.31 million (net cash is defined as total cash ($26.36 million) less total debt ($25.05 million)).

Trade receivables of $33.5 million were down $12.8 million, or nearly 28%, when compared to last fiscal year-end. The impact of foreign currency translation was to increase accounts receivable by $0.9 million versus June 30, 2013. The net remaining decrease is consistent with the sales volume decrease of just over 20% from the fourth quarter of fiscal 2013 compared to the third fiscal quarter of fiscal 2014.

Net inventory increased by $2.3 million, or 2.2%, versus June 30, 2013 to $105.0 million. The impact of foreign currency translation was to increase net inventory by $1.8 million versus June 30, 2013. After adjusting for the impact of foreign currency translation, there was a net increase in inventory of $0.5 million. The Company's distribution operation in Singapore, its largest Company-owned distribution operation, saw a $1.9 million increase in inventory ($1.8 million after adjusting for the impact of foreign currency translation) as it continued 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. On a consolidated basis, as of March 28, 2014, the Company's backlog of orders to be shipped over the next six months approximates $57.6 million, compared to $66.8 million at June 30, 2013 and $64.9 million at March 29, 2013. 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 182% at March 28, 2014.

Net property, plant and equipment (PP&E) decreased $1.3 million versus June 30, 2013. This includes the addition of $5.2 million in capital expenditures, primarily at the Company's Racine-based manufacturing operation, which was more than offset by depreciation of $7.6 million. The net remaining increase is due to foreign currency translation effects. In total, the Company expects to invest up to $10 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 investing in machinery and equipment that improves productivity and the cost competitiveness of the Company. 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 March 28, 2014 of $19.7 million were down $1.0 million, or 4.8%, 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, a continued focus on lowering inventories and the timing of certain payments.

Total borrowings and long-term debt as of March 28, 2014 decreased by $2.1 million, or roughly 8%, to $25.0 million versus June 30, 2013. This decrease was driven by the strong operating cash flow in the first nine months of the fiscal year ($17.8 million). During the first nine months of the fiscal year, the Company generated free cash flow (defined as operating cash flow less acquisitions of fixed assets) of $12.6 million and ended the quarter with total debt, net of cash, of ($1.3) million, compared to $6.4 million at June 30, 2013, for a net change of $7.7 million.

Total equity increased $2.8 million, or 2%, to $146.4 million as of March 28, 2014. Retained earnings decreased by $1.7 million. The net decrease in retained earnings included $1.3 million in net earnings for the first nine months of the fiscal year offset by $3.0 million in dividend payments. Net favorable foreign currency translation of $4.1 million was reported. The net remaining increase in equity of $0.4 million primarily represents the issuance and vesting of stock awards and noncontrolling interest dividends, 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") with an expiration date of 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 March 28, 2014, and a maximum total funded debt to EBITDA ratio of 3.0 at March 28, 2014. As of March 28, 2014, the Company was in compliance with these covenants with a four quarter EBITDA total of $17,659,000 and a funded debt to EBITDA ratio of 1.42. The minimum net worth covenant fluctuates based upon actual earnings and is subject to adjustment for certain pension accounting adjustments to equity. As of March 28, 2014 the minimum equity requirement was $120,018,000 compared to an actual result of $179,710,000 after all required adjustments. The outstanding balance of $14,250,000 and $16,300,000 at March 28, 2014 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 . . .

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