TWIN DISC INC - Quarter Report: 2019 December (Form 10-Q)

 

 

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 27, 2019

 

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)

 

Securities registered pursuant to Section 12(b) of the Exchange Act:

 

Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock (No Par Value)	TWIN	The NASDAQ Stock Market LLC

 

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 every Interactive Data File required to be submitted 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 such files).          Yes  ☑      No  ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer ☐	Accelerated Filer ☑
Non-accelerated filer ☐	Smaller reporting company ☑
Emerging growth company ☐

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

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 30, 2020, the registrant had 13,405,993 shares of its common stock outstanding.

 

 

 

		December 27, 2019				June 30, 2019
ASSETS
Current assets:
Cash		$	14,836			$	12,362
Trade accounts receivable, net			33,302				44,013
Inventories			134,658				125,893
Prepaid expenses			5,522				11,681
Other			7,544				8,420
Total current assets			195,862				202,369
Property, plant and equipment, net			73,768				71,258
Goodwill, net			25,561				25,954
Intangible assets, net			22,625				25,353
Deferred income taxes			21,459				18,178
Other assets			4,006				3,758
Total assets		$	343,281			$	346,870
LIABILITIES AND EQUITY
Current liabilities:
Current maturities of long-term debt		$	2,000			$	2,000
Accounts payable			26,259				31,468
Accrued liabilities			47,730				41,646
Total current liabilities			75,989				75,114
Long-term debt			50,512				40,491
Lease obligations			13,850				12,646
Accrued retirement benefits			24,607				25,878
Deferred income taxes			6,744				7,429
Other long-term liabilities			2,094				2,494
Total liabilities			173,796				164,052
Commitments and contingencies (Note D)
Equity:
Twin Disc shareholders' equity:
Preferred shares authorized: 200,000; issued: none; no par value			-				-
Common shares authorized: 30,000,000; issued: 14,632,802; no par value			42,305				45,047
Retained earnings			183,645				196,472
Accumulated other comprehensive loss			(38,230	)			(37,971	)
			187,720				203,548
Less treasury stock, at cost (1,226,809 and 1,392,524 shares, respectively)			18,796				21,332
Total Twin Disc shareholders' equity			168,924				182,216
Noncontrolling interest			561				602
Total equity			169,485				182,818
Total liabilities and equity		$	343,281			$	346,870

 

		For the Quarter Ended								For the Two Quarters Ended
		December 27, 2019				December 28, 2018				December 27, 2019				December 28, 2018
Net sales		$	59,536			$	78,107			$	118,826			$	152,796
Cost of goods sold			43,825				52,019				93,479				102,723
Gross profit			15,711				26,088				25,347				50,073
Marketing, engineering and administrative expenses			16,413				18,909				32,759				37,894
Restructuring expenses			4,248				434				4,369				607
(Loss) income from operations			(4,950	)			6,745				(11,781	)			11,572
Interest expense			447				417				836				1,134
Other expense (income), net			29				798				720				1,118
			476				1,215				1,556				2,252
(Loss) income before income taxes and noncontrolling interest			(5,426	)			5,530				(13,337	)			9,320
Income tax expense (benefit)			1,040				1,451				(578	)			2,338
Net (loss) income			(6,466	)			4,079				(12,759	)			6,982
Less: Net earnings attributable to noncontrolling interest, net of tax			(50	)			(6	)			(68	)			(47	)
Net (loss) income attributable to Twin Disc		$	(6,516	)		$	4,073			$	(12,827	)		$	6,935
(Loss) income per share data:
Basic (loss) income per share attributable to Twin Disc common shareholders		$	(0.49	)		$	0.31			$	(0.98	)		$	0.56
Diluted (loss) income per share attributable to Twin Disc common shareholders		$	(0.49	)		$	0.31			$	(0.98	)		$	0.56
Weighted average shares outstanding data:
Basic shares outstanding			13,164				12,909				13,135				12,233
Diluted shares outstanding			13,164				12,997				13,135				12,304
Comprehensive (loss) income
Net (loss) income		$	(6,466	)		$	4,079			$	(12,759	)		$	6,982
Benefit plan adjustments, net of income taxes of $169, $146, $338 and $292, respectively			548				478				1,105				949
Foreign currency translation adjustment			1,647				(1,786	)			(1,349	)			(2,347	)
Unrealized income on cash flow hedge, net of income taxes of ($45), $0, ($1) and $0, respectively			146				-				3				-
Comprehensive (loss) income			(4,125	)			2,771				(13,000	)			5,584
Less: Comprehensive (income) loss attributable to noncontrolling interest			(50	)			7				(86	)			(9	)
Comprehensive (loss) income attributable to Twin Disc		$	(4,175	)		$	2,778			$	(13,086	)		$	5,575

