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Annuity contracts represent contractual agreements in which payments are made to an insurance company, which agrees to pay out an income or lump sum amount at a later date. Annuity contracts are valued at fair value using the net present value of future cash flows.
In accordance with ASC 820-10, certain investments that were measured at net asset value per share (or its equivalent) have not been classified in the fair value hierarchy. The fair value amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the fair value of plan assets at the end of the year.
Activity primarily represents amounts written-off during the year, along with other adjustments (primarily foreign currency translation adjustments).
Common stock is valued at the closing price reported on the active market on which the individual securities are traded. These securities include U.S. equity securities invested in companies that are traded on exchanges inside the U.S. and international equity securities invested in companies that are traded on exchanges outside the U.S.
Mutual funds are valued at the daily closing price as reported by the fund. Mutual funds held by the Company’s funded benefit plans are open-end mutual funds that are registered with the Securities Exchange Commission. These funds are required to publish their daily net asset value (“NAV”) and to transact at that price. The mutual funds held by the Company’s funded benefit plans are deemed to be actively traded.
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The notes to consolidated financial statements are an integral part of these statements.
The notes to consolidated financial statements are an integral part of these statements.
The notes to consolidated financial statements are an integral part of these statements.
The notes to consolidated financial statements are an integral part of these statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(AMOUNTS IN THOUSANDS, EXCEPT SHARE AMOUNTS AND PER SHARE DATA)
A. SIGNIFICANT ACCOUNTING POLICIES
COVID-19
Throughout this report, references made to “COVID-19” pertain to the global pandemic declared by the World Health Organization (“WHO”) in March 2020. This pandemic caused shelter-in-place policies, unexpected factory closures, supply chain disruptions, and market volatilities across the globe. These drastic actions resulted in an unprecedented global recession, causing substantial declines in countries’ gross domestic output around the world.
The full impact of the COVID-19 outbreak continues to evolve as of the date of this report. The depth and duration of the pandemic remains unknown. Despite the availability of vaccines, recent surges in the infection rate and the detection of new variants of the virus have reinforced the general consensus that the containment of COVID-19 remains a challenge. Management is actively monitoring the global situation and its effect on its financial condition, liquidity, operations, suppliers, industry, and workforce.
Significant Accounting Policies
The following is a summary of the significant accounting policies followed in the preparation of these financial statements:
Consolidation Principles‑‑The consolidated financial statements include the accounts of Twin Disc, Incorporated and its wholly-owned domestic and foreign subsidiaries. In fiscal 2021, certain subsidiaries changed their reporting periods to conform to the Company’s fiscal year end. The impact of aligning to the corporate reporting period is not material to the consolidated results. All significant intercompany transactions have been eliminated.
Management Estimates--The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual amounts could differ from those estimates.
Translation of Foreign Currencies‑‑The financial statements of the Company’s non-U.S. subsidiaries are translated using the current exchange rate for assets and liabilities and the weighted-average exchange rate for the year for revenues and expenses. The resulting translation adjustments are recorded as a component of accumulated other comprehensive loss, which is included in equity. Gains and losses from foreign currency transactions are included in earnings. Included in other (expense) income are foreign currency transaction gain (losses) of $714 and ($2,108) in fiscal 2022 and 2021, respectively.
Cash--The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalent. Under the Company’s cash management system, cash balances at certain banks are funded when checks are presented for payment. To the extent that checks issued, but not yet presented for payment, exceed the balance on hand at the specific bank against which they were written, the amount of those un-presented checks is included in accounts payable.
Accounts Receivable--These represent trade accounts receivable and are stated net of an allowance for doubtful accounts of $1,741 and $1,870 at June 30, 2022 and 2021, respectively. The Company records an allowance for doubtful accounts for certain customers where a risk of default has been specifically identified as well as provisions determined on a general basis when it is believed that some default is probable and estimable. The assessment of likelihood of customer default is based on a variety of factors, including the length of time the receivables are past due, the historical collection experience and existing economic conditions. Various factors may adversely impact its customer’s ability to access sufficient liquidity and capital to fund their operations and render the Company’s estimation of customer defaults inherently uncertain. While the Company believes current allowances for doubtful accounts are adequate, it is possible that these factors may cause higher levels of customer defaults and bad debt expense in future periods.
Fair Value of Financial Instruments--The carrying amount reported in the consolidated balance sheets for cash, trade accounts receivable and accounts payable approximate fair value because of the immediate short-term maturity of these financial instruments. If measured at fair value, cash would be classified as Level 1 and all other items listed above would be classified as Level 2 in the fair value hierarchy, as defined in Note M, Pension and Other Postretirement Benefit Plans. The Company’s borrowings under the revolving loan agreement, which is classified as long-term debt and consists of loans that are routinely borrowed and repaid throughout the year, approximate fair value at June 30, 2022. The Company’s term loan borrowing, which is SOFR-based, approximates fair value at June 30, 2022. If measured at fair value in the financial statements, long-term debt (including any current portion) would be classified as Level 2 in the fair value hierarchy.
Derivative Financial Instruments--The Company has written policies and procedures that place all financial instruments under the direction of the Company’s corporate treasury department and restrict all derivative transactions to those intended for hedging purposes. The use of financial instruments for trading purposes is prohibited. The Company uses derivative financial instruments to manage certain financial risks. The Company enters into forward contracts to reduce the earnings and cash flow impact of non-functional currency denominated receivables and payables. The Company uses interest rate swap contracts to reduce the exposure to variability in interest rates on floating debt borrowings. The Company designates certain financial instruments as cash flow hedges for accounting purposes. The Company designates certain financial instruments as net investment hedges to reduce the exposure in its foreign currency denominated net investments in wholly-owned subsidiaries. See Note R, Derivative Financial Instruments, for additional information.
Inventories‑‑Inventories are valued at the lower of cost or net realizable value. Cost has been determined by the last‑in, first‑out (LIFO) method for the majority of inventories located in the United States, and by the first‑in, first‑out (FIFO) method for all other inventories. Management specifically identifies obsolete products and analyzes historical usage, forecasted production based on future orders, demand forecasts, and economic trends, among others, when evaluating the adequacy of the reserve for excess and obsolete inventory.
Assets Held for Sale--Assets that will be recovered principally through sale rather than in its continuing use in operations are reclassified out of property, plant and equipment and into assets held for sale if all of the following criteria are met: (a) management, having the authority to approve the action, commits to a plan to sell the asset(s); (b) the asset is available for immediate sale in its present condition subject only to terms that are usual and customary for sales of such assets; (c) an active program to locate a buyer, and other actions required to complete the plan to sell the asset have been initiated; (d) the sale of the asset is probable and the transfer of the asset is expected to qualify for recognition as a completed sale within a year; (e) the asset is being actively marketed for sale at a price that is reasonable in relation to its current fair value; and (f) actions required to complete the plan indicate that it is unlikely that significant changes to the plan will be made or that plan will be withdrawn.
Assets Held for Sale are carried at fair value less costs to sell, or net book value, whichever is lower. The Company ceases to record depreciation expense at the time of designation as held for sale. During fiscal 2021, the Company classified certain properties as held for sale and recorded impairment charges of $4,267. During fiscal 2022, the Company sold certain assets held for sale and record a net gain of $2,939. See Note P, Restructuring of Operations and Income from Extinguishment of Loan, for additional information.
Property, Plant and Equipment and Depreciation‑‑Assets are stated at cost. Expenditures for maintenance, repairs and minor renewals are charged against earnings as incurred. Expenditures for major renewals and betterments are capitalized and depreciated. Depreciation is provided on the straight‑line method over the estimated useful lives of the assets. The lives assigned to buildings and related improvements range from 10 to 40 years, and the lives assigned to machinery and equipment range from 5 to 15 years. Upon disposal of property, plant and equipment, the cost of the asset and the related accumulated depreciation are removed from the accounts and the resulting gain or loss is reflected in earnings. Fully depreciated assets are not removed from the accounts until physically disposed.
Right of Use Lease Assets‑‑In accordance with ASC 842, the Company’s leases, with lease periods longer than twelve months, are recorded on the consolidated balance sheets. These leases primarily consist of office and warehouse facilities, 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 lease period, and the economic environments where the lease activity is concentrated.
Impairment of Long-lived Assets--The Company reviews long-lived assets for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable. For property, plant and equipment and other long-lived assets, including intangible assets, the Company performs undiscounted operating cash flow analyses to determine if an impairment exists. If an impairment is determined to exist, any related impairment loss is calculated based on fair value. Fair value is primarily determined using discounted cash flow analyses; however, other methods may be used to determine the fair value, including third party valuations when necessary.
Intangible Assets-- Intangible assets primarily consist of customer relationships, technology and know-how, and tradenames, all of which are definite-lived. They were initially valued at fair value at acquisition, and are amortized over their respective useful lives on the basis of straight line or accelerated, as appropriate.
Income Taxes--The Company recognizes deferred tax assets and liabilities for the expected future income tax consequences of events that have been recognized in the Company’s financial statements. Under this method, deferred tax assets and liabilities are determined based on the temporary differences between the financial statement carrying amounts and the tax bases of assets and liabilities using enacted tax rates in effect in the years in which temporary differences are expected to reverse. Valuation allowances are provided for deferred tax assets where it is considered more likely than not that the Company will not realize the benefit of such assets. The Company evaluates its uncertain tax positions as new information becomes available. Tax benefits are recognized to the extent a position is more likely than not to be sustained upon examination by the taxing authority.
Revenue Recognition--Revenue from contracts with customers is recognized using a five-step model consisting of the following:
| 1. | identify the contract with a customer; The Company’s customers consist of distributors and direct end-users. With regard to distributors, the Company generally has written distribution agreements which describe the terms of the distribution arrangement, such as the product range, the sales territory, product pricing, sales support, payment and returns policy, etc. Customer contracts are generally in the form of acknowledged purchase orders. Services to be rendered, as part of the delivery of those products, are also generally specified. Such services include installation reviews and technical commissioning. |
| 2. | identify the performance obligations in the contract; The Company’s performance obligations primarily consist of product delivery and certain service obligations such as technical commissioning, repair services, installation reviews, and shift development. |
| 3. | determine the transaction price; The Company considers the invoice as the transaction price. |
| 4. | allocate the transaction price to the performance obligations in the contract; The Company determined that the most relevant allocation method for its service obligations is to apply the expected cost plus appropriate margin. This is the Company’s practice of billing for repairs, overhaul, and other product service related time incurred by its technicians. |
| 5. | recognize revenue; Revenue is recognized as each performance obligation is satisfied which is typically when the Company transfers control of a good or service to a customer, which can occur over time or at a point in time. For technical commissioning, repairs, installation review, and shift development services, revenue is recognized upon completion of the service. The amount of revenue recognized is based on the consideration to which the Company expects to be entitled in exchange for those goods or services, including the expected value of variable consideration. The customer’s ability and intent to pay the transaction price is assessed in determining whether a contract exists with the customer. If collectability of substantially all of the consideration in a contract is not probable, consideration received is not recognized as revenue unless the consideration is nonrefundable and the Company no longer has an obligation to transfer additional goods or services to the customer or collectability becomes probable. |
Goods sold to third party distributors are subject to an annual return policy, for which a provision is made at the time of shipment based upon historical experience. Goods sold under bill and hold arrangements are recorded as revenue when control has been transferred to the customer and when the reason for the arrangement is substantive, when the product is identified as the customer’s asset, when the product is ready for delivery to the customer, and when the Company cannot use the product or redirect the product to another customer.
Shipping and Handling Fees and Costs--The Company records revenue from shipping and handling costs in net sales. The cost associated with shipping and handling of products is reflected in cost of goods sold.
