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TWIN DISC INC - Quarter Report: 2013 February (Form 10-Q)

td10q02062013.htm

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.  20549
Form 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarter ended December 28, 2012

Commission File Number  1-7635


TWIN DISC, INCORPORATED
(Exact name of registrant as specified in its charter)

Wisconsin
39-0667110
(State or other jurisdiction of
(I.R.S. Employer
Incorporation or organization)
Identification No.)
   
1328 Racine Street, Racine, Wisconsin  53403
(Address of principal executive offices)

(262) 638-4000
(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.
Yes                                No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).YesNo__

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):
Large Accelerated Filer                                                      Accelerated Filer 
Non-accelerated filer                                                                                     Smaller reporting company__

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes                                No  √

At January 25, 2013, the registrant had 11,243,484 shares of its common stock outstanding.

 
 

 

 Part I.                      FINANCIAL INFORMATION

Item 1.                      Financial Statements
TWIN DISC, INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
(In Thousands)
(Unaudited)
   
December 28,
   
June 30,
 
   
2012
   
2012
 
Assets
           
Current assets:
           
Cash
  $ 20,570     $ 15,701  
Trade accounts receivable, net
    38,465       63,438  
Inventories, net
    118,298       103,178  
Deferred income taxes
    4,555       3,745  
Other
    11,200       11,099  
Total current assets
    193,088       197,161  
                 
Property, plant and equipment, net
    65,737       66,356  
Goodwill, net
    13,267       13,116  
Deferred income taxes
    13,109       14,335  
Intangible assets, net
    4,794       4,996  
Other assets
    9,581       7,868  
                 
Total assets
  $ 299,576     $ 303,832  
                 
Liabilities and Equity
               
Current liabilities:
               
Short-term borrowings and current maturities of long-term debt
  $ 3,697     $ 3,744  
Accounts payable
    24,367       23,550  
Accrued liabilities
    32,736       39,331  
Total current liabilities
    60,800       66,625  
                 
Long-term debt
    30,297       28,401  
Accrued retirement benefits
    60,223       64,009  
Deferred income taxes
    3,816       3,340  
Other long-term liabilities
    3,291       4,948  
                 
Total liabilities
    158,427       167,323  
                 
Equity
               
Twin Disc shareholders’ equity:
               
Common shares authorized: 30,000,000;
               
issued: 13,099,468; no par value
    11,901       12,759  
Retained earnings
    186,842       184,306  
Accumulated other comprehensive loss
    (30,143 )     (34,797 )
      168,600       162,268  
Less treasury stock, at cost (1,855,984 and 1,794,981 shares, respectively)
    28,423       26,781  
                 
Total Twin Disc shareholders' equity
    140,177       135,487  
                 
Noncontrolling interest
    972       1,022  
                 
Total equity
    141,149       136,509  
                 
Total liabilities and equity
  $ 299,576     $ 303,832  


The notes to condensed consolidated financial statements are an integral part of these statements.

 
 

 




TWIN DISC, INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In Thousands, Except Per Share Data)
(Unaudited)

   
Three Months Ended
   
Six Months Ended
 
   
Dec. 28,
   
Dec. 30,
   
Dec. 28,
   
Dec. 30,
 
   
2012
   
2011
   
2012
   
2011
 
                         
Net sales
  $ 72,325     $ 82,941     $ 141,118     $ 164,271  
Cost of goods sold
    50,014       53,379       99,391       103,941  
                                 
Gross profit
    22,311       29,562       41,727       60,330  
                                 
Marketing, engineering and administrative expenses
    16,770       20,097       33,390       36,006  
                                 
Earnings from operations
    5,541       9,465       8,337       24,324  
                                 
Interest expense
    329       381       635       740  
Other (income) expense, net
    (22 )     (150 )     105       (544 )
      307       231       740       196  
                                 
Earnings before income taxes and noncontrolling interest
    5,234       9,234       7,597       24,128  
Income taxes
    1,815       3,385       2,912       8,569  
                                 
Net earnings
    3,419       5,849       4,685       15,559  
                                 
Less: Net earnings attributable to noncontrolling interest, net of tax
    (59 )     (9 )     (94 )     (63 )
                                 
Net earnings attributable to Twin Disc
  $ 3,360     $ 5,840     $ 4,591     $ 15,496  
                                 
Dividends per share
  $ 0.09     $ 0.08     $ 0.18     $ 0.16  
                                 
Earnings per share data:
                               
Basic earnings per share attributable to Twin Disc common shareholders
  $ 0.30     $ 0.51     $ 0.41     $ 1.36  
Diluted earnings per share attributable to Twin Disc common shareholders
  $ 0.29     $ 0.50     $ 0.40     $ 1.34  
                                 
Weighted average shares outstanding data:
                               
Basic shares outstanding
    11,366       11,429       11,368       11,411  
Dilutive stock awards
    68       143       73       144  
Diluted shares outstanding
    11,434       11,572       11,441       11,555  
                                 
Net earnings
  $ 3,419     $ 5,849     $ 4,685     $ 15,559  
Other comprehensive income (loss), net:
                               
Benefit plan adjustments, net of income taxes of $375, $236, $759 and $507,respectively
  $ 652       411     $ 1,320       885  
Foreign currency translation adjustment
    2,130       (6,258 )     3,394       (8,533 )
Other comprehensive income (loss), net
    2,782       (5,847 )     4,714       (7,648 )
Comprehensive income
    6,201       2       9,399       7,911  
Less: comprehensive income attributable to noncontrolling interest
    (59 )     (9 )     (94 )     (63 )
                                 
Comprehensive income (loss) attributable to Twin Disc
  $ 6,142     $ (7 )   $ 9,305     $ 7,848  

The notes to condensed consolidated financial statements are an integral part of these statements.



TWIN DISC, INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(Unaudited)


   
Six Months Ended
 
   
December 28,
   
December 30,
 
   
2012
   
2011
 
             
Cash flows from operating activities:
           
Net earnings
  $ 4,685     $ 15,559  
Adjustments to reconcile net earnings to net cash
               
(used) provided by operating activities:
               
Depreciation and amortization
    5,345       5,311  
Other non-cash changes, net
    1,599       3,756  
Net change in working capital, excluding cash
    463       (28,215 )
                 
Net cash provided (used) by operating activities
    12,092       (3,589 )
                 
Cash flows from investing activities:
               
Acquisitions of fixed assets
    (3,529 )     (6,893 )
Proceeds from sale of fixed assets
    35       72  
Other, net
    (293 )     (293 )
                 
Net cash used by investing activities
    (3,787 )     (7,114 )
                 
Cash flows from financing activities:
               
Proceeds from notes payable
    42       -  
Payments of notes payable
    (93 )     (52 )
Proceeds from long-term debt, net
    1,892       12,122  
Proceeds from exercise of stock options
    189       169  
Dividends paid to shareholders
    (2,055 )     (1,828 )
Dividends paid to noncontrolling interest
    (204 )     (130 )
Acquisition of treasury stock
    (3,069 )     -  
Excess tax benefits from stock compensation
    1,276       535  
Other
    (1,700 )     (185 )
                 
Net cash (used) provided by financing activities
    (3,722 )     10,631  
                 
Effect of exchange rate changes on cash
    286       (1,474 )
                 
Net change in cash
    4,869       (1,546 )
                 
Cash:
               
Beginning of period
    15,701       20,167  
                 
End of period
  $ 20,570     $ 18,621  






The notes to condensed consolidated financial statements are an integral part of these statements.

 
 

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

A.
Basis of Presentation

The unaudited condensed consolidated financial statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) and, in the opinion of the Company, include all adjustments, consisting only of normal recurring items, necessary for a fair presentation of results for each period.  Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such SEC rules and regulations.  The Company believes that the disclosures made are adequate to make the information presented not misleading.  It is suggested that these financial statements be read in conjunction with the consolidated financial statements and the notes thereto included in the Company's latest Annual Report.  The year-end condensed balance sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America.