 

		For the Two Quarters Ended
		December 27, 2019				December 28, 2018
Cash flows from operating activities:
Net (loss) income		$	(12,759	)		$	6,982
Adjustments to reconcile net (loss) income to net cash provided (used) by operating activities, net of acquired assets:
Depreciation and amortization			5,926				4,510
Restructuring expenses			3,844				-
Provision for deferred income taxes			(3,901	)			2,555
Stock compensation expense and other non-cash changes, net			774				1,506
Amortization of inventory fair value step-up			-				2,173
Net change in operating assets and liabilities			6,232				(21,505	)
Net cash provided (used) by operating activities			116				(3,779	)
Cash flows from investing activities:
Acquisitions of fixed assets			(6,860	)			(6,676	)
Proceeds from sale of fixed assets			55				63
Other, net			(129	)			(129	)
Acquisition of Veth Propulsion, less cash acquired			-				(59,651	)
Net cash used by investing activities			(6,934	)			(66,393	)
Cash flows from financing activities:
Borrowings under revolving loan arrangement			58,993				93,675
Repayments of revolver loans			(48,130	)			(62,326	)
Repayments of long term debt			(603	)			(24,230	)
Dividends paid to noncontrolling interest			(127	)			(115	)
Payments of withholding taxes on stock compensation			(913	)			(926	)
Proceeds from issuance of common stock, net			-				32,210
Proceeds from exercise of stock options			-				36
Borrowings under term debt arrangement			-				35,000
Net cash provided by financing activities			9,220				73,324
Effect of exchange rate changes on cash			72				219
Net change in cash			2,474				3,371
Cash:
Beginning of period			12,362				15,171
End of period		$	14,836			$	18,542

 

A.	Basis of Presentation

 

The unaudited condensed consolidated financial statements have been prepared by Twin Disc, Incorporated (the “Company”) pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) and, in the opinion of the Company, include adjustments, consisting primarily of normal recurring items, necessary for a fair statement 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 Annual Report filed on Form 10-K for June 30, 2019. 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.

 

The consolidated financial statements and information presented herein include the financial results of Veth Propulsion Holding BV (“Veth Propulsion”), the acquisition of which was completed on July 2, 2018. The financial results included in this Form 10-Q related to the acquisition method of accounting for the Veth Propulsion acquisition have been finalized and completed.

 

Recently Adopted Accounting Standards

 

In June 2018, the FASB issued guidance (ASU 2018-07) intended to simplify the accounting for share based payments granted to nonemployees. Under the amendments in this guidance, payments to nonemployees would be aligned with the requirements for share-based payments granted to employees. The Company adopted this guidance effective July 1, 2019. The adoption of this guidance did not have a material impact on the Company’s financial statements and disclosures.

 

New Accounting Releases

 

In August 2018, the FASB issued updated guidance (ASU 2018-13) as part of the disclosure framework project, which focuses on improving the effectiveness of disclosures in the notes to the financial statements. The amendments in this update modify the disclosure requirements on fair value measurements in Topic 820, Fair Value Measurement. The amendments in this guidance are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019 (the Company’s fiscal 2021), with early adoption permitted. The Company is currently evaluating the potential impact of this guidance on the Company’s disclosures.

 

In August 2018, the FASB issued updated guidance (ASU 2018-14) intended to modify the disclosure requirements for employers that sponsor defined benefit pension or postretirement plans. The amendments in this guidance are effective for fiscal years ending after December 15, 2020 (the Company’s fiscal 2021), with early adoption permitted. The Company is currently evaluating the potential impact of this guidance on the Company’s disclosures.

 

In December 2019, the FASB issued guidance (ASU 2019-12) intended to simplify the accounting for income taxes. The amendments in this guidance are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020 (the Company’s fiscal 2022), with early adoption permitted. The Company is currently evaluating the potential impact of this guidance on the Company’s disclosures.