Recently Adopted Accounting Standards
| a. | In August 2018, the Financial Accounting Standards Board (“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 ASC 820, Fair Value Measurement. The Company adopted this guidance effective July 1, 2021. The adoption of this guidance did not have a material impact on the Company’s financial statements and disclosures. |
| b. | 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 Company adopted this guidance effective July 1, 2021. The adoption of this guidance did not have a material impact on the Company’s financial statements and disclosures. |
New Accounting Releases
| a. | In June 2016, the FASB issued updated guidance (ASU 2016-13) and also issued subsequent amendments to the initial guidance under ASU 2018-19, ASU 2019-04, ASU 2019-05 and ASU 2019-10 (collectively ASC 326). ASC 326 requires the measurement and recognition of expected credit losses for financial assets held at amortized cost. This replaces the existing incurred loss model with an expected loss model and requires the use of forward-looking information to calculate credit loss estimates. The amendments in this guidance are effective for filers, excluding smaller reporting companies, for fiscal years beginning after December 15, 2019, and for smaller reporting companies for fiscal years beginning after December 15, 2022 (the Company’s fiscal 2024), with early adoption permitted for certain amendments. ASC 326 must be adopted by applying a cumulative effect adjustment to retained earnings. The Company is currently evaluating the potential impact of this guidance on the Company’s disclosures. |
| b. | 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, 2021 (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. |
| c. | In March 2021 and January 2022, the FASB issued guidance (ASU 2021-04 and ASU 2022-01, respectively), intended to provide optional expedients and exceptions for applying generally accepted accounting principles to contracts, hedging relationships, and other transactions affected by the discontinuation of the London Interbank Offered Rate (“LIBOR”) or by another reference rate expected to be discontinued. The amendments in this guidance are effective beginning on March 12, 2021, and the Company may elect to apply the amendments prospectively through December 31, 2022. The Company is working with its lender and currently evaluating the potential impact of this guidance on the Company’s financial statements and 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 based on its public float as of the last business day of the second quarter of fiscal 2022. Accordingly, it has scaled some of its disclosures of financial and non-financial information in this annual 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 at June 30 were as follows:
| | 2022 | | | 2021 | |
Finished parts | | $ | 65,789 | | | $ | 59,761 | |
Work in process | | | 19,801 | | | | 17,908 | |
Raw materials | | | 41,519 | | | | 37,298 | |
| | $ | 127,109 | | | $ | 114,967 | |
Inventories stated on a LIFO basis represent approximately 44% and 45% of total inventories at June 30, 2022 and 2021, respectively. The approximate current cost of the LIFO inventories exceeded the LIFO cost by $27,797 and $25,969 at June 30, 2022 and 2021, respectively. Inventories were reduced during 2021, resulting in a liquidation of a LIFO inventory layer that was carried at a lower cost prevailing from a prior year, as compared with current costs in the current year (“LIFO decrement”). A LIFO decrement results in the erosion of layers created in earlier years, and, therefore, a LIFO layer is not created for years that have decrements. There was no LIFO decrement for the year ended June 30, 2022. For the year ended June 30, 2021, the effect of this LIFO decrement decreased cost of goods sold by $1,105.
The Company had reserves for inventory obsolescence of $11,557 and $10,279 at June 30, 2022 and 2021, respectively.
C. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment at June 30 were as follows:
| | 2022 | | | 2021 | |
Land | | $ | 2,163 | | | $ | 3,858 | |
Buildings | | | 31,935 | | | | 30,317 | |
Machinery and equipment | | | 146,054 | | | | 150,872 | |
| | | 180,152 | | | | 185,047 | |
Less: accumulated depreciation | | | (138,537 | ) | | | (139,584 | ) |
| | $ | 41,615 | | | $ | 45,463 | |
Included in the above amounts are finance lease right-of-use assets of $4,805 and $5,244 for the years ended June 30, 2022 and 2021, respectively.
Depreciation expense for the years ended June 30, 2022 and 2021 was $6,374 and $7,853, respectively.
38
D. INTANGIBLE ASSETS
At June 30, the following acquired intangible assets have definite useful lives and are subject to amortization:
| | Gross Carrying Amount | | | Accumulated Amortization / Impairment | | | Net Book Value | | | Customer Relationships | | | Technology Know-how | | | Trade Name | | | Other | |
Balance at June 30, 2020 | | $ | 39,245 | | | $ | (20,272 | ) | | $ | 18,973 | | | $ | 11,554 | | | $ | 5,784 | | | $ | 1,388 | | | $ | 247 | |
Addition | | | 833 | | | | - | | | | 833 | | | | - | | | | - | | | | - | | | | 833 | |
Amortization | | | - | | | | (3,390 | ) | | | (3,390 | ) | | | (1,880 | ) | | | (1,226 | ) | | | (184 | ) | | | (100 | ) |
Translation adjustment | | | 1,064 | | | | - | | | | 1,064 | | | | 647 | | | | 325 | | | | 78 | | | | 14 | |
Balance at June 30, 2021 | | | 41,142 | | | | (23,662 | ) | | | 17,480 | | | | 10,321 | | | | 4,883 | | | | 1,282 | | | | 994 | |
Addition | | | 421 | | | | - | | | | 421 | | | | - | | | | - | | | | - | | | | 421 | |
Amortization | | | - | | | | (3,173 | ) | | | (3,173 | ) | | | (1,605 | ) | | | (1,163 | ) | | | (174 | ) | | | (231 | ) |
Translation adjustment | | | (1,718 | ) | | | - | | | | (1,718 | ) | | | (1,080 | ) | | | (482 | ) | | | (136 | ) | | | (20 | ) |
Balance at June 30, 2022 | | $ | 39,845 | | | $ | (26,835 | ) | | $ | 13,010 | | | $ | 7,636 | | | $ | 3,238 | | | $ | 972 | | | $ | 1,164 | |
Other intangibles consist mainly of computer software. 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 7 years.
Intangible amortization expense for the years ended June 30, 2022 and 2021 was $3,173 and $3,390, respectively. Estimated intangible amortization expense for each of the next five fiscal years is as follows:
Fiscal Year | | | | |
2023 | | | 2,880 | |
2024 | | | 2,741 | |
2025 | | | 2,590 | |
2026 | | | 1,354 | |
2027 | | | 1,235 | |
Thereafter | | | 2,210 | |
The changes in the carrying amount of goodwill (impairment charges) are summarized as follows:
| | Net Book Value Rollforward | | | Net Book Value By Reporting Unit | |
| | Gross Carrying Amount | | | Accumulated Impairment | | | Net Book Value | | | European Propulsion | | | European Industrial | |
Balance at June 30, 2020 | | $ | 39,202 | | | $ | (39,202 | ) | | $ | - | | | $ | - | | | $ | - | |
Translation adjustment | | | - | | | | - | | | | - | | | | - | | | | - | |
Balance at June 30, 2021 | | | 39,202 | | | | (39,202 | ) | | | - | | | | - | | | | - | |
Translation adjustment | | | - | | | | - | | | | - | | | | - | | | | - | |
Balance at June 30, 2022 | | $ | 39,202 | | | $ | (39,202 | ) | | $ | - | | | $ | - | | | $ | - | |
E. ACCRUED LIABILITIES
Accrued liabilities at June 30 were as follows:
| | 2022 | | | 2021 | |
Customer deposits | | $ | 17,151 | | | $ | 13,124 | |
Salaries and wages | | | 11,272 | | | | 10,022 | |
Warranty | | | 2,724 | | | | 3,448 | |
Distributor rebates | | | 2,627 | | | | 3,190 | |
Retirement benefits | | | 1,738 | | | | 1,769 | |
Other | | | 15,030 | | | | 13,996 | |
| | $ | 50,542 | | | $ | 45,549 | |
F. WARRANTY
The Company warrants all assembled products, parts (except component products or parts on which written warranties are issued by the respective manufacturers thereof and are furnished to the original customer, as to which the Company makes no warranty and assumes no liability) and service against defective materials or workmanship. Such warranty generally extends from periods ranging from 12 months to 24 months. 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 the Company’s 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 the Company believes that 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 years ended June 30:
| | 2022 | | | 2021 | |
| | | | | | | | |
Reserve balance, July 1 | | $ | 4,369 | | | $ | 4,460 | |
Current period expense and adjustments | | | 1,570 | | | | 3,590 | |
Payments or credits to customers | | | (2,501 | ) | | | (3,742 | ) |
Translation adjustment | | | (109 | ) | | | 61 | |
Reserve balance, June 30 | | $ | 3,329 | | | $ | 4,369 | |
The current portion of the warranty accrual ($2,724 and $3,448 for fiscal 2022 and 2021, respectively) is reflected in accrued liabilities, while the long-term portion ($605 and $921 for fiscal 2022 and 2021, respectively) is included in other long-term liabilities on the consolidated balance sheets.
G. DEBT
Long-term debt consisted of the following at June 30:
| | 2022 | | | 2021 | |
Credit Agreement Debt | | | | | | | | |
Revolving loans (expire June 2025) | | $ | 22,968 | | | $ | 15,415 | |
Term loan (due March 2026) | | | 13,500 | | | | 16,500 | |
Other | | | 75 | | | | 170 | |
Subtotal | | | 36,543 | | | | 32,085 | |
Less: current maturities | | | (2,000 | ) | | | (2,000 | ) |
Total long-term debt | | $ | 34,543 | | | $ | 30,085 | |
Credit Agreement Debt:
On June 29, 2018, the Company entered into a Credit Agreement (the “Credit Agreement”) with BMO Harris Bank N.A. (“BMO”) that provided for the assignment and assumption of the previously existing loans between the Company and Bank of Montreal (the “2016 Credit Agreement”) and subsequent amendments into a term loan (the “Term Loan”) and revolving credit loans (each a “Revolving Loan” and, collectively, the “Revolving Loans,” and, together with the Term Loan, the “Loans”). Pursuant to the Credit Agreement, BMO agreed to make the Term Loan to the Company in a principal amount not to exceed $35.0 million and the Company may, from time to time prior to the maturity date, enter into Revolving Loans in amounts not to exceed, in the aggregate, $50.0 million (the “Revolving Credit Commitment”). The Credit Agreement also allows the Company to obtain Letters of Credit from BMO, which if drawn upon by the beneficiary thereof and paid by BMO, would become Revolving Loans. Under the Credit Agreement, the Company may not pay cash dividends on its common stock in excess of $3.0 million in any fiscal year.
On March 4, 2019, the Company entered into a second amendment (the “Second Amendment”) to the Credit Agreement. The Second Amendment reduced the principal amount of the term loan commitment under the Credit Agreement from $35.0 million to $20.0 million. In connection with the Second Amendment, the Company issued an amended and restated term note in the amount of $20.0 million to the Bank, which amended the original $35.0 million note provided under the Credit Agreement.
Prior to entering into the Second Amendment, the outstanding principal amount of the term loan (the “Term Loan”) under the Credit Agreement was $10.8 million. On the date of the Second Amendment, the Bank made an additional advance on the Term Loan to the Company in the amount of $9.2 million. The Second Amendment also extended the maturity date of the Term Loan from January 2, 2020 to March 4, 2026, and added a requirement that the Company make principal installments of $0.5 million per quarter starting with the quarter ending June 30, 2019.
The Second Amendment also reduced the applicable margin for purposes of determining the interest rate applicable to the Term Loan. Previously, the applicable margin was 3.00%, which was added to the Monthly Reset LIBOR Rate or the Adjusted LIBOR, as applicable. Under the Second Amendment, the applicable margin was between 1.375% and 2.375%, depending on the Company’s total funded debt to EBITDA ratio.
The Second Amendment also adjusted certain financial covenants made by the Company under the Credit Agreement. Specifically, the Company covenanted (i) not to allow its total funded debt to EBITDA ratio to be greater than 3.00 to 1.00 (the cap had previously been 3.50 to 1.00 for quarters ending on or before September 30, 2019 and 3.25 to 1.00 for quarters ending on or about December 31, 2019 through September 30, 2020), and (ii) that its tangible net worth will not be less than $100.0 million plus 50% of net income for each fiscal year ending on and after June 30, 2019 for which net income is a positive number (the $100.0 million figure had previously been $70.0 million).
On January 28, 2020, the Company entered into a third amendment (the “Third Amendment”) to the Credit Agreement. The Third Amendment restated the financial covenant provisions related to the maximum allowable ratio of total funded debt to EBITDA 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. For purposes of determining EBITDA, the Third Amendment added back extraordinary expenses (not to exceed $3.9 million) related to the previously reported isolated product performance issue on one of the Company’s oil and gas transmission models at certain installations. Under the Third Amendment, the applicable margin for revolving loans, letters of credit, and term loans was between 1.25% and 3.375%, depending on the Company’s total funded debt to EBITDA ratio.