Revision of Prior Period Financial Statements

During the second quarter of fiscal 2013, the Company identified errors related to its reserve for uncertain tax positions that affected prior periods beginning in the year ended June 30, 2007 and subsequent periods through September 28, 2012.   In evaluating whether the Company's previously issued consolidated financial statements were materially misstated, the Company considered the guidance in Accounting Standard Codification ("ASC") Topic 250, Accounting Changes and Error Corrections and ASC Topic 250-10-S99-1, Assessing Materiality.  The Company concluded this error was not material individually or in the aggregate to any of the prior reporting periods.  However, the cumulative error would be material in the year ended June 30, 2013, if the entire correction was recorded in the second quarter of fiscal 2013.  As such, the revision for this correction to the applicable prior periods is reflected in the financial information herein and will be reflected in future filings containing such financial information.  As a result of correcting the errors related to its reserve for uncertain tax positions, net earnings attributable to Twin Disc was decreased by $69,000, $50,000 and $104,000 in 2012, 2011 and 2010, respectively.  The cumulative impact of this error correction prior to fiscal 2011 was to reduce shareholders’ equity at June 30, 2010 by $658,000.  In addition to recording this correcting adjustment, the Company recorded other adjustments to prior period amounts to correct other immaterial out-of-period adjustments related to income taxes, including those that had been previously disclosed.  As a result of correcting these other immaterial out-of-period adjustments, net earnings attributable to Twin Disc was increased by $700,000 in 2012, decreased by $783,000 in 2011, and increased by $83,000 in 2010.  The cumulative impact of these other immaterial out-of-period adjustments prior to fiscal 2011 was to increase shareholders’ equity at June 30, 2010 by $83,000.

In addition, in the third quarter of fiscal 2012, the Company identified a prior period error in their first and second quarter 2012 condensed consolidated financial statements related to the cash flow statement classification of the excess tax benefit related to stock-based compensation.  The excess tax benefit in the first and second quarter of fiscal 2012, in the amount of $445,000 and $90,000, respectively, was reflected in operating activities rather than financing activities in the condensed consolidated cash flow statement.  There was no impact of the error on the condensed consolidated statement of comprehensive income or condensed consolidated balance sheet.  The Company concluded this error was not material individually or in the aggregate to any of the prior periods.  The revision for the correction is reflected in the financial information herein and will be reflected in future filings containing affected financial information.

The impacts of these revisions are shown in the following tables (in ‘000’s):

 
As of and for the period ended June 30, 2011
 
As of and for the period ended September 30, 2011
 
Reported
Adjustment
Revised
 
Reported
Adjustment
Revised
Revised consolidated balance sheet amounts
           
               
Accrued liabilities
41,673
700
42,373
 
38,301
608
38,909
Total current liabilities
83,960
700
84,660
 
77,165
608
77,773
Other long term liabilities
7,089
708
7,797
 
4,363
725
5,088
Total liabilities
171,066
1,408
172,474
 
170,619
1,333
171,952
Retained earnings
162,857
(1,408)
161,449
 
171,524
(1,333)
170,191
Total equity
138,054
(1,408)
136,646
 
145,811
(1,333)
144,478
               
Revised consolidated statement of comprehensive income (loss) amounts
       
               
Year to date
             
Income taxes
13,064
833
13,897
 
5,259
(75)
5,184
Net earnings
18,965
 (833)
18,132
 
9,635
75
9,710
Net earnings attributable to Twin Disc
18,830
(833)
17,997
 
9,581
75
9,656
Basic earnings per share
1.66
(0.07)
1.59
 
0.84
0.01
0.85
Diluted earnings per share
1.64
(0.07)
1.57
 
0.83
0.01
0.84
Comprehensive income (loss)
49,743
(833)
48,910
 
7,834
75
7,909
Comprehensive income (loss) attributable to Twin Disc
49,608
(833)
48,775
 
7,780
75
7,855
               
Revised consolidated statement of cash flows amounts
         
               
Net earnings
18,965
(833)
18,132
 
9,635
75
9,710
Net change in working capital, excluding cash and debt, and other
       
(16,354)
(75)
(16,429)
Accrued liabilities
6,713
833
7,546
       
Other non-cash changes, net
       
2,950
(445)
2,505
Net cash used by operating activities
       
(1,196)
(445)
(1,641)
Excess tax benefits from stock comp
       
-
445
445
Net cash provided by financing activities
       
10,051
445
10,496
               
 
As of and for the period ended December 30, 2011
 
As of and for the period ended March 30, 2012
 
Reported
Adjustment
Revised
 
Reported
Adjustment
Revised
Revised consolidated balance sheet amounts
           
               
Accrued liabilities
38,056
608
38,664
       
Total current liabilities
77,872
608
78,480
       
Other long term liabilities
4,845
742
5,587
 
4,478
759
5,237
Total liabilities
170,822
1,350
172,172
 
168,130
759
168,889
Retained earnings
176,467
(1,350)
175,117
 
184,831
(759)
184,072
Total equity
145,586
(1,350)
144,236
 
157,231
(759)
156,472
               
Revised consolidated statement of comprehensive income (loss) amounts
       
               
Year to date
             
Income taxes
8,627
(58)
8,569
 
14,039
(649)
13,390
Net earnings
15,501
58
15,559
 
24,939
649
25,588
Net earnings attributable to Twin Disc
15,438
58
15,496
 
24,831
649
25,480
Basic earnings per share
1.35
0.01
1.36
 
2.18
0.05
2.23
Diluted earnings per share
1.34
-
1.34
 
2.15
0.05
2.20
Comprehensive income (loss)
7,853
58
7,911
 
19,950
649
20,599
Comprehensive income (loss) attributable to Twin Disc
7,790
58
7,848
 
19,842
649
20,491
               
Quarter
             
Income taxes
3,368
17
3,385
 
5,412
(591)
4,821
Net earnings
5,866
(17)
5,849
 
9,438
591
10,029
Near earnings attributable to Twin Disc
5,857
(17)
5,840
 
9,393
591
9,984
Basic earnings per share
0.51
-
0.51
 
0.82
0.05
0.87
Diluted earnings per share
0.51
(0.01)
0.50
 
0.81
0.05
0.86
Comprehensive income (loss)
19
(17)
2
 
12,097
591
12,688
Comprehensive income (loss) attributable to Twin Disc
10
(17)
(7)
 
12,052
591
12,643
               
Revised consolidated statement of cash flows amounts
           
               
Net earnings
15,501
58
15,559
 
24,939
649
25,588
Net change in working capital, excluding cash and debt, and other
(28,157)
(58)
(28,215)
 
(41,315)
(649)
(41,964)
Accrued liabilities
             
Other non-cash changes, net
4,291
(535)
3,756
       
Net cash used by operating activities
(3,054)
(535)
(3,589)
       
Excess tax benefits from stock comp
-
535
535
       
Net cash provided by financing activities
10,096
535
10,631
       
               
 
As of and for the period ended June 30, 2012
 
As of and for the period ended September 28, 2012
 
Reported
Adjustment
Revised
 
Reported
Adjustment
Revised
Revised consolidated balance sheet amounts
           
               
Other long term liabilities
4,171
777
4,948
 
2,200
797
2,997
Total liabilities
166,546
777
167,323
 
160,512
797
161,309
Retained earnings
185,083
(777)
184,306
 
185,308
(797)
184,511
Total equity
137,286
(777)
136,509
 
139,587
(797)
138,790
               
Revised consolidated statement of comprehensive income (loss) amounts
       
               
Year to date
             
Income taxes
18,446
(631)
17,815
 
1,077
20
1,097
Net earnings
26,310
631
26,941
 
1,286
(20)
1,266
Net earnings attributable to Twin Disc
26,112
631
26,743
 
1,251
 (20)
1,231
Basic earnings per share
 2.29
0.05
2.34
 
0.11
-
0.11
Diluted earnings per share
2.26
0.05
2.31
 
0.11
-
0.11
Comprehensive income (loss)
2,882
631
3,513
 
3,218
20
3,238
Comprehensive income (loss) attributable to Twin Disc
2,684
631
3,315
 