 

Special Note Regarding Smaller Reporting Company Status

 

Under SEC Release 33-10513; 34-83550, Amendments to Smaller Reporting Company Definition, the Company qualifies as a smaller reporting company and accordingly, it has scaled some of its disclosures of financial and non-financial information in this quarterly report. The Company will continue to determine whether to provide additional scaled disclosures of financial or non-financial information in future quarterly reports, annual reports and/or proxy statements if it remains a smaller reporting company under SEC rules.

 

 

 

B.	Inventories

 

The major classes of inventories were as follows:

 

 

 

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 for the quarters ended December 27, 2019 and December 28, 2018:

 

 

Included in the current fiscal half expense is a non-recurring warranty charge in the amount of $3,889, to accrue for estimated costs to resolve a unique product performance issue at certain installations.

 

The current portion of the warranty accrual ($4,856 and $3,309 as of December 27, 2019 and December 28, 2018, respectively) is reflected in accrued liabilities, while the long-term portion ($919 and $534 as of December 27, 2019 and December 28, 2018, respectively) 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, azimuth drives, 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's worldwide sales to both domestic and foreign customers are transacted through a direct sales force and a distributor network.

 

 

The Company has two reportable segments: manufacturing and distribution.  Its segment structure reflects the way management makes operating decisions and manages the growth and profitability of the business. It also corresponds with management’s approach of allocating resources and assessing the performance of its segments. 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 income.

 

Information about the Company’s segments is summarized as follows:

 

 

 

Disaggregated revenue:

 

The following table presents details deemed most relevant to the users of the financial statements for the quarters and two quarters ended December 27, 2019 and December 28, 2018.

 

Net sales by product group for the quarter ended December 27, 2019 is summarized as follows:

 

 

Net sales by product group for the quarter ended December 28, 2018 is summarized as follows:

 

 

Net sales by product group for the two quarters ended December 27, 2019 is summarized as follows:

 

 

Net sales by product group for the two quarters ended December 28, 2018 is summarized as follows:

 

 

 

 

F.	Stock-Based Compensation

 

Performance Stock Awards (“PSA”)

 

During the first half of fiscal 2020 and 2019, the Company granted a target number of 131.7 and 42.3 PSAs, respectively, to various employees of the Company, including executive officers. The fiscal 2020 PSAs will vest if the Company achieves performance-based target objectives relating to average return on invested capital, average annual sales and average annual Earnings Per Share (“EPS”) (as defined in the PSA Grant Agreement), in the cumulative three fiscal year period ending June 30, 2022. These PSAs are subject to adjustment if the Company’s return on invested capital, net sales, and EPS 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 184.8. Based upon actual results to date, the Company is currently accruing compensation expense for these PSAs.

 

The fiscal 2019 PSAs will vest if the Company achieves performance-based target objectives relating to average return on invested capital, average annual sales and average annual EPS (as defined in the PSA Grant Agreement), in the cumulative three fiscal year period ending June 30, 2021. These PSAs are subject to adjustment if the Company’s return on invested capital, net sales, and EPS 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 67.0. Based upon actual results to date, the Company is currently accruing compensation expense for the average annual sales component for these PSAs. The Company is not accruing compensation expense for the average return on invested capital and average annual EPS components for these PSAs.

 

There were 214.0 and 188.0 unvested PSAs outstanding at December 27, 2019 and December 28, 2018, respectively. The fair value of the PSAs (on the date of grant) is expensed over the performance period for the shares that are expected to ultimately vest. Compensation expense of ($52) and $242 was recognized for the quarters ended December 27, 2019 and December 28, 2018, respectively, related to PSAs. Compensation expense of $20 and $788 was recognized for the two quarters ended December 27, 2019 and December 28, 2018, respectively, related to PSAs. The weighted average grant date fair value of the unvested awards at December 27, 2019 was $15.24. At December 27, 2019, the Company had $2,355 of unrecognized compensation expense related to the unvested shares that would vest if the specified target objective was achieved for the fiscal 2020, 2019 and 2018 awards. The total fair value of PSAs vested as of December 27, 2019 and December 28, 2018 was $0.