On July 22, 2020, the Company entered into a fifth amendment (the “Fifth Amendment”) to the Credit Agreement that amends the Credit Agreement dated as of June 29, 2018, as amended, between the Company and BMO. The Fifth Amendment reduced BMO’s Revolving Credit Commitment from $50.0 million to $45.0 million. The Fifth Amendment also gives the Company the option to make interest-only payments on the Term Loan for quarterly payments occurring on September 30, 2020 and December 31, 2020, and limits the Company’s Capital Expenditures for the fiscal year ending June 30, 2021 to $10.0 million.
The Fifth Amendment provides the Company with relief from its Total Funded Debt to EBITDA ratio financial covenant under the Credit Agreement through (and including) the earlier of June 30, 2021 or a date selected by the Company. During the financial covenant relief period:
| ● | The “Applicable Margin” to be applied to Revolving Loans, the Term Loan, and the Commitment/Facility Fee will be increased to 3.25%, 3.875%, and 0.20%, respectively. |
| ● | The Company may not make certain restricted payments (specifically, cash dividends, distributions, purchases, redemptions or other acquisitions of or with respect to shares of its common stock or other common equity interests). |
| ● | The Company must maintain liquidity (as defined in the Fifth Amendment) of at least $15.0 million. |
| ● | The Company must maintain minimum EBITDA of at least (1) $1.0 million for the fiscal quarter ending June 30, 2020 and the two fiscal quarters ending on or about September 30, 2020; (2) $2.5 million for the three fiscal quarters ending on or about December 31, 2020; (3) $6.0 million for the four fiscal quarters ending on or about March 31, 2021; and (4) $10.0 million for the four fiscal quarters ending June 30, 2021. |
For purposes of the minimum EBITDA covenant and the Total Funded Debt to EBITDA ratio, the Fifth Amendment clarified that EBITDA shall exclude any gain that is realized on the forgiveness of the Small Business Administration Paycheck Protection Program loan that the Company previously received.
The Fifth Amendment also changed the definition of “LIBOR” (used in calculating interest on Eurodollar Loans), “Monthly Reset LIBOR Rate” (used in calculating interest on LIBOR Loans), and “LIBOR Quoted Rate” (used in the definition of “Base Rate,” which is used in calculating interest on Letters of Credit that are drawn upon and not timely reimbursed).
The Company also entered into a Deposit Account Control Agreement with the Bank, reflecting the Bank’s security interest in deposit accounts the Company maintains with the Bank. Under the Fifth Amendment, the Bank may not provide a notice of exclusive control of a deposit account (thereby obtaining exclusive control of the account) prior to the occurrence or existence of a Default or an Event of Default under the Credit Agreement or otherwise upon the occurrence or existence of an event or condition that would, but for the passage of time or the giving of notice, constitute a Default or an Event of Default under the Credit Agreement.
On January 27, 2021, the Company entered into a Forbearance Agreement and Amendment No. 6 to the Credit Agreement (the “Forbearance Agreement”) that further amended the Credit Agreement.
The Company entered into the Forbearance Agreement because the Company was not in compliance with its financial covenant to maintain a minimum EBITDA of at least $2.5 million for the three fiscal quarters ended as of December 25, 2020. In the Forbearance Agreement, the Bank has agreed to forbear from exercising its rights and remedies against the Company under the Credit Agreement with respect to the Company’s noncompliance with the minimum EBITDA covenant during the period (the “Forbearance Period”) commencing January 27, 2021 and ending on the earlier of (i) September 30, 2021, and (ii) the date on which a default under the Forbearance Agreement or Credit Agreement occurs. During the Forbearance Period, the Bank may continue to honor requests of the Company for draws on the revolving note provided by the Bank under the Credit Agreement, except that the revolving credit commitment is reduced from $45.0 million to $42.5 million during the Forbearance Period.
The Forbearance Agreement also added to the Company’s financial reporting requirements under the Credit Agreement by requiring the Company to provide the Bank with monthly forecasts of the Company’s financial statements, and monthly reports on the Company’s six-month backlog.
On September 30, 2021, the Company entered into a First Amended and Restated Forbearance Agreement and Amendment No. 7 to Credit Agreement (the “Amended and Restated Forbearance Agreement”) that amends the Credit Agreement dated as of June 29, 2018, as amended between the Company and the Bank.
The Amended and Restated Forbearance Agreement extended the Forbearance Period through February 28, 2022, or if earlier, through the date on which a default under the Amended and Restated Forbearance Agreement or Credit Agreement occurs. During the extended Forbearance Period, the Bank will continue to forbear from exercising its rights and remedies against the Company under the Credit Agreement with respect to the Company’s noncompliance with its minimum EBITDA covenants. The Amended and Restated Forbearance Agreement also made certain adjustments to the Credit Agreement, including:
| ● | Permitting the Company to sell its manufacturing facility in Novazzano, Switzerland for a gross sales price of approximately $10 million, resulting in Net Cash Proceeds of approximately $8.7 million (the “Rolla Disposition”). |
| ● | Requiring the Company to promptly repatriate approximately $7 million of the Net Cash Proceeds from the Rolla Disposition (the “Rolla Repatriation”), and to apply $1 million of such Net Cash Proceeds to the Term Loan and the remainder to the revolving Loans under the Credit Agreement. |
| ● | Upon completion of the Rolla Repatriation: (1) reducing the portion of the Borrowing Base that is based on Eligible Inventory from the lesser of $35 million or 50% of the value of Eligible Inventory to the lesser of $30 million or 50% of the value of Eligible Inventory; and (2) reducing the Revolving Credit Commitment from a maximum of $42.5 million to a maximum of $40 million. |
On February 28, 2022, the Company entered into a Second Amended and Restated Forbearance Agreement and Amendment No. 8 to Credit Agreement (the “Second Amended and Restated Forbearance Agreement”) that amended the Credit Agreement dated as of June 29, 2018, as amended between the Company and the Bank.
The Second Amended and Restated Forbearance Agreement extended the Forbearance Period through June 30, 2022, or if earlier, through the date on which a default under the Amended and Restated Forbearance Agreement or Credit Agreement occurs. During the extended Forbearance Period, the Bank continued to forbear from exercising its rights and remedies against the Company under the Credit Agreement with respect to the Company’s noncompliance with its minimum EBITDA covenants. The Second Amended and Restated Forbearance Agreement also made certain adjustments to the Credit Agreement, including:
| ● | Reduced the portion of the Borrowing Base that is based on Eligible Inventory from the lesser of $35,000,000 or 50% of the value of Eligible Inventory to the lesser of $30,000,000 or 50% of the value of Eligible Inventory. This change was already in effect under the terms of the Amended and Restated Forbearance Agreement, due to the Company’s previously reported sale of its manufacturing facility in Novazzano, Switzerland for a gross sales price of approximately $10,000,000, resulting in Net Cash Proceeds (as defined in the Amended and Restated Forbearance Agreement) of approximately $8,700,000 (the “Rolla Disposition”) and repatriation of approximately $7,000,000 of those Net Cash Proceeds (the “Rolla Repatriation”). |
| ● | Reduced the Revolving Credit Commitment from a maximum of $42,500,000 to a maximum of $40,000,000. This change was also already in effect under the terms of the Amended and Restated Forbearance Agreement due to the Rolla Disposition and Rolla Repatriation. |
The Company also executed a Third Amended and Restated Revolving Note with the Bank, reflecting the maximum Revolving Credit Commitment of $40,000,000.
On June 30, 2022, the Company entered into Amendment No. 9 to Credit Agreement (the “Ninth Amendment”) that amends and extends the Credit Agreement dated as of June 29, 2018, as amended (the “Credit Agreement”) between the Company and BMO.
Pursuant to the Credit Agreement, as in effect prior to the Ninth Amendment, the Bank made a Term Loan to the Company in the principal amount of $20,000,000, and the Company may, from time to time prior to the maturity date, enter into Revolving Loans in amounts not to exceed, in the aggregate and subject to a Borrowing Base, $40,000,000 (the “Revolving Credit Commitment”). The Credit Agreement also allows the Company to obtain Letters of Credit from the Bank, which if drawn upon by the beneficiary thereof and paid by the Bank, would become Revolving Loans.
The Ninth Amendment extended the Credit Agreement through June 30, 2025. Prior to the Ninth Amendment, the Credit Agreement was scheduled to terminate as of June 30, 2023.
The Ninth Amendment also formally terminated the January 27, 2021 Forbearance Agreement, which had been entered into because the Company had not been in compliance with a requirement to maintain a minimum EBITDA of $2,500,000 for the three fiscal quarters ended as of December 25, 2020. The Bank also waived the Company’s compliance with the minimum EBITDA requirements under the Credit Agreement and any Event of Default associated with the Company’s noncompliance with the minimum EBITDA requirements.
The Ninth Amendment also replaced LIBOR-based interest rates with different benchmark rates based on the secured overnight financing rate (“SOFR”) or the euro interbank offered rate (the “EURIBO Rate”). Loans under the Credit Agreement are designated either as “SOFR Loans,” which accrue interest at an Adjusted Term SOFR plus an Applicable Margin, or “Eurodollar Loans,” which accrue interest at the EURIBO Rate plus an Applicable Margin. Amounts drawn on a Letter of Credit that are not timely reimbursed to the Bank bear interest at a Base Rate plus an Applicable Margin. The Company also pays a commitment fee on the average daily Unused Revolving Credit Commitment equal to an Applicable Margin.
The Ninth Amendment also reduced the Applicable Margins from the rates that had been in effect during the period of the Forbearance Agreement. During the period covered by the Forbearance Agreement, the Applicable Margins for Revolving Loans, Term Loans, and the Unused Revolving Credit Commitment were 3.25%, 3.875%, and .20%, respectively. Under the Ninth Amendment, the Applicable Margins are between 1.25% and 2.75% for Revolving Loans and Letters of Credit; 1.375% and 2.875% for Term Loans; and .10% and .15% for the Unused Revolving Credit Commitment (each depending on the Company’s Total Funded Debt to EBITDA ratio).
The Ninth Amendment also revised the Company’s financial covenants under the Credit Agreement. The Company’s Total Funded Debt to EBITDA ratio (for which the Bank provided relief during period covered by the Forbearance Agreement) may not exceed 3.50 to 1.00, and the Company’s Fixed Charge Coverage Ratio may not be less than 1.10 to 1.00. The Company’s Tangible Net Worth may not be less than $100,000,000 plus 50% of positive Net Income for each fiscal year ending on or after June 30, 2023.
Borrowings under the Credit Agreement are secured by substantially all of the Company’s personal property, including accounts receivable, inventory, machinery and equipment, and intellectual property. The Company has also pledged 100% of its equity interests in certain domestic subsidiaries and 65% of its equity interests in certain foreign subsidiaries. The Company also entered into a Collateral Assignment of Rights under Purchase Agreement for its acquisition of Veth Propulsion. To effect these security interests, the Company entered into various amendment and assignment agreements that consent to the assignment of certain agreements previously entered into between the Company and the Bank of Montreal in connection with the 2016 Credit Agreement. The Company also amended and assigned to BMO a Negative Pledge Agreement that it has previously entered into with Bank of Montreal, pursuant to which it agreed not to sell, lease or otherwise encumber real estate that it owns except as permitted by the Credit Agreement and the Negative Pledge Agreement.
Upon the occurrence of an Event of Default, BMO may take the following actions upon written notice to the Company: (1) terminate its remaining obligations under the Credit Agreement; (2) declare all amounts outstanding under the Credit Agreement to be immediately due and payable; and (3) demand the Company to immediately Cash Collateralize L/C Obligations in an amount equal to 105% of the aggregate L/C Obligations or a greater amount if BMO determines a greater amount is necessary. If such Event of Default is due to the Company’s bankruptcy, BMO may take the three actions listed above without notice to the Company.
The PPP Loan:
On April 17, 2020, the Company entered into a promissory note (the “PPP Loan”) evidencing an unsecured loan in the amount of $8,200 made to the Company under the Payment Protection Plan ("PPP"). The PPP is a liquidity facility program established by the U.S. government as part of the CARES Act in response to the negative economic impact of the COVID-19 outbreak. The PPP Loan is funded by the Small Business Administration (“SBA”) and administered by BMO. The PPP Loan has a two-year term and bears interest at a rate of 1.0% per annum. Monthly principal and interest payments were deferred until April 2022.
The PPP Loan is a forgivable loan to the extent proceeds are used to cover qualified documented payroll, mortgage interest, rent, and utility costs over a 24-week measurement period (as amended) following loan funding. For the loan to be forgiven, the Company was required to formally apply for forgiveness, and potentially, could be required to pass an audit that it met the eligibility qualifications of the loan.