3,183
20
3,203
               
Quarter
             
Income taxes
4,407
18
4,425
 
1,077
20
1,097
Net earnings
1,371
(18)
1,353
 
1,286
(20)
1,266
Net earnings attributable to Twin Disc
1,281
(18)
1,263
 
1,251
(20)
1,231
Basic earnings per share
0.11
-
0.11
 
0.11
-
0.11
Diluted earnings per share
0.11
-
0.11
 
0.11
-
0.11
Comprehensive income (loss)
(17,068)
(18)
(17,086)
 
3,218
20
3,238
Comprehensive income (loss) attributable to Twin Disc
(17,158)
(18)
(17,176)
 
3,183
20
3,203
               
Revised consolidated statement of cash flows amounts
           
               
Net earnings
26,310
 631
26,941
 
1,286
(20)
1,266
Net change in working capital, excluding cash and debt, and other
       
(4,059)
20
(4,039)
Accrued liabilities
(2,273)
(631)
(2,904)
       


New Accounting Releases

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

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

B.
Inventory

The major classes of inventories were as follows (in thousands):

 
December 28,
June 30,
 
2012
2012
Inventories:
   
Finished parts
$78,710
$62,909
Work in process
13,983
16,608
Raw materials
25,605
23,661
     
 
$118,298
$103,178


C.
Warranty

The Company engages in extensive product quality programs and processes, including actively monitoring and evaluating the quality of its suppliers.  However, its warranty obligation is affected by product failure rates, the number of units affected by the failure and the expense involved in satisfactorily addressing the situation.  The warranty reserve is established based on our best estimate of the amounts necessary to settle future and existing claims on products sold as of the balance sheet date.  When evaluating the adequacy of the reserve for warranty costs, management takes into consideration the term of the warranty coverage, historical claim rates and costs of repair, knowledge of the type and volume of new products and economic trends.  While we believe the warranty reserve is adequate and that the judgment applied is appropriate, such amounts estimated to be due and payable in the future could differ materially from what actually transpires.  The following is a listing of the activity in the warranty reserve during the three and six month periods ended December 28, 2012 and December 30, 2011 (in thousands):

 
Three Months Ended
Six Months Ended
 
Dec. 28,
Dec. 30,
Dec. 28,
Dec. 30,
 
2012
2011
2012
2011
         
Reserve balance, beginning of period
$5,462
$6,583
$5,745
$6,022
Current period expense
1,086
317
1,967
1,781
Payments or credits to customers
(1,066)
(906)
(2,251)
(1,679)
Foreign currency translation
51
(111)
72
(241)
         
Reserve balance, end of period
$5,533
$5,883
$5,533
$5,883


The current portion of the warranty accrual ($3,812,000) is reflected in accrued liabilities, while the long-term portion ($1,721,000) is included in other long-term liabilities on the Consolidated Balance Sheets.

D.
Contingencies

The Company is involved in litigation of which the ultimate outcome and liability to the Company, if any, is not presently determinable.  Management believes that final disposition of such litigation will not have a material impact on the Company’s results of operations, financial position or cash flows.

E.
Business Segments

The Company and its subsidiaries are engaged in the manufacture and sale of marine and heavy duty off-highway power transmission equipment.  Principal products include marine transmissions, surface drives, propellers and boat management systems, as well as power-shift transmissions, hydraulic torque converters, power take-offs, industrial clutches and controls systems.  The Company sells to both domestic and foreign customers in a variety of market areas, principally pleasure craft, commercial and military marine markets, as well as in the energy and natural resources, government and industrial markets.

The Company has two reportable segments: manufacturing and distribution. These segments are managed separately because each provides different services and requires different technology and marketing strategies. The accounting practices of the segments are the same as those described in the summary of significant accounting policies. Transfers among segments are at established inter-company selling prices.  Management evaluates the performance of its segments based on net earnings.

Information about the Company’s segments is summarized as follows (in thousands):

 
Three Months Ended
Six Months Ended
 
Dec. 28,
Dec. 30,
Dec. 28,
Dec. 30,
 
2012
2011
2012
2011
         
Manufacturing segment sales
$66,914
$78,044
$125,196
$149,027
Distribution segment sales
33,742
29,082
64,745
63,177
Inter/Intra segment elimination - manufacturing
(23,522)
(22,280)
(39,080)
(41,949)
Inter/Intra segment elimination - distribution
(4,809)
(1,905)
(9,743)
(5,984)
         
Net sales
$72,325
$82,941
$141,118
$164,271
         
Manufacturing segment net earnings
$5,055
$8,259
$7,889
$16,978
Distribution segment net earnings
1,551
1,065
2,703
3,230
Corporate and eliminations
(3,246)
(3,484)
(6,001)
(4,712)
         
Net earnings attributable to Twin Disc
$3,360
$5,840
$4,591
$15,496
         
 
Dec. 28,
June 30,
   
Assets
2012
2012
   
         
Manufacturing segment assets
$282,930
$272,098
   
Distribution segment assets
62,981
58,275
   
Corporate assets and elimination
       
of inter-company assets
(46,335)
(26,541)
   
         
 
$299,576
$303,832
   


F.
Stock-Based Compensation

In the first half of fiscal 2013 and 2012, the Company granted a target number of 28,255 and 15,449 performance stock unit awards, respectively, to various employees of the Company, including executive officers.  The performance stock unit awards granted in fiscal 2013 will vest if the Company achieves a specified target objective relating to consolidated economic profit (as defined in the Performance Stock Unit Award Grant Agreement) in the cumulative three fiscal year period ending June 30, 2015.  The performance stock unit awards granted in fiscal 2013 are subject to adjustment if the Company’s economic profit for the period falls below or exceeds the specified target objective, and the maximum number of performance stock units that can be awarded if the target objective is exceeded is 33,906.  Based upon actual results to date and the low probability of achieving the threshold performance levels, the Company is not accruing the performance stock unit awards granted in fiscal 2013 and has reversed previously recognized expenses related to these awards. The performance stock unit awards granted in fiscal 2012 will vest if the Company achieves a specified target objective relating to consolidated economic profit (as defined in the Performance Stock Unit Award Grant Agreement) in the cumulative three fiscal year period ending June 30, 2014.  The performance stock unit awards granted in fiscal 2012 are subject to adjustment if the Company’s economic profit for the period falls below or exceeds the specified target objective, and the maximum number of performance stock units that can be awarded if the target objective is exceeded is 18,539.  Based upon actual results to date and the low probability of achieving the threshold performance levels, the Company is not accruing the performance stock unit awards granted in fiscal 2012 and has reversed previously recognized expenses related to these awards. There were 161,734 and 243,647 unvested stock unit awards outstanding at December 28, 2012 and December 30, 2011, respectively.  The performance stock unit awards are remeasured at fair-value based upon the Company’s stock price at the end of each reporting period.  The fair-value of the stock unit awards are expensed over the performance period for the shares that are expected to ultimately vest.  The compensation (income) expense for the three and six months ended December 28, 2012, related to the performance stock unit awards, approximated $(58,000) and $120,000 respectively. The compensation expense for the three and six months ended December 30, 2011, related to the performance stock unit awards, approximated $2,016,000 and $1,051,000 respectively.