 

Restricted Stock Awards (“RS”)

 

The Company has unvested RS awards outstanding that will vest if certain service conditions are fulfilled. The fair value of the RS grants is recorded as compensation expense over the vesting period, which is generally 1 to 3 years. During the first half of fiscal 2020 and 2019, the Company granted 180.4 and 35.6 service based restricted shares, respectively, to employees and non-employee directors. There were 231.4 and 185.3 unvested shares outstanding at December 27, 2019 and December 28, 2018, respectively. A total of 20.5 and 2.8 shares of restricted stock were forfeited during the two quarters ended December 27, 2019 and December 28, 2018, respectively. Compensation expense of $218 and $266 was recognized for the quarters ended December 27, 2019 and December 28, 2018, respectively. Compensation expense of $524 and $516 was recognized for the two quarters ended December 27, 2019 and December 28, 2018, respectively. The total fair value of restricted stock grants vested as of December 27, 2019 and December 28, 2018 was $1,241 and $2,102, respectively. As of December 27, 2019, the Company had $1,982 of unrecognized compensation expense related to restricted stock which will be recognized over the next three years.

 

Restricted Stock Unit Awards (“RSU”)

 

Under the 2018 Long Term Incentive Plan, the Company has been authorized to issue RSUs. The RSUs entitle the employee to shares of common stock of the Company if the employee remains employed by the Company through a specified date, generally three years from the date of grant. During the first half of fiscal 2019, the Company granted 38.0 RSUs to various employees of the Company, including executive officers. The fair value of the RSUs (on the date of grant) is recorded as compensation expense over the vesting period. There were 38.0 unvested RSUs outstanding at December 27, 2019 and at December 28, 2018. Compensation expense of $81 and $82 was recognized for the quarters ended December 27, 2019 and December 28, 2018, respectively. Compensation expense of $163 and $136 was recognized for the two quarters ended December 27, 2019 and December 28, 2018, respectively. The weighted average grant date fair value of the unvested awards at December 27, 2019 was $25.77. As of December 27, 2019, the Company had $516 of unrecognized compensation expense related to restricted stock which will be recognized over the next two years.

 

 

 

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. The components of the net periodic benefit cost for the defined benefit pension plans and the other postretirement benefit plan are as follows:

 

 

The Company expects to contribute approximately $1,936 to its pension plans in fiscal 2020. As of December 27, 2019, the amount of $785 in contributions has been made.

 

The Company has reclassified $548 (net of $169 in taxes) of benefit plan adjustments from accumulated other comprehensive loss during the quarter ended December 27, 2019, and $478 (net of $146 in taxes) during the quarter ended December 28, 2018. The Company has reclassified $1,105 (net of $338 in taxes) of benefit plan adjustments from accumulated other comprehensive loss during the two quarters ended December 27, 2019, and $949 (net of $292 in taxes) during the two quarters ended December 28, 2018. These reclassifications are included in the computation of net periodic benefit cost.

 

H.	Income Taxes

 

For the two quarters ended December 27, 2019 and December 28, 2018, the Company’s effective income tax rate was 4.3% and 25.1% respectively. Under the Tax Cuts and Jobs Act, a company is prohibited from recognizing certain foreign global intangible low taxed income (“GILTI”) deductions and credits when in a domestic loss position, but is required to include the foreign GILTI income inclusions. In the prior year, the Company recognized domestic income and recognized a net benefit of GILTI income inclusions and deductions which resulted in a net benefit of 0.67%. In the current year, the benefit generated from domestic losses was reduced by the required GILTI foreign income inclusions and no GILTI deductions. The $9,385 GILTI inclusion decreased the rate by 18.55%. Income generated in foreign jurisdictions and other tax preference items also impacted the rate.

 

The Company maintains valuation allowances when it is more likely than not that all or a portion of a deferred tax asset will not be realized. Changes in valuation allowances from period to period are included in the tax provision in the period of change. In determining whether a valuation allowance is required, the Company takes into account such factors as prior earnings history, expected future earnings, carry-back and carry-forward periods, and tax strategies that could potentially enhance the likelihood of realization of a deferred tax asset. In addition, all other available positive and negative evidence is taken into consideration, including all new impacts of tax reform. The Company has evaluated the realizability of the net deferred tax assets related to its operations and based on this evaluation management has concluded that no valuation allowances are required.