In accounting for the terms of the PPP Loan, the Company is guided by ASC 470 Debt, and ASC 450-30 Gain contingency. Accordingly, it recorded the proceeds of the PPP Loan of $8,200 as debt and it will derecognize the liability when the loan is paid off or it has obtained forgiveness. The Company believes that the possibility of loan forgiveness is to be regarded as a contingent gain and therefore did not recognize the gain (and derecognize the loan) until all uncertainty was removed (i.e., all conditions for forgiveness are met). The Company applied for forgiveness, and on June 16, 2021, it was notified by BMO that the SBA remitted funds to BMO to repay the PPP Loan in full, evidencing that the PPP Loan was fully forgiven. The Company removed the balance of the PPP Loan from its consolidated balance sheet and recorded $8,200 in income from extinguishment of loan in its consolidated statement of operations in fiscal 2021.
While the loan has been formally forgiven, under the terms of the PPP Loan, the Company remains subject to an audit by the SBA for a period of six years after forgiveness. The audit is intended to confirm the Company’s eligibility for the PPP loan and the appropriateness of the PPP loan forgiveness. In accordance with ASC 450 Contingencies, the Company assessed the probability of failing the audit and being required to repay all or any portion of the PPP Loan. The Company is aware of the requirements and has retained all necessary documentation in support of its eligibility, including gross receipts calculations, supporting payroll expenses and related information. The Company believes that it has materially complied with all the requirements of the PPP and reasonably assured it would satisfy the requirements of an audit.
Other:
Other long-term debt pertains mainly to a financing arrangement in Europe. During fiscal 2019, the Company entered into sale leaseback agreements with a leasing company covering various company vehicles. Under the terms of the agreements, the Company received $329 in cash proceeds and agreed to lease back those same vehicles under various terms, ranging from 3 to 5 years. Under ASC 842, Leases, these agreements are required to be accounted for as financing transactions. Consequently, the Company recorded long-term liabilities for the proceeds received, and they are reduced as lease payments are made. These liabilities carry implied interest rates ranging from 7% to 25%. A total amount of $91 in principal was paid on these liabilities during the current fiscal year.
During fiscal year 2022, the average interest rate was 4.10% on the Term Loan, and 4.23% on the Revolving Loans.
As of June 30, 2022, the Company’s borrowing capacity under the terms of the Credit Agreement was approximately $40,662 and the Company had approximately $17,032 of available borrowings.
The Company’s borrowings described above approximates fair value at June 30, 2022 and June 30, 2021. 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.
The Company is party to an interest rate swap arrangement with Bank of Montreal, with an outstanding notional amount of $13,500 as of June 30, 2022, and maturing on March 2026. 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 R, Derivative Financial Instruments.
During the fourth quarter of fiscal 2021, the Company designated its euro denominated Revolving Loan as a net investment hedge to mitigate the risk of variability in its euro denominated net investments in wholly-owned foreign companies. Effective upon the designation, all changes in fair value of the euro Revolving Loan are reported in accumulated other comprehensive loss along with the foreign currency translation adjustments on those foreign investments. This net investment hedge is included in the disclosures in Note R, Derivative Financial Instruments.
The aggregate scheduled maturities of outstanding long-term debt obligations in subsequent years are as follows:
Fiscal Year | | | | |
2023 | | $ | 2,038 | |
2024 | | | 2,014 | |
2025 | | | 24,968 | |
2026 | | | 5,500 | |
2027 | | | - | |
Thereafter | | | 22 | |
| | $ | 34,543 | |
Other lines of credit:
The Company has established unsecured lines of credit, which may be withdrawn at the option of the banks. Under these arrangements, the Company has unused and available credit lines of $1,049 with a weighted average interest rate of 5.7% as of June 30, 2022, and $1,535 with a weighted average interest rate of 5.6% as of June 30, 2021.
H. LEASE OBLIGATIONS
The following table provides a summary of leases recorded on the consolidated balance sheet at June 30.
| Balance Sheet Location | | 2022 | | | 2021 | |
Lease Assets | | | | | | | | | |
Operating lease right-of-use assets | Right-of-use assets operating leases | | $ | 12,685 | | | $ | 14,736 | |
Finance lease right-of-use assets | Property, plant and equipment, net | | | 4,805 | | | | 5,244 | |
| | | | | | | | | |
Lease Liabilities | | | | | | | | | |
Operating lease liabilities | Accrued liabilities | | $ | 2,127 | | | $ | 1,870 | |
Operating lease liabilities | Lease obligations | | | 10,575 | | | | 12,887 | |
Finance lease liabilities | Accrued liabilities | | | 576 | | | | 541 | |
Finance lease liabilities | Other long-term liabilities | | | 4,440 | | | | 4,836 | |
The components of lease expense for the years ended June 30 were as follows:
| | 2022 | | | 2021 | |
Finance lease cost: | | | | | | | | |
Amortization of right-of-use assets | | $ | 650 | | | $ | 580 | |
Interest on lease liabilities | | | 277 | | | | 273 | |
Operating lease cost | | | 2,908 | | | | 2,795 | |
Short-term lease cost | | | 98 | | | | 24 | |
Variable lease cost | | | 173 | | | | 159 | |
Total lease cost | | | 4,106 | | | | 3,831 | |
Less: Sublease income | | | (75 | ) | | | (154 | ) |
Net lease cost | | $ | 4,031 | | | $ | 3,677 | |
Other information related to leases was as follows:
| | 2022 | | | 2021 | |
Cash paid for amounts included in the measurement of lease liabilities: | | | | | | | | |
Operating cash flows from operating leases | | $ | 3,050 | | | $ | 3,022 | |
Operating cash flows from finance leases | | | 277 | | | | 273 | |
Financing cash flows from finance leases | | | 933 | | | | 747 | |
Right-of-use-assets obtained in exchange for lease obligations: | | | | | | | | |
Operating leases | | | 1,192 | | | | 1,481 | |
Finance leases | | | 406 | | | | 4,814 | |
Weighted average remaining lease term (years): | | | | | | | | |
Operating leases | | | 8.7 | | | | 9.8 | |
Finance lease | | | 11.3 | | | | 12.0 | |
Weighted average discount rate: | | | | | | | | |
Operating leases | | | 7.1 | % | | | 7.2 | % |
Finance leases | | | 5.1 | % | | | 5.2 | % |
Approximate future minimum rental commitments under non-cancellable leases as of June 30, 2022 were as follows:
| | Operating Leases | | | Finance Leases | |
2023 | | $ | 2,941 | | | $ | 855 | |
2024 | | | 2,378 | | | | 821 | |
2025 | | | 1,539 | | | | 578 | |
2026 | | | 1,404 | | | | 512 | |
2027 | | | 1,130 | | | | 457 | |
Thereafter | | | 7,742 | | | | 3,376 | |
Total future lease payments | | | 17,134 | | | | 6,598 | |
Less: Amount representing interest | | | (4,432 | ) | | | (1,582 | ) |
Present value of future payments | | $ | 12,702 | | | $ | 5,016 | |
I. SHAREHOLDERS' EQUITY
The total number of shares of common stock outstanding at June 30, 2022 and 2021 was 13,672,343 and 13,648,663, respectively. At June 30, 2022 and 2021, treasury stock consisted of 960,459 and 984,139 shares of common stock, respectively. The Company issued 57,204 and 249,480 shares of treasury stock in fiscal 2022 and 2021, respectively, to fulfill its obligations under its incentive compensation plans. The Company also recorded forfeitures of 29,810 and 6,809 shares of previously issued restricted stock in fiscal 2022 and 2021, respectively. The difference between the cost of treasury shares and the option price is recorded in common stock.
Under an authorization given by the Board of Directors on July 27, 2012, the Company is permitted to make open market purchases of its common stock. The Company did not make any open market purchases during the two most recent fiscal years. As of June 30, 2022 and 2021, 315,000 shares remain authorized for purchase.
Cash dividends per share were $0.00 in both fiscal 2022 and 2021.
The Company is authorized to issue 200,000 shares of preferred stock, none of which have been issued. The Company has designated 150,000 shares of the preferred stock as Series A Junior Preferred Stock.
The components of accumulated other comprehensive loss included in equity as of June 30, 2022 and 2021 are as follows:
| | 2022 | | | 2021 | |
Translation adjustments | | $ | (2,266 | ) | | $ | 9,192 | |
Benefit plan adjustments, net of income taxes of $9,452 and $9,537 respectively | | | (31,726 | ) | | | (678 | ) |
Net loss on cash flow hedge derivatives, net of income taxes of $34 and $211, respectively | | | 356 | | | | 334 | |
Net gain on net investment hedge derivatives, net of income taxes of $388 and $103, respectively | | | 1,550 | | | | (31,463 | ) |
Accumulated other comprehensive loss | | $ | (32,086 | ) | | $ | (22,615 | ) |
A reconciliation for the changes in accumulated other comprehensive loss, net of tax, by component for the years ended June 30, 2022 and June 30, 2021 is as follows:
| | Translation | | | Benefit Plan | | | Cash Flow | | | Net Investment | |
| | Adjustment | | | Adjustment | | | Hedges | | | Hedges | |
Balance at June 30, 2021 | | $ | 9,192 | | | $ | (31,463 | ) | | $ | (678 | ) | | $ | 334 | |
Other comprehensive loss before reclassifications | | | (11,458 | ) | | | (1,835 | ) | | | - | | | | - | |
Amounts reclassified from accumulated other comprehensive loss | | | - | | | | 1,572 | | | | 1,034 | | | | 1,216 | |
Net current period other comprehensive income | | | (11,458 | ) | | | (263 | ) | | | 1,034 | | | | 1,216 | |
Balance at June 30, 2022 | | $ | (2,266 | ) | | $ | (31,726 | ) | | $ | 356 | | | $ | 1,550 | |
| | Translation | | | Benefit Plan | | | Cash Flow | | | Net Investment | |
| | Adjustment | | | Adjustment | | | Hedges | | | Hedges | |
Balance at June 30, 2020 | | $ | 3,454 | | | $ | (43,576 | ) | | $ | (1,104 | ) | | $ | - | |
Other comprehensive loss before reclassifications | | | 5,738 | | | | 9,783 | | | | 426 | | | | 334 | |
Amounts reclassified from accumulated other comprehensive loss | | | - | | | | 2,330 | | | | - | | | | - | |
Net current period other comprehensive loss | | | 5,738 | | | | 12,113 | | | | 426 | | | | 334 | |
Balance at June 30, 2021 | | $ | 9,192 | | | $ | (31,463 | ) | | $ | (678 | ) | | $ | 334 | |
A reconciliation for the reclassifications out of accumulated other comprehensive loss, net of tax, for the year ended June 30, 2022 is as follows:
| | Amount | |
| | Reclassified | |
Amortization of benefit plan items | | | | |
Actuarial losses | | $ | (2,376 | ) |
Transition asset and prior service benefit | | | 321 | |
Total before tax benefit | | | (2,055 | ) |
Tax benefit | | | 483 | |
Total reclassification net of tax | | $ | (1,572 | ) |
A reconciliation for the reclassifications out of accumulated other comprehensive loss, net of tax, for the year ended June 30, 2021 is as follows:
| | Amount | |
| | Reclassified | |
Amortization of benefit plan items | | | | |
Actuarial losses | | $ | (3,246 | ) |
Transition asset and prior service benefit | | | 187 | |
Total before tax benefit | | | (3,059 | ) |
Tax benefit | | | 729 | |
Total reclassification net of tax | | $ | (2,330 | ) |
J. BUSINESS SEGMENTS AND FOREIGN OPERATIONS
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, energy and natural resources, government, and industrial markets.
Net sales by product group is summarized as follows:
| | 2022 | | | 2021 | |
Industrial | | $ | 32,100 | | | $ | 23,454 | |
Land-based transmissions | | | 64,904 | | | | 58,421 | |
Marine and propulsion systems | | | 125,446 | | | | 127,243 | |
Other | | | 20,463 | | | | 9,463 | |
Total | | $ | 242,913 | | | $ | 218,581 | |
Industrial products include clutches, power take-offs and pump drives sold to the agriculture, recycling, construction and oil and gas markets. The land-based transmission products include applications for oil field and natural gas, military and airport rescue and firefighting. The marine and propulsion systems include marine transmission, azimuth drives, controls, surface drives, propellers and boat management systems for the global commercial marine, pleasure craft and patrol boat markets. Other includes non-Twin Disc manufactured product sold through Company-owned distribution entities.