In the first half of fiscal 2013 and 2012, the Company granted a target number of 28,535 and 15,335 performance stock awards, respectively, to various employees of the Company, including executive officers.  The performance stock awards granted in fiscal 2013 will vest if the Company achieves a specified target objective relating to consolidated economic profit (as defined in the Performance Stock Award Grant Agreement) in the cumulative three fiscal year period ending June 30, 2015.  The performance stock awards granted in fiscal 2013 are subject to adjustment if the Company’s economic profit for the period falls below or exceeds the specified target objective, and the maximum number of performance shares that can be awarded if the target objective is exceeded is 34,242.  Based upon actual results to date and the low probability of achieving the threshold performance levels, the Company is not accruing the performance stock awards granted in fiscal 2013 and has reversed previously recognized expenses related to these awards.  The performance stock awards granted in fiscal 2012 will vest if the Company achieves a specified target objective relating to consolidated economic profit (as defined in the Performance Stock Award Grant Agreement) in the cumulative three fiscal year period ending June 30, 2014.  The performance stock awards granted in fiscal 2012 are subject to adjustment if the Company’s economic profit for the period falls below or exceeds the specified target objective, and the maximum number of performance shares that can be awarded if the target objective is exceeded is 18,402.  Based upon actual results to date and the low probability of achieving the threshold performance levels, the Company is not accruing the performance stock awards granted in fiscal 2012 and has reversed previously recognized expenses related to these awards. There were 130,926 and 191,398 unvested stock awards outstanding at December 28, 2012 and December 30, 2011, respectively.  The fair value of the stock awards (on the date of grant) is expensed over the performance period for the shares that are expected to ultimately vest.  The compensation (income) expense for the three and six months ended December 28, 2012, related to performance stock awards, approximated $(164,000) and $15,000, respectively.  The compensation expense for the three and six months ended December 30, 2011, related to performance stock awards, approximated $214,000 and $411,000, respectively.

In addition to the performance shares mentioned above, the Company has unvested restricted stock outstanding that will vest if certain service conditions are fulfilled.  The fair value of the restricted stock grants is recorded as compensation over the vesting period, which is generally 1 to 4 years.  During the first half of fiscal 2013 and 2012, the Company granted 83,729 and 43,620 service-based restricted shares, respectively, to employees and non-employee directors.  There were 220,343 and 250,323 unvested shares outstanding at December 28, 2012 and December 30, 2011, respectively.  The compensation expense for the three and six months ended December 28, 2012, related to these service-based awards approximated $400,000 and $788,000, respectively. The compensation expense for the three and six months ended December 30, 2011, related to these service-based awards approximated $364,000 and $706,000, respectively.

G.
Pension and Other Postretirement Benefit Plans

The Company has non-contributory, qualified defined benefit plans covering substantially all domestic employees hired prior to October 1, 2003 and certain foreign employees.  Additionally, the Company provides health care and life insurance benefits for certain domestic retirees.  Components of net periodic benefit cost for the defined benefit pension plans and the other postretirement benefit plan are as follows (in thousands):

 
Three Months Ended
Six Months Ended
 
Dec. 28,
Dec. 30,
Dec. 28,
Dec. 30,
 
2012
2011
2012
2011
         
Pension Benefits:
       
Service cost
$49
$53
$93
$99
Interest cost
1,311
1,517
2,619
3,027
Expected return on plan assets
(1,580)
(1,928)
(3,151)
(3,847)
Amortization of net loss
835
580
1,669
1,160
Net periodic benefit cost
$615
$222
$1,230
$439
         
Postretirement Benefits:
       
Service cost
$9
$10
$17
$21
Interest cost
191
247
383
493
Amortization of net actuarial loss
197
105
395
210
Net periodic benefit cost
$397
$362
$795
$724

The Company expects to contribute approximately $4,352,000 to its pension plans in fiscal 2013.  As of December 28, 2012, $3,562,000 in contributions have been made.

H.
Income Taxes
 
For the six months ended December 28, 2012 and December 30, 2011, the Company’s effective income tax rate was 38.3% and 35.5% respectively.  The fiscal 2013 rate reflects the impact of the valuation allowance on a continued reduced earnings base, increased net foreign earnings and additional reserves for uncertain tax positions ($380,000).  Decreased domestic sales were offset by a limited Section 199 deduction.  No research and development tax credit was reflected as it was not extended within the quarter.  The favorable impact of the recently extended research and development tax credit will be recorded in the third fiscal quarter, as it was signed January 2, 2013.
 
Accounting policies for interim reporting require the Company to adjust its effective tax rate each quarter to be consistent with the estimated annual effective tax rate.  Under this effective tax rate methodology, the Company applies an estimated annual income tax rate to its year-to-date ordinary earnings to derive its income tax provision each quarter.  The impact of the Company’s operations in certain foreign jurisdictions is removed from the overall effective tax rate methodology and recorded directly based upon year-to-date results as these operations anticipate net operating losses for the year for which no tax benefit can be recognized.
 
The Company has approximately $1,500,000 of unrecognized tax benefits, including related interest and penalties, after the revision discussed in footnote A as of December 28, 2012, which, if recognized, would favorably impact the effective tax rate.  The Company finalized an audit settlement in the U.S. for fiscal years 2010 and 2011 which resulted in a decrease in unrecognized tax benefits of $305,000.  Additionally, as a result of an on-going state audit, the Company added an additional reserve of $380,000.
 
Annually, the Company files income tax returns in various taxing jurisdictions inside and outside the United States.  In general, the tax years that remain subject to examination are 2008 through 2011 for the major operations in Italy, Belgium, and Japan.  The tax years open to examination in the U.S. are for years subsequent to fiscal 2011.  The state of Wisconsin income tax audit remains ongoing for the fiscal years 2001 through 2009.  During this quarter the Company was notified by the state of Florida of a tax examination covering open periods.  It is reasonably possible that at least one of these audit cycles will be completed during fiscal 2013.

I.
Goodwill and Other Intangibles

The changes in the carrying amount of goodwill, all of which is allocated to the manufacturing segment, for the six months ended December 28, 2012 were as follows (in thousands):

Gross balance at June 30, 2012
$16,786
Accumulated impairment losses
(3,670)
Net balance at June 30, 2012
$13,116
   
Gross balance at June 30, 2012
$16,786
Translation adjustment
151
Gross balance at December 28, 2012
16,937
Accumulated impairment losses
(3,670)
Net balance at December 28, 2012
$13,267


The gross carrying amount and accumulated amortization of the Company’s intangible assets that have defined useful lives and are subject to amortization as of December 28, 2012 and June 30, 2012 were as follows (in thousands):

 
December 28,
June 30,
 
2012
2012
Intangible assets with finite lives:
   
Licensing agreements
$3,015
$3,015
Non-compete agreements
2,050
2,050
Other
5,991
5,991
     
 
11,056
11,056
Accumulated amortization
(8,937)
(8,583)
Foreign currency translation
545
469
     
Total
$2,664
$2,942

The weighted average remaining useful life of the intangible assets included in the table above is approximately 6 years.

Intangible amortization expense was $166,000 and $354,000 for the three and six months ended December 28, 2012, respectively, and $201,000 and $417,000 for the three and six months ended December 30, 2011, respectively. Estimated intangible amortization expense for the remainder of fiscal 2013 and each of the next five fiscal years is as follows (in thousands):

Fiscal Year
 
2013
$376
2014
722
2015
420
2016
280
2017
276
2018
276

The gross carrying amount of the Company’s intangible assets that have indefinite lives and are not subject to amortization as of December 28, 2012 and June 30, 2012 are $2,130,000 and $2,054,000, respectively.  These assets are comprised of acquired tradenames.

J.  
Long-term Debt

Long-term debt at December 28, 2012 and June 30, 2012 consisted of the following (in thousands):

 
December 28,
June 30,
 
2012
2012
     
Revolving loan
$19,500
$17,550
10-year unsecured senior notes
14,286
14,286
Other
208
309
Subtotal
33,994
32,145
Less: current maturities and short-term borrowings
(3,697)
(3,744)
Total long-term debt
$30,297
$28,401

The revolving loan and unsecured senior notes listed above are subject to certain covenants, including restrictions on investments, acquisitions and indebtedness.  Financial covenants, as defined, include a minimum consolidated net worth, a minimum EBITDA for the most recent four fiscal quarters, and a maximum total funded debt to EBITDA ratio.  As of December 28, 2012, the Company was in compliance with these covenants.