 

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 Company has approximately $1,158 of unrecognized tax benefits, including related interest and penalties, as of December 27, 2019, which, if recognized, would favorably impact the effective tax rate. There was no significant change in the total unrecognized tax benefits due to the settlement of audits, the expiration of statutes of limitations or for other items during the quarter ended December 27, 2019. It appears possible that the amount of unrecognized tax benefits could change in the next twelve months due to on-going audit activity.

 

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 in foreign jurisdictions are 2013 through 2019. The tax year open to exam in the Netherlands is 2019. The tax years open to examination in the U.S. are for years subsequent to fiscal 2015. The state of Wisconsin income tax audit remains ongoing for the fiscal years 2011 through 2013. It is reasonably possible that other audit cycles will be completed during fiscal 2020.

 

I.	Goodwill and Other Intangibles

 

Goodwill represents the amount of the consideration transferred in excess of the net of the acquisition-date fair values of the identifiable assets acquired and the liabilities assumed.

 

The Company reviews goodwill for impairment on a reporting unit basis annually as of the first day of the Company’s fourth fiscal quarter, and whenever events or changes in circumstances (“triggering events”) indicate that the carrying value of goodwill may not be recoverable.

 

The fair value of reporting units is primarily driven by projected growth rates and operating results under the income approach using a discounted cash flow model, which applies an appropriate market-participant discount rate, and consideration of other market approach data from guideline public companies. If declining actual operating results or future operating results become indicative that the fair value of the Company’s reporting units has declined below their carrying values, an interim goodwill impairment test may need to be performed and may result in a non-cash goodwill impairment charge.

 

During the first half of fiscal 2020, the Company determined that there were no triggering events to warrant an interim goodwill impairment test. As of December 27, 2019, goodwill in the amounts of $23,013 and $2,548 is carried in the European Propulsion and European Industrial reporting units, respectively.

 

As of December 27, 2019, changes in the carrying amount of goodwill is summarized as follows:

 

 

As of December 27, 2019, the following acquired intangible assets have definite useful lives and are subject to amortization:

 

 

Other intangibles consist of certain proprietary technology, computer software, patents and licensing agreements. Amortization is recorded on the basis of straight-line or accelerated, as appropriate, over the estimated useful lives of the assets.

 

The weighted average remaining useful life of the intangible assets included in the table above is approximately 9 years.

 

 

Intangible amortization expense was $1,143 and $583 for the quarters ended December 27, 2019, and December 28, 2018, respectively. Intangible amortization expense was $2,272 and $1,249 for the two quarters ended December 27, 2019, and December 28, 2018, respectively. Estimated intangible amortization expense for the remainder of fiscal 2020 and each of the next five fiscal years is as follows:

 

 

The gross carrying amount of the Company’s intangible assets that have indefinite lives and are not subject to amortization as of December 27, 2019 and June 30, 2019 was $200 and $200, respectively. These assets are comprised of acquired trade names.

 

J.	Long-term Debt

 

The Company’s long-term debt represents borrowings made under the credit agreement, as amended, which it entered into with BMO Harris Bank N.A, on June 29, 2018 (“Credit Agreement”). The borrowings consist of a term loan component (“Term Loan”) with an interest rate based on LIBOR plus an applicable margin, requiring quarterly principal payments of $500 and maturing on March 4, 2026, and a revolving loan component (“Revolving Loans”) with a maximum facility of $50,000. The borrowings are subject to financial covenants, such as maintaining a maximum allowable ratio of total funded debt to earnings before interest, taxes, depreciation and amortization (“EBITDA”), as defined in the Credit Agreement, and are secured by substantially all of the Company’s personal property, including accounts receivable, inventory, machinery and equipment and intellectual property.

 

On January 28, 2020, an amendment to the Credit Agreement was finalized to increase such maximum allowable ratio from 3.00 to 1.00 to 4.00 to 1.00 for the quarter ended December 27, 2019, 5.00 to 1.00 for the quarter ending March 27, 2020, 4.00 to 1.00 for the quarter ending June 30, 2020, 3.50 to 1.00 for the quarter ending September 25, 2020 and 3.00 to 1.00 for quarters ending on or after December 25, 2020. The amendment also increased interest rate margins at the higher debt ratio levels. All other terms of the Credit Agreement were substantially unchanged. Prior to the amendment, as of the December 27, 2019 balance sheet date, the Company’s total funded debt to EBITDA ratio was greater than 3.00 to 1.00. The classification of the debt on the condensed consolidated balance sheet for the quarter ended December 27, 2019 reflects this subsequent amendment.