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 earnings.
Information about the Company's segments, before intercompany eliminations, is summarized as follows:
2022 | | Manufacturing | | | Distribution | | | Total | |
Net Sales | | $ | 217,488 | | | $ | 106,731 | | | $ | 324,219 | |
Intra-segment sales | | | 4,218 | | | | 12,987 | | | | 17,206 | |
Inter-segment sales | | | 60,220 | | | | 3,880 | | | | 64,100 | |
Interest income | | | 423 | | | | 269 | | | | 692 | |
Interest expense | | | 2,734 | | | | 1 | | | | 2,735 | |
Income taxes | | | 795 | | | | 1,177 | | | | 1,972 | |
Depreciation and amortization | | | 8,912 | | | | 294 | | | | 9,205 | |
Net income attributable to Twin Disc | | | 22,455 | | | | 3,238 | | | | 25,692 | |
Assets | | | 364,174 | | | | 50,958 | | | | 415,132 | |
Expenditures for segment assets | | | (8,112 | ) | | | 386 | | | | (7,726 | ) |
2021 | | Manufacturing | | | Distribution | | | Total | |
Net Sales | | $ | 191,510 | | | $ | 100,221 | | | $ | 291,731 | |
Intra-segment sales | | | 9,436 | | | | 14,746 | | | | 24,182 | |
Inter-segment sales | | | 44,575 | | | | 4,393 | | | | 48,968 | |
Interest income | | | 172 | | | | 17 | | | | 189 | |
Interest expense | | | 2,449 | | | | 1 | | | | 2,450 | |
Income taxes | | | (980 | ) | | | 189 | | | | (791 | ) |
Depreciation and amortization | | | 10,455 | | | | 412 | | | | 10,867 | |
Net (loss) income attributable to Twin Disc | | | 11,016 | | | | 105 | | | | 11,121 | |
Assets | | | 364,379 | | | | 46,956 | | | | 411,335 | |
Expenditures for segment assets | | | 3,500 | | | | 188 | | | | 3,688 | |
The following is a reconciliation of reportable segment net sales and net income (loss) to the Company’s consolidated totals:
| | 2022 | | | 2021 | |
Net sales: | | | | | | | | |
Total net sales from reportable segments | | $ | 324,219 | | | $ | 291,731 | |
Elimination of inter-company sales | | | (81,305 | ) | | | (73,150 | ) |
Total consolidated net sales | | $ | 242,913 | | | $ | 218,581 | |
| | | | | | | | |
Net income (loss) attributable to Twin Disc: | | | | | | | | |
Total net income (loss) from reportable segments | | $ | 25,692 | | | $ | 11,121 | |
Other adjustments and corporate expenses | | | (17,598 | ) | | | (40,840 | ) |
Total consolidated net loss attributable to Twin Disc | | $ | 8,095 | | | $ | (29,719 | ) |
Corporate expenses pertain to certain costs that are not allocated to the reportable segments, primarily consisting of corporate overhead costs, including administrative functions and global functional expenses.
Other significant items:
| | Segment | | | | | | | Consolidated | |
| | Totals | | | Adjustments | | | Totals | |
2022 | | | | | | | | | | | | |
Interest income | | $ | 692 | | | $ | (664 | ) | | $ | 28 | |
Interest expense | | | 2,735 | | | | (607 | ) | | | 2,128 | |
Income taxes | | | 1,972 | | | | (148 | ) | | | 1,823 | |
Depreciation and amortization | | | 9,205 | | | | 342 | | | | 9,547 | |
Assets | | | 415,132 | | | | (138,610 | ) | | | 276,523 | |
Expenditures for segment assets | | | (7,726 | ) | | | 12,455 | | | | 4,729 | |
| | | | | | | | | | | | |
2021 | | | | | | | | | | | | |
Interest income | | $ | 189 | | | $ | (170 | ) | | $ | 19 | |
Interest expense | | | 2,450 | | | | (92 | ) | | | 2,358 | |
Income taxes | | | (791 | ) | | | 20,471 | | | | 19,680 | |
Depreciation and amortization | | | 10,867 | | | | 376 | | | | 11,243 | |
Assets | | | 411,335 | | | | (135,922 | ) | | | 275,413 | |
Expenditures for segment assets | | | 3,688 | | | | 776 | | | | 4,464 | |
All adjustments represent inter-company eliminations and corporate amounts.
Geographic information about the Company is summarized as follows:
| | 2022 | | | 2021 | |
Net sales | | | | | | | | |
United States | | $ | 81,454 | | | $ | 64,344 | |
Netherlands | | | 28,099 | | | | 25,790 | |
China | | | 26,870 | | | | 33,026 | |
Australia | | | 18,404 | | | | 17,963 | |
Italy | | | 16,577 | | | | 16,041 | |
Other countries | | | 71,510 | | | | 61,417 | |
Total | | $ | 242,913 | | | $ | 218,581 | |
Net sales by geographic region are based on product shipment destination.
Long-lived assets primarily pertain to property, plant and equipment and exclude goodwill, other intangibles, and deferred income taxes. They are summarized as follows:
Long-lived assets | | 2022 | | | 2021 | |
United States | | $ | 32,293 | | | $ | 34,629 | |
Netherlands | | | 10,471 | | | | 12,447 | |
Belgium | | | 6,760 | | | | 8,575 | |
Italy | | | 1,244 | | | | 1,525 | |
Switzerland | | | 923 | | | | 503 | |
Other countries | | | 5,191 | | | | 5,776 | |
Total | | $ | 56,883 | | | $ | 63,455 | |
There was one customer, an authorized distributor of the Company, that accounted for 10% of consolidated net sales in fiscal year 2022. There were no customers that accounted for 10% of consolidated net sales in fiscal 2021.
Disaggregated revenue:
The following tables present details deemed most relevant to the users of the financial statements for the years ended June 30, 2022 and June 30, 2021.
Net sales by product group for the year ended June 30, 2022 is summarized as follows:
| | | | | | | | | | Elimination of | | | | | |
| | Manufacturing | | | Distribution | | | Intercompany Sales | | | Total | |
Industrial | | $ | 30,769 | | | $ | 5,506 | | | $ | (4,175 | ) | | $ | 32,100 | |
Land-based transmissions | | | 65,332 | | | | 30,177 | | | | (30,605 | ) | | | 64,904 | |
Marine and propulsion systems | | | 112,149 | | | | 56,909 | | | | (43,612 | ) | | | 125,446 | |
Other | | | 9,238 | | | | 14,139 | | | | (2,914 | ) | | | 20,463 | |
Total | | $ | 217,488 | | | $ | 106,731 | | | $ | (81,305 | ) | | $ | 242,913 | |
Net sales by product group for the year ended June 30, 2021 is summarized as follows:
| | | | | | | | | | Elimination of | | | | | |
| | Manufacturing | | | Distribution | | | Intercompany Sales | | | Total | |
Industrial | | $ | 22,621 | | | $ | 5,494 | | | $ | (4,661 | ) | | $ | 23,454 | |
Land-based transmissions | | | 52,441 | | | | 26,003 | | | | (20,023 | ) | | | 58,421 | |
Marine and propulsion systems | | | 116,371 | | | | 59,276 | | | | (48,404 | ) | | | 127,243 | |
Other | | | 77 | | | | 9,448 | | | | (62 | ) | | | 9,463 | |
Total | | $ | 191,510 | | | $ | 100,221 | | | $ | (73,150 | ) | | $ | 218,581 | |
K. STOCK-BASED COMPENSATION
In fiscal 2022, the Company adopted the Twin Disc, Incorporated 2021 Long-Term Incentive Plan (the “2021 LTI Plan”). Benefits under the 2021 LTI Plan may be granted, awarded or paid in any one or a combination of stock options, stock appreciation rights, restricted stock awards, restricted stock units, cash-settled restricted stock units, performance stock awards, performance stock unit awards, performance unit awards, and dividend equivalent awards. There is reserved for issuance under the Plan an aggregate of 715,000 shares of the Company’s common stock, which may be authorized and unissued shares or shares reacquired by the Company in the open market or a combination of both. The aggregate amount is subject to proportionate adjustments for stock dividends, stock splits and similar changes.
In fiscal 2021, the Company adopted the Twin Disc, Incorporated 2020 Stock Incentive Plan for Non-Employee Directors (the “2020 Directors' Plan”) a plan to grant non-employee directors equity-based awards. Benefits under the 2020 Directors’ Plan may be granted, awarded or paid in any one or a combination of stock options, restricted stock awards, or cash-settled restricted stock units. Under the 2020 Directors’ Plan, non-employee directors may elect to receive all or a portion of their base cash retainer in the form of restricted stock. There is reserved for issuance under the 2020 Directors’ Plan an aggregate of 750,000 shares of the Company's common stock, which may be authorized and unissued shares or shares reacquired by the Company in the open market or a combination of both. The aggregate amount is subject to proportionate adjustments for stock dividends, stock splits and similar changes.
In fiscal 2019, the Company adopted the Twin Disc, Incorporated 2018 Long-Term Incentive Plan (the “2018 LTI Plan”). Benefits under the 2018 LTI Plan may be granted, awarded or paid in any one or a combination of stock options, stock appreciation rights, restricted stock awards, restricted stock units, cash-settled restricted stock units, performance stock awards, performance stock unit awards, performance unit awards, and dividend equivalent awards. There is reserved for issuance under the Plan an aggregate of 850,000 shares of the Company’s common stock, which may be authorized and unissued shares or shares reacquired by the Company in the open market or a combination of both. The aggregate amount is subject to proportionate adjustments for stock dividends, stock splits and similar changes.
Shares available for future awards as of June 30 were as follows (assuming that outstanding performance awards are issued at the target level of performance):
| | 2022 | | | 2021 | |
2020 Directors' Plan | | | 612,981 | | | | 666,913 | |
2021 LTI Plan | | | 551,901 | | | | - | |
Performance Stock Awards (“PSA”)
In fiscal 2022 and 2021, the Company granted a target number of 103,575 and 265,256 PSAs, respectively, to various employees of the Company, including executive officers.
The PSAs granted in fiscal 2022 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”) or average free cashflow (as defined in the PSA Grant Agreement), in the cumulative three fiscal year period ending June 30, 2024. These PSAs are subject to adjustment if the Company’s return on invested capital, net sales, and EPS or average free cashflow 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 146,562. Based upon actual results to date, the Company is currently accruing compensation expense for these PSAs.
The PSAs granted in fiscal 2021 will vest if the Company achieves performance-based target objectives relating to average return on invested capital, average annual sales and average free cash flow (as defined in the PSA Grant Agreement), in the cumulative three fiscal year period ending June 30, 2023. These PSAs are subject to adjustment if the Company’s return on invested capital, net sales, and free cash flow 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 397,884. Based upon actual results to date, the Company is currently accruing compensation expense for these PSAs.
There were 320,779 and 388,433 unvested PSAs outstanding at June 30, 2022 and 2021, 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. The compensation expense for the year ended June 30, 2022 and 2021, related PSAs, was $883 and $491, respectively. The tax expense from compensation expense for the year ended June 30, 2022 and 2021, related PSAs, was $207 and $116, respectively. The weighted average grant date fair value of the unvested awards at June 30, 2022 was $8.37. At June 30, 2022, the Company had $1,322 of unrecognized compensation expense related to the unvested shares that would vest if the specified target objective was achieved for the fiscal 2022 and 2021 awards. The total fair value of performance stock awards vested in fiscal 2022 and fiscal 2021 was $0.
Restricted Stock Awards (“RS”)
The Company has unvested RS outstanding that will vest if certain service conditions are fulfilled. The fair value of the RS grants is recorded as compensation over the vesting period, which is generally 1 to 3 years. During fiscal 2022 and 2021, the Company granted 57,204 and 251,804 service based restricted shares, respectively, to employees and non-employee directors in each year. A total of 29,810 and 6,809 shares of restricted stock were forfeited during fiscal 2022 and 2021, respectively. There were 272,438 and 379,095 unvested shares outstanding at June 30, 2022 and 2021, respectively. Compensation expense of $1,223 and $1,335 was recognized during the year ended June 30, 2022 and 2021, respectively, related to these service-based awards. The tax benefit from compensation expense for the year ended June 30, 2022 and 2021, related to these service-based awards, was $287 and $315, respectively. The total fair value of restricted stock grants vested in fiscal 2022 and 2021 was $1,711 and $533, respectively. As of June 30, 2022, the Company had $618 of unrecognized compensation expense related to restricted stock which will be recognized over the next three years.