The fair value of long-term debt is estimated by discounting the future cash flows at rates offered to the Company for similar debt instruments of comparable maturities.  This rate was represented by the US Treasury Three-Year Yield Curve Rate (0.36% and 0.41% for December 28, 2012 and June 30, 2012, respectively), plus the current add-on related to the revolving loan agreement (1.50% for December 28, 2012 and June 30, 2012).  The fair value of the Company’s 10-year unsecured senior notes due April 10, 2016 was approximately $15,499,000 and $15,768,000 at December 28, 2012 and June 30, 2012, respectively.  The Company’s revolving loan agreement approximates fair value at December 28, 2012 and June 30, 2012.  If measured at fair value in the financial statements, long-term debt (including the current portion) would be classified as Level 2 in the fair value hierarchy.

K.  
Shareholders’ Equity

On February 1, 2008, the Board of Directors authorized the purchase of 500,000 shares of Common Stock at market values.  On July 27, 2012, the Board of Directors authorized the purchase of an additional 375,000 shares of Common Stock at market values.  These authorizations have no expiration.  The Company purchased 125,000 shares of its outstanding Common Stock in the fourth quarter of fiscal 2012 and 185,000 shares in the first six months of fiscal 2013.

The following is a reconciliation of the Company’s equity balances for the first fiscal six months of 2012 and 2013 (in thousands):
 
Twin Disc, Inc. Shareholders’ Equity
   
     
Accumulated
     
     
Other
 
Non-
 
 
Common
Retained
Comprehensive
Treasury
Controlling
Total
 
Stock
Earnings
Income (Loss)
Stock
Interest
Equity
Balance –June 30, 2011
$10,863
$161,449
($11,383)
($25,252)
$969
$136,646
             
Net income
 
15,496
   
63
15,559
Translation adjustments
   
(8,590)
 
57
(8,533)
Benefit plan adjustments, net of tax
   
885
   
885
Cash dividends
 
(1,828)
   
(130)
(1,958)
Compensation expense and
           
windfall tax benefits
1,653
       
1,653
Shares (acquired) issued, net
(912)
   
896
 
(16)
Balance-December 30, 2011
$11,604
$175,117
($19,088)
($24,356)
$959
$144,236
             
 
Twin Disc, Inc. Shareholders’ Equity
 
 
     
Accumulated
     
     
Other
 
Non-
 
 
Common
Retained
Comprehensive
Treasury
Controlling
Total
 
Stock
Earnings
Income (Loss)
Stock
Interest
Equity
Balance-June 30, 2012
$12,759
$184,306
($34,797)
($26,781)
$1,022
$136,509
Net income
 
4,591
   
94
4,685
Translation adjustments
   
3,334
 
60
3,394
Benefit plan adjustments, net of tax
   
1,320
   
1,320
Cash dividends
 
(2,055)
   
(204)
(2,259)
Compensation expense and
           
windfall tax benefits
2,079
       
2,079
Shares (acquired) issued, net
(2,937)
   
(1,642)
 
(4,579)
Balance-December 28, 2012
$11,901
$186,842
($30,143)
($28,423)
$972
$141,149

Item 2.                      Management Discussion and Analysis

In the financial review that follows, we discuss our results of operations, financial condition and certain other information.  The figures discussed in this review reflect the revision described in Note A.  This discussion should be read in conjunction with our consolidated fiscal 2012 financial statements and related notes.

Some of the statements in this Quarterly Report on Form 10-Q are “forward looking statements” as defined in the Private Securities Litigation Reform Act of 1995.  Forward-looking statements include the Company’s description of plans and objectives for future operations and assumptions behind those plans.  The words “anticipates,” “believes,” “intends,” “estimates,” and “expects,” or similar anticipatory expressions, usually identify forward-looking statements. In addition, goals established by Twin Disc, Incorporated should not be viewed as guarantees or promises of future performance.  There can be no assurance the Company will be successful in achieving its goals.

In addition to the assumptions and information referred to specifically in the forward-looking statements, other factors, including but not limited to those factors discussed under Item 1A, Risk Factors, of the Company’s Annual Report filed on Form 10-K for June 30, 2012 could cause actual results to be materially different from what is presented here.

Results of Operations

(In thousands)
               
 
Three Months Ended
Six Months Ended
 
December 28,
December 30,
December 28,
December 30,
 
2012
%
2011
%
2012
%
2011
%
                 
Net sales
$72,325
 
$82,941
 
$141,118
 
$164,271
 
Cost of goods sold
50,014
 
53,379
 
99,391
 
103,941
 
                 
Gross profit
22,311
30.8%
29,562
35.6%
41,727
29.6%
60,330
36.7%
                 
Marketing, engineering and
               
administrative expenses
16,770
23.2
20,097
24.2
33,390
23.7
36,006
21.9
                 
Earnings from operations
$5,541
7.7
$9,465
11.4
$8,337
5.9
$24,324
14.8


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

Net sales for the second quarter decreased 12.8%, or $10.6 million, to $72.3 million from the record $82.9 million in the same period a year ago.  Compared to the second quarter of fiscal 2012, on average, the euro and Asian currencies weakened against the U.S. dollar.  The net translation effect of this on foreign operations was to decrease revenues by approximately $0.7 million versus the prior year, before eliminations.  The decrease in sales was primarily the result of lower demand from customers in the pressure pumping sector of the North American oil and gas market.  Offsetting weakness in this market was higher demand from customers in the North American and Asian commercial marine markets.  Sales to customers serving the global mega yacht market remained at historical lows in the quarter, while demand remained steady for equipment used in the airport rescue and fire fighting (ARFF), and military markets.

Sales at our manufacturing segment were down 14.3% versus the same period last year.  Compared to the second quarter of fiscal 2012, on average, the euro weakened against the U.S. dollar.  The net translation effect of this on foreign manufacturing operations was to decrease revenues for the manufacturing segment by approximately $0.7 million versus the prior year, before eliminations.  In the current fiscal year’s second quarter, our domestic manufacturing operation saw a decrease in sales of 14.5% versus the second fiscal quarter of 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 16.7% decrease in sales compared to the prior fiscal year’s second quarter.  Nearly a third of this decrease relates to foreign currency translation.  The Company’s Belgian manufacturing operation, which also continues to be adversely impacted by the softness in the global mega yacht market, saw a 14.4% decrease in sales versus the prior fiscal year’s second quarter.  A little more than half of the decrease was driven by foreign exchange translation, as the Euro weakened against the U.S. Dollar compared to the second quarter of fiscal 2012.  The Company’s Swiss manufacturing operation, which supplies customized propellers for the global mega yacht and patrol boat markets, experienced flat sales.

Our distribution segment experienced an increase of 16.0% in sales compared to the second quarter of fiscal 2012.  Compared to the second quarter of fiscal 2012, 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 $0.8 million versus the prior year, before eliminations.  The Company’s distribution operation in Singapore continues to experience record demand for marine transmission products for use in various commercial applications.  This operation saw a nearly 50% increase in shipments versus the prior fiscal year’s record second quarter.  The Company’s distribution operation in the Northwest of the United States and Southwest of Canada experienced a decrease in sales of just over 40% versus the prior fiscal year’s record second quarter.  This operation continued to be impacted by the 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, saw a 5% decrease in sales due to continued weakness in the global mega yacht market as well as customer requests to delay shipments.  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 7%.

The elimination for net inter/intra segment sales increased $4.1 million, including an unfavorable exchange movement of $0.8 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 480 basis points to 30.8% of sales, compared to 35.6% of sales for the same period last year.  Gross profit for fiscal 2013’s second quarter was significantly impacted by lower sales volumes, primarily due to lower shipments to the Company’s North American pressure pumping transmission customers (approximately $5.4 million), a less profitable mix related to the Company’s oil and gas transmission business (approximately $1.2 million), and unfavorable manufacturing efficiency and absorption due to lower volumes.