 

The Credit Agreement, including its amendments, is more fully described in the Company’s Annual Report filed on Form 10-K for June 30, 2019, as well as in Item 2 of this quarterly report.

 

Long-term debt at December 27, 2019 and June 30, 2019 consisted of the following:

 

 

During the two quarters ended December 27, 2019, the average interest rate was 3.58% on the Term Loan, and 2.48% on the Revolving Loans.

 

Other long-term debt pertains mainly to a financing arrangement in Europe. These liabilities carry terms of three to five years and implied interest rates ranging from 7% to 25%. A total amount of $36 in principal was paid on these liabilities during the current fiscal year.

 

As of December 27, 2019, the Company’s borrowing capacity on the Revolving Loans under the terms of the Credit Agreement was $41,699, and the Company had approximately $8,470 of available borrowings. In addition to the Credit Agreement, the Company has established unsecured lines of credit that are used from time to time to secure certain performance obligations by the Company.

 

The Company’s borrowings described above approximate fair value at December 27, 2019 and June 30, 2019. 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.

 

 

On April 22, 2019, the Company entered into an interest rate swap arrangement with Bank of Montreal, with an initial notional amount of $20,000 and a maturity date of March 4, 2026 to hedge the Term Loan. The notional amount decreases as the Term Loan balance decreases due to repayments of principal. As of December 27, 2019, the notional amount was $19,000. This swap has been designated as a cash flow hedge under ASC 815, Derivatives and Hedging. This swap is included in the disclosures in Note O, Derivative Financial Instruments.

 

K.	Shareholders’ Equity

 

The Company, from time to time, makes open market purchases of its common stock under authorizations given to it by the Board of Directors, of which 315.0 shares as of December 27, 2019 remain authorized for purchase.  The Company did not make any open market purchases of its shares during the quarters ended December 27, 2019 and December 28, 2018.

 

The following is a reconciliation of the Company’s equity balances for the first two fiscal quarters of 2020 and 2019:

 

 

 

 

Reconciliations for the changes in accumulated other comprehensive income (loss), net of tax, by component for the quarters ended September 27, and December 27, 2019, and September 28, and December 28, 2018 are as follows:

 

 

 

 

Reconciliation for the changes in benefit plan adjustments, net of tax for the quarter and two quarters ended December 27, 2019 are as follows:

 

 

Reconciliation for the changes in benefit plan adjustments, net of tax for the quarter and two quarters ended December 28, 2018 is as follows:

 

 

(a)

These accumulated other comprehensive income components are included in the computation of net periodic pension cost (see Note G, "Pension and Other Postretirement Benefit Plans" for further details).

 

L.	Restructuring of Operations

 

The Company has implemented various restructuring programs in response to unfavorable macroeconomic trends in certain of the Company’s markets since the fourth quarter of fiscal 2015. These programs primarily involved the reduction of workforce in several of the Company’s manufacturing locations, under a combination of voluntary and involuntary programs. In its European operations, the Company also implemented actions to reorganize for productivity.

 

These actions resulted in restructuring charges of $1,063 and $1,184 in the quarter and two quarters ended December 27, 2019, respectively, and restructuring charges of $434 and $607 for the quarter and two quarters ended December 28, 2018, respectively.

 

Restructuring activities since June 2015 have resulted in the elimination of 203 full-time employees in the manufacturing segment. Accumulated costs to date under these programs within the manufacturing segment through December 27, 2019 were $11,636.

 

During the second quarter of fiscal 2020, a marine propulsion development program, for which the Company had provided development and production services, was terminated. The cost of exiting the contract consisted of a noncash write-off of assets and liabilities relating to the program amounting to $2,185, and a cash settlement to satisfy supplier commitments associated with the program amounting to $1,000. The Company has classified the total contract exit cost of $3,185 as a restructuring charge, within the manufacturing segment, in the quarter ended December 27, 2019.