Restricted Stock Unit Awards (“RSU”)
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. The fair value of the RSUs (on the date of grant) is recorded as compensation expense over the vesting period. There were 62,119 and 34,822 unvested RSUs outstanding at June 30, 2022 and June 30, 2021, respectively. Compensation expense of $321 and $328 was recognized during the year ended June 30, 2022 and 2021, respectively. The tax benefit from compensation expense for the year ended June 30, 2022 and 2021, related to these service-based awards, was $75 and $78, respectively. The weighted average grant date fair value of the unvested awards at June 30, 2022 was $14.18. As of June 30, 2022, the Company had $585 of unrecognized compensation expense related to RSUs which will be recognized over the next year.
L. ENGINEERING AND DEVELOPMENT COSTS
Engineering and development costs include research and development expenses for new products, development and major improvements to existing products, and other costs for ongoing efforts to refine existing products. Research and development costs charged to operations totaled $1,576 and $1,867 in fiscal 2022 and 2021, respectively. Total engineering and development costs were $8,808 and $8,535 in fiscal 2022 and 2021, respectively.
M. PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS
The Company has non-contributory, qualified defined benefit pension plans covering substantially all domestic employees hired prior to October 1, 2003, and certain foreign employees. Domestic plan benefits are based on years of service, and, for salaried employees, on average compensation for benefits earned prior to January 1, 1997, and on a cash balance plan for benefits earned from January 1, 1997 through July 31, 2009, at which time the Company froze future accruals under domestic defined benefit pension plans. The Company's funding policy for the plans covering domestic employees is to contribute an actuarially determined amount which falls between the minimum required contribution and maximum amount that can be deducted for federal income tax purposes.
In addition, the Company has unfunded, non-qualified retirement plans for certain management employees and Directors. In the case of management employees, benefits are based on an annual credit to a bookkeeping account, intended to restore the benefits that would have been earned under the qualified plans, but for the earnings limitations under the Internal Revenue Code. In the case of Directors, benefits are based on years of service on the Board. All benefits vest upon retirement from the Company.
In addition to providing pension benefits, the Company provides other postretirement benefits, including healthcare and life insurance benefits for certain domestic retirees. All employees retiring after December 31, 1992, and electing to continue healthcare coverage through the Company's group plan, are required to pay 100% of the premium cost.
The measurement date for the Company’s pension and postretirement benefit plans in fiscal 2022 and 2021 was June 30.
Obligations and Funded Status
The following table sets forth the Company's defined benefit pension plans’ and other postretirement benefit plans’ funded status and the amounts recognized in the Company's balance sheets and statement of operations and comprehensive loss as of June 30:
| | | | | | | | | | Other | |
| | Pension | | | Postretirement | |
| | Benefits | | | Benefits | |
| | 2022 | | | 2021 | | | 2022 | | | 2021 | |
Change in benefit obligation: | | | | | | | | | | | | | | | | |
Benefit obligation, beginning of year | | $ | 98,700 | | | $ | 105,520 | | | $ | 6,102 | | | $ | 7,059 | |
Service cost | | | 507 | | | | 608 | | | | 14 | | | | 16 | |
Interest cost | | | 2,472 | | | | 2,516 | | | | 140 | | | | 154 | |
Prior service cost | | | 40 | | | | 65 | | | | - | | | | - | |
Actuarial (gain) loss | | | (14,253 | ) | | | (1,577 | ) | | | (786 | ) | | | (395 | ) |
Contributions by plan participants | | | 105 | | | | 114 | | | | 203 | | | | 269 | |
Benefits paid | | | (8,022 | ) | | | (8,546 | ) | | | (888 | ) | | | (1,001 | ) |
Benefit obligation, end of year | | $ | 79,549 | | | $ | 98,700 | | | $ | 4,785 | | | $ | 6,102 | |
| | | | | | | | | | | | | | | | |
Change in plan assets: | | | | | | | | | | | | | | | | |
Fair value of assets, beginning of year | | $ | 92,430 | | | $ | 83,284 | | | $ | - | | | $ | - | |
Actual return on plan assets | | | (11,884 | ) | | | 15,325 | | | | - | | | | - | |
Employer contribution | | | 709 | | | | 2,253 | | | | 686 | | | | 732 | |
Contributions by plan participants | | | 105 | | | | 114 | | | | 203 | | | | 269 | |
Benefits paid | | | (8,022 | ) | | | (8,546 | ) | | | (889 | ) | | | (1,001 | ) |
Fair value of assets, end of year | | $ | 73,338 | | | $ | 92,430 | | | $ | - | | | $ | - | |
| | | | | | | | | | | | | | | | |
Funded status | | $ | (6,211 | ) | | $ | (6,270 | ) | | $ | (4,785 | ) | | $ | (6,102 | ) |
| | | | | | | | | | | | | | | | |
Amounts recognized in the balance sheet consist of: | | | | | | | | | | | | | | | | |
Other assets - noncurrent | | $ | - | | | $ | 60 | | | $ | - | | | $ | - | |
Accrued liabilities - current | | | (271 | ) | | | (423 | ) | | | (751 | ) | | | (833 | ) |
Accrued retirement benefits - noncurrent | | | (5,940 | ) | | | (5,907 | ) | | | (4,034 | ) | | | (5,269 | ) |
Net amount recognized | | $ | (6,211 | ) | | $ | (6,270 | ) | | $ | (4,785 | ) | | $ | (6,102 | ) |
| | | | | | | | | | | | | | | | |
Amounts recognized in accumulated other comprehensive loss consist of (net of tax): | | | | | | | | | | | | | | | | |
Net transition obligation | | $ | 102 | | | $ | 133 | | | $ | - | | | $ | - | |
Prior service cost | | | 9 | | | | 94 | | | | (278 | ) | | | (487 | ) |
Actuarial net loss | | | 32,453 | | | | 31,563 | | | | (560 | ) | | | 160 | |
Net amount recognized | | $ | 32,564 | | | $ | 31,790 | | | $ | (838 | ) | | $ | (327 | ) |
The amounts in accumulated other comprehensive loss that are expected to be recognized as components of net periodic benefit cost during the next fiscal year for the qualified defined benefit and other postretirement benefit plans are as follows:
| | | | | | Other | |
| | Pension | | | Postretirement | |
| | Benefits | | | Benefits | |
Net transition obligation | | $ | 36 | | | $ | - | |
Prior service cost | | | 37 | | | | (275 | ) |
Actuarial net loss | | | 2,482 | | | | (39 | ) |
Net amount to be recognized | | $ | 2,555 | | | $ | (314 | ) |
The accumulated benefit obligation for all defined benefit pension plans was approximately $79,549 and $98,700 at June 30, 2022 and 2021, respectively.
Information for pension plans with an accumulated benefit obligation in excess of plan assets:
| | June 30 | |
| | 2022 | | | 2021 | |
Projected and accumulated benefit obligation | | $ | 79,549 | | | $ | 53,780 | |
Fair value of plan assets | | | 73,338 | | | | 47,450 | |
Components of Net Periodic Benefit Cost:
| | Pension Benefits | |
| | 2022 | | | 2021 | |
Service cost | | $ | 511 | | | $ | 615 | |
Interest cost | | | 2,473 | | | | 2,516 | |
Prior service cost | | | 40 | | | | 65 | |
Expected return on plan assets | | | (5,055 | ) | | | (4,552 | ) |
Amortization of transition obligation | | | 40 | | | | 40 | |
Amortization of prior service cost | | | (85 | ) | | | 47 | |
Amortization of actuarial net loss | | | 2,375 | | | | 3,246 | |
Net periodic benefit cost | | $ | 299 | | | $ | 1,977 | |
| | Other Postretirement Benefits | |
| | 2022 | | | 2021 | |
Service cost | | $ | 14 | | | $ | 16 | |
Interest cost | | | 140 | | | | 154 | |
Amortization of prior service cost | | | (274 | ) | | | (274 | ) |
Net periodic benefit cost | | $ | (120 | ) | | $ | (104 | ) |
Other Changes in Plan Assets and Benefit Obligations Recognized in Other Comprehensive Loss for Fiscal 2022 (Pre-tax):
| | | | | | Other | |
| | | | | | Postretirement | |
| | Pension | | | Benefits | |
Net income (loss) | | $ | 2,860 | | | $ | (785 | ) |
Amortization of transition asset | | | (40 | ) | | | - | |
Amortization of prior service (cost) benefit | | | 85 | | | | 275 | |
Amortization of net loss | | | (2,375 | ) | | | - | |
Total recognized in other comprehensive income | | | 530 | | | | (510 | ) |
Net periodic benefit cost (benefit) | | | 299 | | | | (120 | ) |
Total recognized in net periodic benefit cost and other comprehensive income | | $ | 829 | | | $ | (630 | ) |
Other Changes in Plan Assets and Benefit Obligations Recognized in Other Comprehensive Loss for Fiscal 2021 (Pre-tax):
| | | | | | Other | |
| | | | | | Postretirement | |
| | Pension | | | Benefits | |
Net loss | | $ | (12,460 | ) | | $ | (397 | ) |
Amortization of transition asset | | | (40 | ) | | | - | |
Amortization of prior service (cost) benefit | | | (47 | ) | | | 275 | |
Amortization of net loss | | | (3,246 | ) | | | - | |
Total recognized in other comprehensive income | | | (15,793 | ) | | | (122 | ) |
Net periodic benefit cost (benefit) | | | 1,977 | | | | (104 | ) |
Total recognized in net periodic benefit cost and other comprehensive income | | $ | (13,816 | ) | | $ | (226 | ) |
Additional Information
Assumptions
| | | | | | | | | | Other | |
| | Pension Benefits | | | Postretirement Benefits | |
Weighted average assumptions used to determine benefit obligations at June 30 | | | | | | | | | | | | | | | | |
| | 2022 | | | 2021 | | | 2022 | | | 2021 | |
Discount rate | | | 4.61 | % | | | 2.63 | % | | | 4.83 | % | | | 2.47 | % |
Expected return on plan assets | | | 6.13 | % | | | 5.69 | % | | | | | | | | |
| | Pension Benefits | | | Other Postretirement Benefits | |
Weighted average assumptions used to determine net periodic benefit costs for years ended June 30 | | | | | | | | | | | | | | | | |
| | 2022 | | | 2021 | | | 2022 | | | 2021 | |
Discount rate | | | 2.59 | % | | | 2.49 | % | | | 2.47 | % | | | 2.37 | % |
Expected return on plan assets | | | 5.50 | % | | | 5.89 | % | | | | | | | | |
The assumed weighted-average healthcare cost trend rate was 5.75% in 2022, grading down to 5.00% in 2025.
Plan Assets
The Company’s Benefits Committee (“Committee”), a non-board management committee, oversees investment matters related to the Company’s funded benefit plans. The Committee works with external actuaries and investment consultants on an ongoing basis to establish and monitor investment strategies and target asset allocations. The overall objective of the Committee’s investment strategy is to earn a rate of return over time to satisfy the benefit obligations of the pension plans and to maintain sufficient liquidity to pay benefits and address other cash requirements of the pension plans. The Committee has established an Investment Policy Statement which provides written documentation of the Company’s expectations regarding its investment programs for the pension plans, establishes objectives and guidelines for the investment of the plan assets consistent with the Company’s financial and benefit-related goals, and outlines criteria and procedures for the ongoing evaluation of the investment program. The Company employs a total return on investment approach whereby a mix of investments among several asset classes are used to maximize long-term return of plan assets while avoiding excessive risk. Investment risk is measured and monitored on an ongoing basis through quarterly investment portfolio reviews, and annual liability measurements.
The Company’s pension plan weighted-average asset allocations at June 30, 2022 and 2021 by asset category were as follows:
| | Target | | | June 30 | |
Asset Category | | Allocation | | | 2022 | | | 2021 | |
Equity securities | | | 43 | % | | | 40 | % | | | 53 | % |
Debt securities | | | 50 | % | | | 49 | % | | | 38 | % |
Real estate | | | 7 | % | | | 11 | % | | | 9 | % |
| | | 100 | % | | | 100 | % | | | 100 | % |
Due to market conditions and other factors, actual asset allocation may vary from the target allocation outlined above. The U.S. pension plans held 98,211 shares of Company stock with a fair market value of $890 (1.3% of total plan assets) at June 30, 2022 and 98,211 shares with a fair market value of $1,398 (1.5% of total plan assets) at June 30, 2021.
The U.S. plans have a long-term return assumption of 6.40%. This rate was derived based upon historical experience and forward-looking return expectations for major asset class categories. The weighted average long-term return across all plans is 6.13%.
Fair value is defined as the price that would be received on the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The inputs used to measure fair value are classified into the following hierarchy:
Level I | Unadjusted quoted prices in active markets for identical instruments |
Level II | Unadjusted quoted prices in active markets for similar instruments, or |
| Unadjusted quoted prices for identical or similar instruments in markets that are not active, or |
| Other inputs that are observable in the market or can be corroborated by observable market data |
Level III | Use of one or more significant unobservable inputs |
The following table presents plan assets using the fair value hierarchy as of June 30, 2022:
| | Total | | | Level I | | | Level II | | | Level III | |
Cash and cash equivalents | | $ | 865 | | | $ | 865 | | | $ | - | | | $ | - | |
Equity securities: | | | | | | | | | | | | | | | | |
Company common stock (a) | | | 890 | | | | 890 | | | | - | | | | - | |
Common stock (a) | | | 10,612 | | | | 10,612 | | | | - | | | | - | |
Mutual funds (b) | | | 4,720 | | | | 4,720 | | | | - | | | | - | |
Annuity contracts (c) | | | 6,302 | | | | - | | | | - | | | | 6,302 | |
Total | | $ | 23,389 | | | $ | 17,087 | | | $ | - | | | $ | 6,302 | |
Investments Measured at Net Asset Value (d) | | | 49,949 | | | | | | | | | | | | | |
Total | | $ | 73,338 | | | | | | | | | | | | | |
The following table presents plan assets using the fair value hierarchy as of June 30, 2021:
| | Total | | | Level I | | | Level II | | | Level III | |
Cash and cash equivalents | | $ | 1,043 | | | $ | 1,043 | | | $ | - | | | $ | - | |
Equity securities: | | | | | | | | | | | | | | | | |
Company common stock (a) | | | 1,398 | | | | 1,398 | | | | - | | | | - | |
Common stock (a) | | | 18,201 | | | | 18,201 | | | | - | | | | - | |
Mutual funds (b) | | | 9,366 | | | | 9,366 | | | | - | | | | - | |
Annuity contracts (c) | | | 6,646 | | | | - | | | | - | | | | 6,646 | |
Total | | $ | 36,654 | | | $ | 30,008 | | | $ | - | | | $ | 6,646 | |
Investments Measured at Net Asset Value (d) | | | 55,776 | | | | | | | | | | | | | |
Total | | $ | 92,430 | | | | | | | | | | | | | |
(a) Common stock is valued at the closing price reported on the active market on which the individual securities are traded. These securities include U.S. equity securities invested in companies that are traded on exchanges inside the U.S. and international equity securities invested in companies that are traded on exchanges outside the U.S.
(b) Mutual funds are valued at the daily closing price as reported by the fund. Mutual funds held by the Company’s funded benefit plans are open-end mutual funds that are registered with the Securities Exchange Commission. These funds are required to publish their daily net asset value (“NAV”) and to transact at that price. The mutual funds held by the Company’s funded benefit plans are deemed to be actively traded.
(c) Annuity contracts represent contractual agreements in which payments are made to an insurance company, which agrees to pay out an income or lump sum amount at a later date. Annuity contracts are valued at fair value using the net present value of future cash flows.
(d) In accordance with ASC 820-10, certain investments that were measured at net asset value per share (or its equivalent) have not been classified in the fair value hierarchy. The fair value amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the fair value of plan assets at the end of the year.
55
The following table sets forth additional disclosures for the fair value measurement of the fair value of pension plan assets that calculate fair value based on NAV per share practical expedient as of June 30, 2022 and June 30, 2021:
| | 2022 | | | 2021 | |
Fixed income funds | | $ | 31,763 | | | $ | 31,627 | |
International equity securities | | | 2,198 | | | | 4,282 | |
Real estate | | | 7,074 | | | | 7,747 | |
Hedged equity mutual funds | | | 8,914 | | | | 12,120 | |
Total | | $ | 49,949 | | | $ | 55,776 | |
The following tables present a reconciliation of the fair value measurements using significant unobservable inputs (Level III) as of June 30, 2022 and 2021:
| | 2022 | | | 2021 | |
Beginning balance | | $ | 6,646 | | | $ | 6,095 | |
Actual return on plan assets: | | | | | | | | |
Relating to assets still held at reporting date | | | (452 | ) | | | 600 | |
Purchases, sales and settlements, net | | | 108 | | | | (49 | ) |
Ending balance | | $ | 6,302 | | | $ | 6,646 | |
Cash Flows
Contributions
The Company expects to contribute $612 to its defined benefit pension plans in fiscal 2023.
Estimated Future Benefit Payments
The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid:
| | | | | | | | Other | |
| | | | Pension | | | Postretirement | |
| | | | Benefits | | | Benefits | |
| | | | | | | | | | |
2022 | | | | $ | 7,946 | | | $ | 769 | |
2023 | | | | | 7,380 | | | | 693 | |
2024 | | | | | 7,068 | | | | 608 | |
2025 | | | | | 6,833 | | | | 544 | |
2026 | | | | | 6,738 | | | | 501 | |
Years 2027 | - | 2031 | | | 34,812 | | | | 1,806 | |
The Company does not expect to make any Part D reimbursements for the periods presented.
The Company sponsors defined contribution plans covering substantially all domestic employees and certain foreign employees. These plans provide for employer contributions based primarily on employee participation. The total expense under the plans was $2,245 and $2,162 in fiscal 2022 and 2021, respectively.
56
N. INCOME TAXES
United States and foreign (loss) income before income taxes and minority interest were as follows:
| | 2022 | | | 2021 | |
United States | | $ | (1,165 | ) | | $ | (15,925 | ) |
Foreign | | | 11,394 | | | | 6,086 | |
| | $ | 10,229 | | | $ | (9,839 | ) |
The provision (benefit) for income taxes is comprised of the following:
| | 2022 | | | 2021 | |
Currently payable: | | | | | | | | |
Federal | | $ | (164 | ) | | $ | 28 | |
State | | | (2 | ) | | | 49 | |
Foreign | | | 2,838 | | | | 1,948 | |
| | | 2,672 | | | | 2,025 | |
Deferred: | | | | | | | | |
Federal | | $ | - | | | | 15,554 | |
State | | | 62 | | | | 2,341 | |
Foreign | | | (911 | ) | | | (240 | ) |
| | | (849 | ) | | | 17,655 | |
| | $ | 1,823 | | | $ | 19,680 | |
The components of the net deferred tax asset as of June 30 are summarized in the table below.
| | 2022 | | | 2021 | |
Deferred tax assets: | | | | | | | | |
Retirement plans and employee benefits | | $ | 4,787 | | | $ | 4,584 | |
Foreign tax credit carryforwards | | | 7,822 | | | | 7,609 | |
Federal tax credits, net of ASU 2013-11 | | | 1,597 | | | | 1,801 | |
State net operating loss and other state credit carryforwards, net of ASU 2013-11 | | | 2,179 | | | | 2,208 | |
Federal net operating loss | | | 5,492 | | | | 6,506 | |
Inventory | | | - | | | | - | |
Reserves | | | 1,119 | | | | 1,670 | |
Foreign NOL carryforwards | | | - | | | | 66 | |
Accruals | | | 703 | | | | 871 | |
Right of use assets - operating leases | | | 3,381 | | | | 3,674 | |
Disallowed interest | | | 980 | | | | 982 | |
Capital loss carryforward | | | 108 | | | | - | |
Other assets | | | 358 | | | | 1,033 | |
| | | 28,526 | | | | 31,004 | |
Valuation allowance | | | (23,097 | ) | | | (24,420 | ) |
| | | 5,429 | | | | 6,584 | |
| | | | | | | | |
Deferred tax liabilities: | | | | | | | | |
Inventory | | | 285 | | | | 480 | |
Property, plant and equipment | | | 1,155 | | | | 1,852 | |
Intangibles | | | 2,012 | | | | 2,982 | |
Long term operating lease obligations | | | 3,352 | | | | 3,622 | |
Other liabilities | | | 249 | | | | 182 | |
| | | 7,053 | | | | 9,118 | |
| | | | | | | | |
Total net deferred tax (liabilities) assets | | $ | (1,624 | ) | | $ | (2,534 | ) |
At June 30, 2022 the Company has net operating loss carryforwards (“NOLs”) of approximately $26,154 and $30,901 for federal and state income tax purposes which will expire at various dates from fiscal year 2023 – 2042. Federal NOLs were generated subsequent to fiscal 2019 and have an indefinite carryover period. The Company has federal and state tax credit carryforwards of approximately $9,738 and $935, respectively, which will expire at various dates from fiscal 2026 – 2042.
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. The Company has evaluated the likelihood of whether the net deferred tax assets would be realized and concluded that it is more likely than not that all of deferred tax assets would not be realized. Management believes that it is more likely than not that the results of future operations will not generate sufficient taxable income and foreign source income to realize all the domestic deferred tax assets, therefore, a valuation allowance in the amount of $23,097 and $24,420 have been recorded for fiscal year 2022 and 2021, respectively.
Following is a reconciliation of the applicable U.S. federal income taxes to the actual income taxes reflected in the statements of operations:
| | 2022 | | | 2021 | |
| | | | | | | | |
U.S. federal income tax at 21% | | $ | 2,148 | | | $ | (2,066 | ) |
Increases (reductions) in tax resulting from: | | | | | | | | |
Foreign tax items | | | (575 | ) | | | 552 | |
State taxes | | | (12 | ) | | | (440 | ) |
Change in prior year estimate | | | 372 | | | | (1,138 | ) |
Nondeductible PPP loan expenses | | | - | | | | (1,722 | ) |
Research and development tax credits | | | (10 | ) | | | (336 | ) |
Unrecognized tax benefits | | | (152 | ) | | | 59 | |
Stock compensation | | | (46 | ) | | | 252 | |
Rate changes | | | 121 | | | | 18 | |
Deferred tax basis adjustments | | | (54 | ) | | | 42 | |
Executive compensation | | | 42 | | | | - | |
GILTI inclusion | | | 920 | | | | - | |
Valuation allowance | | | (981 | ) | | | 24,420 | |
Other, net | | | 50 | | | | 39 | |
| | $ | 1,823 | | | $ | 19,680 | |
On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”). The Tax Act makes broad and complex changes to the Internal Revenue Code. The Tax Act is generally applicable for tax years beginning after December 31, 2017, which is the Company’s fiscal year 2018. However, several provisions of the Tax Act have differing effective dates, meaning these provisions did not impact the Company’s financial statements until fiscal year 2019. The provisions impacting the Company’s fiscal year 2019 financial statements include the global intangible low taxed income (“GILTI”) income and foreign-derived intangible income (“FDII”) deduction and limitations on the deductibility of executive compensation.
Executive Compensation Limitations: The Tax Act substantially modifies the limitation on corporate deductibility of executive compensation under Section 162(m) of the Code. Section 162(m) limits the deduction for compensation paid by a publicly held corporation to certain of its executive employees to $1,000 per year. The Tax Act has amended the definition of “covered employee” to correspond to the general SEC reporting requirements for named executive officers. These are the corporation’s principal executive officer, principal financial officer, and the next three highest-paid executive officers. Most significantly, the Tax Act has eliminated the exemptions for commissions and performance-based compensation. This had an impact on the company’s effective tax rate in fiscal years 2022 and 2021 of $42 and $0 respectively.
Global Intangible Low Taxed Income (“GILTI”): The Tax Act changed the foreign source income calculations and related foreign tax credit amounts. The GILTI require 10% domestic shareholders (“U.S. Shareholders”) of controlled foreign corporations (“CFC’s”) to include in gross income annually the U.S. Shareholders’ pro rata share of GILTI for the year. The High Tax Exception (“HTE") rules were finalized and applicable for the Company during fiscal year 2022. Accordingly, the Company may exclude from the GILTI inclusion tested income from tested units with an effective tax rate greater than 18.9%. The Company was able to take advantage of this high tax exception, which resulted in zero GILTI inclusion in the Company’s effective tax rate for fiscal year 2021. In fiscal year 2022, the GILTI inclusion was $920. During Q4 FY2022, neither Rolla nor TD China qualified for the HTE because their effective tax rates are lower than 18.9%. This resulted in a GILTI income inclusion of approximately $4.9 million. The Rolla inclusion is largely due to the gain on the sale of their building, while TD China’s inclusion is due to a temporary tax rate decrease in China.
Foreign Derived Intangible Income (“FDII”): The Tax Act provides companies with a new permanent deduction. An incentive for C corporations to generate revenue from serving foreign markets, the provision applies a preferential tax rate to eligible income. The new tax law assumes a fixed rate of return on a corporation’s tangible assets. Any remaining income is deemed to be generated by intangible assets. This did not have an impact on the Company’s effective tax rate in fiscal year 2022 and 2021.
The Company has not provided additional U.S. income taxes on cumulative earnings of its consolidated foreign subsidiaries that are considered to be reinvested indefinitely. The Company reaffirms its position that the earnings of those subsidiaries remain permanently invested and has no plans to repatriate funds from any permanently reinvested subsidiaries to the U.S. for the foreseeable future. These earnings relate to ongoing operations and were approximately $14,175 and $10,871 at June 30, 2022 and June 30, 2021, respectively. Such earnings could become taxable upon the sale or liquidation of these foreign subsidiaries or upon dividend repatriation. The Company’s intent is for such earnings to be reinvested by the subsidiaries or to be repatriated only when it would be tax effective through the utilization of foreign tax credits.
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 2017 through 2022 for our major operations in Belgium, Japan, Netherlands, Singapore and Australia. The tax years open to examination in the U.S. are for years subsequent to fiscal 2017.
The Company has approximately $716 and $778 of unrecognized tax benefits as of June 30, 2022 and June 30, 2021, respectively, which, if recognized, would impact the effective tax rate. During the fiscal year the amount of unrecognized tax benefits decreased primarily due to settlements with tax authorities. No material changes are expected to the reserve during the next 12 months. The Company’s policy is to accrue interest and penalties related to unrecognized tax benefits in income tax expense.
Below is a reconciliation of beginning and ending amount of unrecognized tax benefits as of June 30:
| | 2022 | | | 2021 | |
Unrecognized tax benefits, beginning of year | | $ | 778 | | | $ | 918 | |
Additions based on tax positions related to the prior year | | | - | | | | - | |
Additions based on tax positions related to the current year | | | 3 | | | | 66 | |
Reductions based on tax positions related to the prior year | | | (65 | ) | | | (21 | ) |
Subtractions due to statutes closing | | | - | | | | - | |
Settlements with taxing authorities | | | - | | | | (185 | ) |
Unrecognized tax benefits, end of year | | $ | 716 | | | $ | 778 | |
Substantially all of the Company’s unrecognized tax benefits as of June 30, 3022, if recognized, would affect the effective tax rate. As of June 30, 2022 and 2021, the amounts accrued for interest and penalties totaled $38 and $141, respectively, and are not included in the reconciliation above.
O. CONTINGENCIES
The Company is involved in litigation of which the ultimate outcome and liability to the Company, if any, are 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, either individually or in the aggregate.
P. RESTRUCTURING OF OPERATIONS AND INCOME FROM EXTINGUISHMENT OF LOAN
Restructuring expenses
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. During the fourth quarter of fiscal 2021, the Company undertook a series of steps to accelerate its focus on its core competencies, improve its fixed cost structure, and monetize some of its under-utilized assets.
With regard to its Belgian operations, on June 30, 2021, the Company announced a new phase in its restructuring plans. Under this plan, the Belgian operation’s workforce was reduced by 18 employees. This reduction in force resulted in an accrual of $2,200, pertaining to the Company’s current estimate for the payment of severance benefits, which is expected to be completed by December 2022. The action was taken to allow the Belgian operation to focus resources on core manufacturing processes, while allowing for savings on the outsourcing of non-core processes.
Total restructuring charges relating to streamlining operations amounted to $973 and $3,110 in fiscal 2022 and 2021, respectively. Restructuring activities since June 2015 have resulted in the elimination of 254 full-time employees in the manufacturing segment. Accumulated costs to date under these programs within the manufacturing segment through June 30, 2022 were $16,226.
The following is a roll-forward of restructuring activity:
Accrued restructuring liability, June 30, 2020 | | $ | 84 | |
Additions | | | 7,377 | |
Payments and adjustments | | | (5,109 | ) |
Accrued restructuring liability, June 30, 2021 | | | 2,352 | |
Additions | | | 973 | |
Payments and adjustments | | | (2,301 | ) |
Accrued restructuring liability, June 30, 2022 | | $ | 1,024 | |
Assets held for sale
To improve its fixed cost structure and monetize some of its under-utilized assets, the Company commenced the active marketing of three of its real estate properties, namely, its corporate headquarters in Racine, its propeller machining plant and office in Switzerland, and a spare warehouse in Italy during the fourth quarter of fiscal 2021. Such actions required the Company to reclassify these assets from Property, Plant and Equipment to Assets Held for Sale, at fair value less costs to sell, or net book value, whichever is lower. Fair value was determined using real estate broker estimates and would be classified as Level 3 in the fair value hierarchy. This assessment of fair value resulted in the Company recognizing a write-down of the carrying value of its corporate headquarters by $4,267.
In the first quarter of fiscal 2022, the Company completed the sale of its propeller machining plant and office in Switzerland and received $9,138 in proceeds, net of fees and local taxes and recorded a gain of $2,939 in other operating income. In the fourth quarter of fiscal 2022, the Company completed the sale of its spare warehouse in Italy and received net proceeds of about $305.
Income from extinguishment of loan
As discussed in Note G, Debt, on June 16, 2021, the Company received formal forgiveness of its PPP Loan in the amount of $8,200. In accordance with ASC 470 Debt and ASC 450-30 Gain contingency, the Company recorded $8,200 in income from extinguishment of loan in its condensed consolidated statement of operations in fiscal 2021.
Q. 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. Restricted stock award recipients under the 2010 LTI Plan 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:
| | 2022 | | | 2021 | |
Basic: | | | | | | | | |
Net income (loss) | | $ | 8,406 | | | $ | (29,519 | ) |
Less: Net earnings attributable to noncontrolling interest | | | (311 | ) | | | (200 | ) |
Less: Undistributed earnings attributable to unvested shares | | | - | | | | - | |
Net income (loss) attributable to Twin Disc | | | 8,095 | | | | (29,719 | ) |
| | | | | | | | |
Weighted average shares outstanding - basic | | | 13,353 | | | | 13,247 | |
| | | | | | | | |
Basic Loss Per Share: | | | | | | | | |
Net income (loss) per share - basic | | $ | 0.61 | | | $ | (2.24 | ) |
| | | | | | | | |
Diluted: | | | | | | | | |
Net income (loss) | | $ | 8,406 | | | $ | (29,519 | ) |
Less: Net earnings attributable to noncontrolling interest | | | (311 | ) | | | (200 | ) |
Less: Undistributed earnings attributable to unvested shares | | | - | | | | - | |
Net income (loss) attributable to Twin Disc | | | 8,095 | | | | (29,719 | ) |
| | | | | | | | |
Weighted average shares outstanding - basic | | | 13,353 | | | | 13,247 | |
Effect of dilutive stock awards | | | 29 | | | | - | |
Weighted average shares outstanding - diluted | | | 13,382 | | | | 13,247 | |
| | | | | | | | |
Diluted Loss Per Share: | | | | | | | | |
Net income (loss) per share - diluted | | $ | 0.60 | | | $ | (2.24 | ) |
The following potential common shares were excluded from diluted EPS for the year ended June 30, 2021 as the Company reported a net loss: 388,433 related to the Company’s unvested PSAs, 379,095 related to the Company’s unvested RS awards, and 34,822 related to the Company’s unvested RSUs.
R. DERIVATIVE FINANCIAL INSTRUMENTS
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.
As a global organization, the Company faces exposure to market risks, such as fluctuations in foreign currency exchange rates, interest rates and commodity prices. To manage the volatility relating to these exposures, the Company enters into various derivative instruments from time to time under its risk management policies. The Company designates derivative instruments as hedges on a transaction basis to support hedge accounting. The changes in fair value of these hedging instruments offset in part or in whole corresponding changes in the fair value or cash flows of the underlying exposures being hedged. The Company assesses the initial and ongoing effectiveness of its hedging relationships in accordance with its policy. 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.
Interest Rate Swaps Designated as Cash Flow Hedges
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 SOFR-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. 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 twelve months.
Net unrealized after-tax losses related to cash flow hedging activities that were included in accumulated other comprehensive loss were ($356) and $678 for the years ended June 30, 2022 and 2021, 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 ($68) 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.
Derivatives Designated as Net Investment Hedges
The Company is exposed to foreign currency exchange risk related to its investment in net assets in foreign countries. As discussed in Note G, Debt, during the fourth quarter of fiscal 2022, the Company designated its euro denominated Revolving Loan, with a notional amount of €13,500, as a net investment hedge to mitigate the risk of variability in its euro denominated net investments in wholly-owned foreign subsidiaries. All changes in fair value of the euro revolver were then reported in accumulated other comprehensive loss along with the foreign currency translation adjustments on those foreign investments. Net unrealized after-tax income related to net investment hedging activities that were included in accumulated other comprehensive loss were ($1,551) and $334 for the years ended June 30, 2022 and 2021, respectively.
Foreign Currency Forward Contracts Not Designated as Hedges
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 consolidated statement of operations and comprehensive loss 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 2022 and 2021 was the euro. At June 30, 2022 and 2021, there were no significant forward exchange contracts outstanding.
Other Derivative Instruments
The Company does not utilize commodity price hedges to manage commodity price risk exposure. Likewise, the Company does not hedge the translation exposure represented by the net assets of its foreign subsidiaries.
Fair Value of Derivative Instruments
The Company’s interest rate swaps and foreign currency forward contracts are recorded at fair value on the consolidated balance sheets using a discounted cash flow analysis that incorporates observable market inputs. These market inputs include foreign currency spot and forward rates, and various interest rate curves, and are obtained from pricing data quoted by various banks, third-party sources and foreign currency dealers involving identical or comparable instruments (Level 2).
Counterparties to these foreign currency forward contracts have at least an investment grade rating. Credit ratings on some of the Company’s counterparties may change during the term of the financial instruments. The Company closely monitors its counterparties’ credit ratings and, if necessary, will make any appropriate changes to its financial instruments. The fair value generally reflects the estimated amounts that the Company would receive or pay to terminate the contracts at the reporting date.
As discussed in Note G, Debt, the Company's euro denominated Revolving Loan approximates fair value at June 30, 2022 and June 30, 2021. If measured at fair value in the financial statements, it would be classified as Level 2 in the fair value hierarchy.
The fair value of derivative instruments included in the consolidated balance sheets at June 30 were as follows:
| Balance Sheet Location | | 2022 | | | 2021 | |
Derivatives designated as hedges: | | | | | | | | | |
Interest rate swaps | Other current assets | | $ | 68 | | | $ | - | |
Interest rate swaps | Other noncurrent assets | | | 77 | | | | - | |
Interest rate swaps | Accrued liabilities | | | - | | | | (346 | ) |
Interest rate swaps | Other long-term liabilities | | | - | | | | (542 | ) |
The impact of the Company’s derivative instruments on the consolidated statement of operations and comprehensive loss for the years ended June 30 was as follows:
| Statement of Comprehensive | | | | | | | | |
| Loss Location | | 2022 | | | 2021 | |
Derivatives designated as hedges: | | | | | | | | | |
Interest rate swap | Interest expense | | $ | 362 | | | $ | 399 | |
Interest rate swap | Unrealized gain (loss) on hedges | | | 1,034 | | | | 425 | |
Net investment hedge | Unrealized gain (loss) on hedges | | | 1,216 | | | | 335 | |
| | | | | | | | | |
Derivatives not designated as hedges: | | | | | | | | | |
Foreign currency forward contracts | Other income (expense), net | | $ | - | | | $ | (15 | ) |
63