For the fiscal 2013 second quarter, marketing, engineering and administrative (ME&A) expenses, as a percentage of sales, were 23.2 %, compared to 24.2 % for the fiscal 2012 second quarter.  ME&A expenses decreased $3.3 million versus the same period last fiscal year.  Stock-based compensation expense decreased $2.4 million versus the prior year’s second fiscal quarter.  In addition, the annual bonus expense decreased approximately $1 million versus the prior year’s second fiscal quarter.

Interest expense of $0.3 million for the quarter was down 13.6% versus last year’s second fiscal quarter.  Total interest on the Company’s $40 million revolving credit facility (“revolver”) increased 9% to $0.1 million in fiscal 2013’s second quarter.  This increase can be attributed to an overall increase in the average borrowings year-over-year, partially offset by a lower interest rate on the revolver.  The average borrowing on the revolver, computed monthly, increased to $22.5 million in fiscal 2013’s second quarter, compared to $22.0 million in the same period a year ago.  The interest rate on the revolver decreased from a range of 1.74% to 2.12% in the prior fiscal year’s second quarter to a range of 1.71% to 1.73% in the current year.  The interest expense on the Company’s $25 million Senior Note decreased 20%, at a fixed rate of 6.05%, to $0.2 million, due to a lower remaining principal balance.

Other income of $0.0 million for the quarter ended December 28, 2012 decreased from other income of $0.2 million for the comparable period a year ago.  The prior year’s improvement was due primarily to favorable foreign currency movements of the Euro, Canadian Dollar and Swiss Franc.

The effective tax rate for the first half of fiscal 2013 is 38.3 percent, which is slightly higher than the prior year rate of 35.5 percent.  The current year rate is somewhat inflated due to the non-deductibility of the losses in certain foreign jurisdictions during the first half, due to an ongoing valuation allowance determination, on an overall reduced earnings base.  The favorable impact of the recently extended research and development tax credit will be recorded in the third fiscal quarter, as it was signed January 2, 2013.  The Company estimates the favorable impact of this item to be approximately $0.5 million.

Comparison of the First Six Months of FY 2013 with the First Six Months of FY 2012

Net sales for the first six months of fiscal 2013 decreased 14.1%, or $23.2 million, to $141.1 million from a record $164.3 million in the same period a year ago.  Compared to the first six months of 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 $2.8 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 in the first half, while demand remained steady for equipment used in the airport rescue and fire fighting (ARFF), and military markets.

Sales at our manufacturing segment were down 16.0% versus the same period last year.  Compared to the first six months of 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 $2.7 million versus the prior year, before eliminations.  In the current fiscal year’s first six months, our domestic manufacturing operation saw a decrease of nearly 19% in sales versus the first six months of 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 24.1% decrease compared to the prior fiscal year’s first six months.  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 a nearly 2% increase in sales versus the prior fiscal year’s first six months.  Adjusted for unfavorable foreign currency translation, the increase would have been closer to 6.5%.  The Company’s Swiss manufacturing operation, which supplies customized propellers for the global mega yacht and patrol boat markets, experienced a 13.5% decrease in sales.

Our distribution segment experienced a slight increase of 2.5% in sales compared to the first six months of fiscal 2012.  Compared to the first six months of fiscal 2012, on average, the Asian currencies strengthened again the U.S. dollar.  The net translation effect of this on foreign distribution operations was to increase revenues for the distribution segment by approximately $0.5 million versus the prior year, before eliminations.  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 62.3% increase in sales versus the prior fiscal year’s record first six months.  The Company’s distribution operation in the Northwest of the United States and Southwest of Canada experienced a nearly 56% 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, saw a decrease in sales of 6.7% 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 nearly 12%.

The elimination for net inter/intra segment sales increased $0.1 million, including an unfavorable exchange movement of $0.6 million, accounting for the remainder of the net change in sales versus the same period last year.

Gross profit as a percentage of sales decreased 710 basis points to 29.6% of sales, compared to 36.7% of sales for the same period last year.  Gross profit for fiscal 2013’s first six months was significantly impacted by lower sales volumes, primarily due to lower shipments to the Company’s North American pressure pumping transmission customers (approximately $11.7 million), a less profitable mix related to the Company’s oil and gas transmission business (approximately $2.9 million), and unfavorable manufacturing efficiency and absorption due to lower volumes.

Year-to-date, ME&A expenses, as a percentage of sales, were 23.7 %, compared to 21.9 % for the fiscal 2012 first six months.  For the fiscal 2013 first half, ME&A expenses decreased $2.6 million versus the same period last fiscal year.  Stock based compensation expense in the fiscal 2013 first half of $0.9 million decreased $1.5 million versus the same period a year ago.  In addition, the annual bonus expense decreased approximately $1.9 million versus the prior year’s first six months.  Year-to-date, movements in foreign exchange rates decreased ME&A expenses by $0.8 million versus the comparable period a year ago.  The net remaining increase primarily relates to increased research and development activities, age inflation and additional headcount, partially offset by lower pension expense.

Interest expense of $0.6 million for the first six months was down 14.1% versus last fiscal year’s first six months.  Total interest on the Company’s $40 million revolving credit facility (“revolver”) increased 4% to $0.2 million in fiscal 2013’s first six months versus the same period a year ago.  This increase can be attributed to an overall increase in the average borrowing year-over-year, partially offset by a decrease in the interest rate on the revolver.  The average borrowing on the revolver, computed monthly, increased to $19.7 million in fiscal 2013’s first six months, compared to $17.9 million in the same period a year ago.  The interest rate on the revolver decreased from a range of 1.74% to 2.12% in the prior fiscal year’s first half to a range of 1.71% to 1.75% in the current year.  The interest expense on the Company’s $25 million Senior Note decreased 20%, at a fixed rate of 6.05%, to $0.4 million, due to a lower remaining principal balance.

The effective tax rate for the first half of fiscal 2013 is 38.3 percent, which is slightly higher than the prior year rate of 35.5 percent.  The current year rate is somewhat inflated due to the non-deductibility of the losses in certain foreign jurisdictions during the first half, due to an ongoing valuation allowance determination, on an overall reduced earnings base.  The favorable impact of the recently extended research and development tax credit will be recorded in the third fiscal quarter, as it was signed January 2, 2013.  The Company estimates the favorable impact of this item to be approximately $0.5 million.

Financial Condition, Liquidity and Capital Resources

Comparison between December 28, 2012 and June 30, 2012

As of December 28, 2012, the Company had net working capital of $132.3 million, which represents an increase of $1.7 million, or just over 1%, from the net working capital of $130.5 million as of June 30, 2012.

Cash increased $4.9 million to $20.6 million as of December 28, 2012, versus $15.7 million as of June 30, 2012.  The majority of the cash as of December 28, 2012 is at our overseas operations in Europe and Asia-Pacific.

Trade receivables of $38.5 million were down $25.0 million, or nearly 40%, when compared to last fiscal year-end.  The impact of foreign currency translation was to increase accounts receivable by $0.8 million versus June 30, 2012.  The net remaining decrease is consistent with the sales volume decrease versus the fourth quarter of fiscal 2012.  Historically, the fourth fiscal quarter generally is the strongest sales quarter of the fiscal year.

Net inventory increased by $15.1 million versus June 30, 2012 to $118.3 million.  The impact of foreign currency translation was to increase net inventory by $2.1 million versus June 30, 2012.  After adjusting for the impact of foreign currency translation, the net increase of $13.0 million primarily came at the Company’s domestic manufacturing and Asian distribution locations.  The increase was driven primarily by an elevated level of oil and gas transmissions inventory that has yet to work its way through sales as well as increased inventory to meet increased demand from North American and Asian commercial marine markets.  On a consolidated basis, as of December 28, 2012, the Company’s backlog of orders to be shipped over the next six months approximates $68.2 million, compared to $98.7 million at June 30, 2012 and $148.5 million at December 30, 2011.  The majority of the decrease is being experienced at the Company’s domestic manufacturing location due to continued softness in the North American pressure pumping transmission market.  As a percentage of six month backlog, inventory has increased from 104% at June 30, 2012 to 173% at December 28, 2012.

Net property, plant and equipment (PP&E) decreased $0.6 million versus June 30, 2012.  This includes the addition of $3.5 million in capital expenditures, primarily at the Company’s Racine-based manufacturing operation, which was partially offset by depreciation of $5.0 million.  The net remaining decrease is due to foreign currency translation effects.  In total, the Company expects to invest approximately $10 million in capital assets in fiscal 2013.  The Company continues to review its capital plans based on overall market conditions and availability of capital, and may make changes to its capital plans accordingly.  In addition, the quoted lead times on certain manufacturing equipment purchases may push some of the capital expenditures into the next fiscal year.  In fiscal 2012, the Company spent $13.7 million for capital expenditures, up from $12.0 million and $4.5 million in fiscal years 2011 and 2010, 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 28, 2012 of $24.4 million were up $0.8 million, or 3.5%, from June 30, 2012.  The impact of foreign currency translation was to increase accounts payable by $0.7 million versus June 30, 2012.

Total borrowings and long-term debt as of December 28, 2012 increased by $1.8 million, or roughly 6%, to $34.0 million versus June 30, 2012.  This increase was driven by the overall increase in working capital levels, primarily driven by an increase in inventory and a net decrease in accrued liabilities, and the repurchase of $3.1 million (185,000 shares) of the Company’s stock.  These were substantially offset by a nearly $25 million reduction in accounts receivable.  In addition, the Company made payments for its annual incentive program in the first fiscal quarter of 2012 based on the achievement of fiscal 2012 targets.

Total equity increased $4.6 million, or 3%, to $141.1 million as of December 28, 2012.  Retained earnings increased by $2.5 million.  The net increase in retained earnings included $4.6 million in net earnings attributable to Twin Disc for the first six months offset by $2.1 million in dividend payments.  Net favorable foreign currency translation of $3.4 million was reported.  In addition, the adjustment for the amortization of net actuarial loss and prior service cost on the Company’s defined benefit pension plans was $1.3 million.  The net remaining movement of $2.6 million primarily relates to changes in Treasury Stock, including the repurchase of 185,000 shares of the Company’s stock for $3.1 million in the second fiscal quarter.

In December 2002, the Company entered into a $20,000,000 revolving loan agreement with M&I Marshall & Ilsley Bank (“M&I”), which had an original expiration date of October 31, 2005.  Through a series of amendments, the last of which was agreed to during the fourth quarter of fiscal 2011, the total commitment was increased to $40,000,000 and the term was extended to May 31, 2015.  This agreement contains certain covenants, including restrictions on investments, acquisitions and indebtedness.  Financial covenants include a minimum consolidated net worth, minimum EBITDA for the most recent four fiscal quarters of $11,000,000 at December 28, 2012, and a maximum total funded debt to EBITDA ratio of 3.0 at December 28, 2012.  As of December 28, 2012, the Company was in compliance with these covenants with a four quarter EBITDA total of $40,156,000 and a funded debt to EBITDA ratio of 0.85.  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 28, 2012 the minimum equity requirement was $119,373,000 compared to an actual result of $174,177,000 after all required adjustments.  The outstanding balance of $19,500,000 and $17,550,000 at December 28, 2012 and June 30, 2012, respectively, is classified as long-term debt.  In accordance with the loan agreement as amended, the Company can borrow at LIBOR plus an additional “Add-On,” between 1.5% and 2.5%, depending on the Company’s Total Funded Debt to EBITDA ratio.  The rate was 1.71% and 1.74% at December 28, 2012 and June 30, 2012, respectively.

On April 10, 2006, the Company entered into a Note Agreement (the “Note Agreement”) with The Prudential Insurance Company of America and certain other entities (collectively, “Purchasers”).  Pursuant to the Note Agreement, Purchasers acquired, in the aggregate, $25,000,000 in 6.05% Senior Notes due April 10, 2016 (the “Notes”).  The Notes mature and become due and payable in full on April 10, 2016 (the “Payment Date”).  Prior to the Payment Date, the Company is obligated to make quarterly payments of interest during the term of the Notes, plus prepayments of principal of $3,571,429 on April 10 of each year from 2010 to 2015, inclusive.  The outstanding balance was $14,285,714 at December 28, 2012 and June 30, 2012, respectively.  Of the outstanding balance, $3,571,429 was classified as a current maturity of long-term debt at December 28, 2012 and June 30, 2012, respectively.  The remaining $10,714,286 is classified as long-term debt. The Company also has the option of making additional prepayments subject to certain limitations, including the payment of a Yield-Maintenance Amount as defined in the Note Agreement.  In addition, the Company will be required to make an offer to purchase the Notes upon a Change of Control, and any such offer must include the payment of a Yield-Maintenance Amount.  The Note Agreement includes certain financial covenants which are identical to those associated with the revolving loan agreement discussed above.  The Note Agreement also includes certain restrictive covenants that limit, among other things, the incurrence of additional indebtedness and the disposition of assets outside the ordinary course of business.  The Note Agreement provides that it shall automatically include any covenants or events of default not previously included in the Note Agreement to the extent such covenants or events of default are granted to any other lender of an amount in excess of $1,000,000.  Following an Event of Default, each Purchaser may accelerate all amounts outstanding under the Notes held by such party.

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 M&I 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 December 28, 2012, there were no borrowings under the Credit Agreement.

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

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

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

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

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

Four Quarter EBITDA Reconciliation
 
Net Earnings
$15,838,000
Depreciation & Amortization
  10,790,000
Interest Expense
    1,370,000
Income Taxes
  12,158,000
Four Quarter EBITDA
$40,156,000
   
Total Funded Debt to Four Quarter EBITDA
 
Total Debt
$33,994,000
Divided by: Four Quarter EBITDA
  40,156,000
  Total Funded Debt to Four Quarter EBITDA
             0.85
   
As of December 28, 2012, the Company was in compliance with all of the covenants described above.  As of December 28, 2012, the Company’s backlog of orders scheduled for shipment during the next six months (six-month backlog) was $68.2 million, or approximately 31% lower than the six-month backlog of $98.7 million as of June 30, 2012.  In spite of the decrease in order backlog driven primarily by the recent decline in the North American oil and gas market, as rig operators adjust to the natural gas supply overhang and lower prices, the Company does not expect to violate any of its financial covenants in fiscal 2013.  The current margin surrounding ongoing compliance with the above covenants, in particular, minimum EBITDA for the most recent four fiscal quarters and total funded debt to EBITDA, are expected to continue to decrease in fiscal 2013.  Please see the factors discussed under Item 1A, Risk Factors, of the Company’s Annual Report filed on Form 10-K for June 30, 2012 for further discussion of this topic.

The Company’s balance sheet remains very strong, there are no off-balance-sheet arrangements other than the operating leases listed below, and we continue to have sufficient liquidity for near-term needs.  The Company had $20.5 million of available borrowings on our $40 million revolving loan agreement as of December 28, 2012 as well as $15 million available under its recently announced 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.  As of December 28, 2012, the Company also had cash of $20.6 million, primarily at its overseas operations.  These funds, with some restrictions, are available for repatriation as deemed necessary by the Company.  In fiscal 2012, the Company expects to contribute $4.4 million to its defined benefit pension plans, the minimum contributions required.  However, if the Company elects to make voluntary contributions in fiscal 2012, it intends to do so using cash from operations and, if necessary, from available borrowings under existing credit facilities.  As of December 28, 2012, $3.6 million in contributions have been made.

As of December 28, 2012, the Company has obligations under non-cancelable operating lease contracts and loan and senior note agreements for certain future payments.  A summary of those commitments follows (in thousands):

 
 
Contractual Obligations
 
 
Total
 
Less than
1 year
 
1-3
Years
 
3-5
Years
 
After 5
Years
Revolver borrowing
$19,500
 
$19,500
   
Long-term debt
$14,494
$3,697
$7,197
$3,572
$28
Operating leases
$6,981
$3,120
$2,705
$1,156
 
Total obligations
$40,975
$6,817
$29,402
$4,728
$28

The table above does not include tax liabilities related to uncertain income tax positions totaling $1.5 million, excluding related interest and penalties, as the timing of their resolution can not be estimated.  See Note H of the Condensed Consolidated Financial Statements for disclosures surrounding uncertain income tax positions.

The Company maintains defined benefit pension plans for some of its operations in the United States and Europe.  The Company has established the Pension Committee to manage the operations and administration of the defined benefit plans.  The Company estimates that fiscal 2013 contributions to all defined benefit plans will total $4.4 million.  As of December 28, 2012, $3.6 million in contributions have been made.

New Accounting Releases

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

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

Critical Accounting Policies

The preparation of this Quarterly Report requires management’s judgment to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the dates of the financial statements, and the reported amounts of revenues and expenses during the reporting period.  There can be no assurance that actual results will not differ from those estimates.

Twin Disc’s critical accounting policies are described in Item 7 of the Company’s Annual Report filed on Form 10-K for June 30, 2012.  There have been no significant changes to those accounting policies subsequent to June 30, 2012.

Item 3.                      Quantitative and Qualitative Disclosure About Market Risk

The Company is exposed to market risks from changes in interest rates, commodities and foreign exchange.  To reduce such risks, the Company selectively uses financial instruments and other pro-active management techniques.  All hedging transactions are authorized and executed pursuant to clearly defined policies and procedures, which prohibit the use of financial instruments for trading or speculative purposes.

Interest rate risk - The Company’s earnings exposure related to adverse movements of interest rates is primarily derived from outstanding floating rate debt instruments that are indexed to the prime and LIBOR interest rates.  In accordance with the $40,000,000 revolving loan agreement expiring May 31, 2015, the Company has the option of borrowing at the prime interest rate or LIBOR plus an additional “Add-On”, between 1.5% and 2.5%, depending on the Company’s Total Funded Debt to EBITDA ratio.  Due to the relative stability of interest rates, the Company did not utilize any financial instruments at December 28, 2012 to manage interest rate risk exposure.  A 10 percent increase or decrease in the applicable interest rate would result in a change in pretax interest expense of approximately $33,000.

Commodity price risk - The Company is exposed to fluctuation in market prices for such commodities as steel and aluminum.  The Company does not utilize commodity price hedges to manage commodity price risk exposure.

Stock market risk - The Company’s earnings are exposed to stock market risk relative to the Performance Stock Unit Awards.  These are cash based awards which are revalued at the end of each reporting period based upon the Company’s closing stock price as of the end of the period.  A one dollar increase or decrease in the Company’s stock price would result in a decrease or increase, respectively, in earnings from operations of approximately $98,000 as of December 28, 2012.  These awards were valued based upon the average of the high and low of the Company’s December 28, 2012 stock price of $17.06.

Currency risk - The Company has exposure to foreign currency exchange fluctuations.  Approximately 21% of the Company’s revenues in the six months ended December 28, 2012 were denominated in currencies other than the U.S. dollar.  Of that total, approximately 70% was denominated in euros with the balance composed of Japanese yen, the Swiss franc and the Australian and Singapore dollars.  The Company does not hedge the translation exposure represented by the net assets of its foreign subsidiaries.  Foreign currency translation adjustments are recorded as a component of shareholders’ equity.  Forward foreign exchange contracts are occasionally used to hedge the currency fluctuations on significant transactions denominated in foreign currencies.

Derivative financial instruments - The Company has written policies and procedures that place all financial instruments under the direction of the Company corporate treasury and restrict derivative transactions to those intended for hedging purposes.  The use of financial instruments for trading purposes is prohibited.  The Company occasionally uses financial instruments to manage the market risk from changes in foreign exchange rates.

The Company primarily enters into forward exchange contracts to reduce the earnings and cash flow impact of non-functional currency denominated receivables and payables.  These contracts are highly effective in hedging the cash flows attributable to changes in currency exchange rates.  Gains and losses resulting from these contracts offset the foreign exchange gains or losses on the underlying assets and liabilities being hedged.  The maturities of the forward exchange contracts generally coincide with the settlement dates of the related transactions.  Gains and losses on these contracts are recorded in Other expense, net in the Condensed Consolidated Statement of Operations as the changes in the fair value of the contracts are recognized and generally offset the gains and losses on the hedged items in the same period.  The primary currency to which the Company was exposed in fiscal 2013 and 2012 was the euro.  The Company had no outstanding forward exchange contracts at December 28, 2012 or June 30, 2012.

Item 4.                      Controls and Procedures

(a)           Evaluation of Disclosure Controls and Procedures

The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, have evaluated the effectiveness of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (“the Exchange Act”)) as of the end of the period covered by this report.  Based on such evaluation,  the Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Company’s disclosure controls and procedures are effective in recording, processing, summarizing, and reporting, on a timely basis, information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act, and that such information is accumulated and communicated to the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely discussions regarding required disclosure.

(b)           Changes in Internal Control Over Financial Reporting

Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f).  During the period covered by this report, no changes were made which have materially affected, or which are reasonably likely to materially affect, our internal control over financial reporting.

Part II.                      OTHER INFORMATION

Item 1.                      Legal Proceedings

Twin Disc is a defendant in several product liability or related claims which are considered either adequately covered by appropriate liability insurance or involving amounts not deemed material to the business or financial condition of the Company.

Item 1A.                      Risk Factors

There have been no material changes to the risk factors previously disclosed in response to Item 1A to Part I of our 2012 Annual Report on Form 10-K.

Item 2.                      Unregistered Sales of Equity Securities and Use of Proceeds

(a)  
Unregistered Sales of Equity Securities

There were no securities of the Company sold by the Company during the six months ended December 28, 2012, which were not registered under the Securities Act of 1933, in reliance upon an exemption from registration provided by Section 4 (2) of the Act.

(b)  
Use of Proceeds

Not applicable.

(c)  
Issuer Purchases of Equity Securities

Issuer Purchases of Equity Securities

Period
(a) Total Number of Shares Purchased
(b) Average Price Paid per Share
(c) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
(d) Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs
         
Sept. 29, 2012 – Oct. 26, 2012
0
NA
0
500,000
         
Oct. 27, 2012 – Nov. 30, 2012
85,050
$16.02
85,050
414,950
         
Dec. 1, 2012 – Dec. 28, 2012
99,950
$17.07
99,950
315,000
         
Total
185,000
$16.59
185,000
315,000

On February 1, 2008, the Board of Directors authorized the purchase of up to 500,000 shares of Common Stock at market values, of which 250,000 shares were purchased during fiscal 2009 and 125,000 shares were purchased during fiscal 2012.  On July 27, 2012, the Board of Directors authorized the purchase of an additional 375,000 shares of Common Stock at market values.  This authorization has no expiration.  During the second quarter of fiscal 2013, the Company purchased 185,000 shares under this authorization.

Item 3.                      Defaults Upon Senior Securities

None.

Item 5.                      Other Information

None.

Item 6.                      Exhibits

31a
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31b
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32a
Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32b
Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101.INS
XBRL Instance Document

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XBRL Schema

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XBRL Calculation Linkbase

101.DEF
XBRL Definition Linkbase

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XBRL Label Linkbase

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XBRL Presentation Linkbase

 
 

 

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.



 
TWIN DISC, INCORPORATED
 
(Registrant)
   
   
Date:  February 6, 2013
/s/ JEFFREY S. KNUTSON
 
Jeffrey S. Knutson
 
Corporate Controller
 
Chief Accounting Officer