 

 

 

 

The following is a roll-forward of restructuring activity:

 

 

M.	Earnings Per Share

 

The Company calculates basic earnings per share based upon the weighted average number of common shares outstanding during the period, while the calculation of diluted earnings per share includes the dilutive effect of potential common shares outstanding during the period. The calculation of diluted earnings per share excludes all potential common shares if their inclusion would have an anti-dilutive effect. Certain restricted stock award recipients have a non-forfeitable right to receive dividends declared by the Company, and are therefore included in computing earnings per share pursuant to the two-class method. 

 

The components of basic and diluted earnings per share were as follows:

 

 

The following potential common shares were excluded from diluted EPS for the quarter and two quarters ended December 27, 2019 as the Company reported a net loss: 214.0 related to the Company’s unvested PSAs, 231.4 related to the Company’s unvested RS awards, and 38.0 related to the Company’s unvested RSUs.

 

The following potential common shares were excluded from diluted EPS for the quarter and two quarters ended December 28, 2018 because they were anti-dilutive: 134.4 related to the Company’s unvested PSAs, 185.3 related to the Company’s unvested RS awards, 33.6 and 16.6, respectively, related to the Company’s unvested RSUs, and 3.4 related to outstanding stock options.

 

N.	Lease Liabilities

 

The Company leases certain office and warehouse space, as well as production and office equipment.

 

The Company determines if an arrangement is a lease at contract inception. The lease term begins upon lease commencement, which is when the Company takes possession of the asset, and may include options to extend or terminate the lease when it is reasonably certain that such options will be exercised. As its lease agreements typically do not provide an implicit rate, the Company primarily uses an incremental borrowing rate based upon the information available at lease commencement. In determining the incremental borrowing rate, the Company considers its current borrowing rate, the term of the lease, and the economic environments where the lease activity is concentrated.

 

 

The components of lease expense were as follows:

 

 

Other information related to leases was as follows:

 

 

Approximate future minimum rental commitments under non-cancellable leases as of December 27, 2019 were as follows:

 

 

The following table provides a summary of leases recorded on the condensed consolidated balance sheet.

 

 

 

 

O.	Derivative Financial Instruments

 

From time to time, the Company enters into derivative instruments to manage volatility arising from risks relating to interest rates and foreign exchange. The Company does not purchase, hold or sell derivative financial instruments for trading purposes. The Company’s practice is to terminate derivative transactions if the underlying asset or liability matures or is sold or terminated, or if it determines the underlying forecasted transaction is no longer probable of occurring.

 

The Company reports all derivative instruments on its consolidated balance sheets at fair value and establishes criteria for designation and effectiveness of transactions entered into for hedging purposes.

 

Interest Rate Swap Contracts

 

The Company has one outstanding interest rate swap contract as of December 27, 2019, which it entered into on April 22, 2019. It has been designated as a cash flow hedge in accordance with ASC 815, Derivatives and Hedging.

 

The primary purpose of the Company’s cash flow hedging activities is to manage the potential changes in value associated with interest payments on the Company’s LIBOR-based indebtedness. The Company records gains and losses on interest rate swap contracts qualifying as cash flow hedges in accumulated other comprehensive loss to the extent that these hedges are effective and until the Company recognizes the underlying transactions in net earnings, at which time these gains and losses are recognized in interest expense on its consolidated statements of operations and comprehensive (loss) income. Cash flows from derivative financial instruments are classified as cash flows from financing activities on the consolidated statements of cash flows. These contracts generally have original maturities of greater than 12 months.

 

Net unrealized after-tax losses related to cash flow hedging activities that were included in accumulated other comprehensive loss were $506 and $509 as of December 27, 2019 and June 30, 2019, respectively. The unrealized amounts in accumulated other comprehensive loss will fluctuate based on changes in the fair value of open contracts during each reporting period.

 

The Company estimates that $144 of net unrealized losses related to cash flow hedging activities included in accumulated other comprehensive loss will be reclassified into earnings within the next twelve months.

 

Foreign Currency Forward Contracts

 

The Company has no outstanding foreign currency forward exchange contracts at December 27, 2019 or at June 30, 2019.

 

Fair Value of Derivative Instruments

 

The fair value of derivative instruments included in the condensed consolidated balance sheets were as follows:

 

 

The impact of the Company’s derivative instruments on the consolidated statement of operations and comprehensive (loss) income for the quarter and two quarters ended December 27, 2019 and December 28, 2018, respectively, was as follows: