Twin Disc
Annual Report 2014

Plain-text annual report

an n u a l re p o r T 2 0 1 4 T w i n D i s c , i n c o r p o r a T e D | A n n u A l r e p o r t 2 0 1 4 1328 Racine Street Racine, Wisconsin 53403 United States of America www.twindisc.com 0 0 1 c s n 1 8eB Twin Disc, incORPORATED | AnnuAl RepoRt 2014 finAnciAl highlighTs Net Sales Net Earnings Basic Earnings Per Share Diluted Earnings Per Share Dividends Per Share 2 0 1 4 2 0 1 3 2 0 1 2 $263,909 $285,282 $355,870 3,644 3,882 26,743 0.32 0.32 0.36 0.34 0.34 0.36 2.34 2.31 0.34 Average Shares Outstanding For The Year 11,258,342 11,304,280 11,409,467 Diluted Shares Outstanding For The Year 11,264,421 11,377,091 11, 555,561 In thousands of dollars except per share and shares outstanding statistics. Company engineers work hand-in-hand with Twin Disc also sells industrial products such customers and engine manufacturers to design as power take-offs, mechanical, hydraulic and products with characteristics unique to their specific modulating clutches and control systems to the applications. Twin Disc supplies the commercial, agricultural, environmental and energy and natural pleasure craft and military segments of the marine resources markets. The Corporation, which is a market with transmissions, surface drives, electronic multinational organization headquartered in Racine, controls, propellers and boat management systems. Wisconsin, currently has a diverse shareholder base Its off-highway transmission products are used with approximately one-third of the outstanding in agricultural, all-terrain specialty vehicle and shares held by management, active and retired military applications. employees and other long-term investors. Cover: This restored 1942 Higgins boat, a World War II and likely Normandy Invasion survivor, held an esteemed position in the June 6, 2014, tribute to D-Day’s 70th anniversary. Twin Disc marine transmissions were on some 20,000 Higgins boats, including the estimated 800 to 1000 the Allies used to storm the beaches of Normandy. The owner and restorer of the boat Hugues Eliard was driving along a Normandy canal 12 years ago when he spotted a curious shape embedded in the river’s mud. Upon further scrutiny he recognized the object to be the rotting hulk of a WWII-era Higgins boat. Over the next dozen years he meticulously restored the craft and proudly operated it in the recent D-Day commemoration. In the early 1930s, Andrew Higgins designed and built the shallow-draft, barge-like boats to operate in Louisiana swamps and marshes to extract felled trees for his timber business. In the late 30s the U.S. Navy and Marine Corp. adopted the boat as a Landing Craft, Vehicle, Personnel (LCVP). Higgins Industries and licensees built more than 20,000 of the landing craft. They were built of plywood with a steel ramp door. Despite their small size (36’ long with a 10’ beam), the boat could carry 36 men or a jeep and 12 men, or 8000 pounds of cargo. The boat was propelled by a 225-hp (168-kW) Gray Marine diesel engine or a Hall-Scott 250-hp (186-kW) gasoline engine, with either engine working through a Twin Disc marine transmission. Twin Disc-equipped Higgins boats served extensively in WWII amphibious landings in both European and Pacific theaters. 1 2 twin disc, incorporated is an international manufacturer and distributor of heavy-duty off-highway power transmission equipment.MG Bryan, Dallas, Texas, has just introduced a new line of high-horsepower, high-pressure pumping units incorporating Twin Disc’s TA90-8501 power-shift transmission with integral torque converter for maximum productivity in hydraulic fracturing. This Couach 2800 Open (91 feet/28 meters) achieves 40 knots and nimble maneuvering from twin 2400-hp (1790-kW) MTU engines and a contingent of Twin Disc products including Arneson ASD15 Surface Drives™, trim tabs, thrusters and Rolla™ Propellers.Twin Disc, incORPORATED | AnnuAl RepoRt 2014 sAlEs A nD EAR nings bY Q uARTER 2014 Net Sales Gross Profit Net Earnings Basic Earnings Per Share Diluted Earnings Per Share Dividends Per Share 1sT QTR $66, 426 20,667 1,277 0.11 0.11 0.09 2nD QTR $63,212 18,544 518 0.05 0.05 0.09 3RD QTR $60,705 16,528 (475) (0.04 ) (0.04 ) 0.09 4Th QTR $73,566 21,515 2,324 0.20 0.20 0.09 YEAR $263,909 77,254 3,644 0.32 0.32 0.36 Stock Price Range (High – Low) 27.32 – 22.67 29.00 – 24.16 27.88 – 18.67 34.34 – 23.41 34.34 – 18.67 2013 Net Sales Gross Profit Net Earnings Basic Earnings Per Share Diluted Earnings Per Share Dividends Per Share $68,793 19,416 1,231 0.11 0.11 0.09 $72,325 22,311 3,360 0.30 0.29 0.09 $68,232 17,674 (757 ) (0.07 ) (0.07 ) 0.09 $75,932 20,624 48 0.00 0.00 0.09 $285,282 80,025 3,882 0.34 0.34 0.36 Stock Price Range (High – Low) 22.41 – 17.88 18.27 – 13.70 27.72 – 16.92 26.02 – 20.58 27.72 – 13.70 In thousands of dollars except per share and stock price range statistics. Florida Marine Transporters’ 90-foot (27-meter) vessel Capt. Troy J. Hotard, with its twin Caterpillar 1500-hp (1119-kW) engines driving through Twin Disc MGX-5600 QuickShift® marine transmissions, transports petroleum products on the Illinois River. TO OuR shAREhOlDERs Fiscal 2014 was not the year that we had anticipated, as the sluggish market dynamics of 2013 have persisted much longer than expected. Most markets continued well below peak levels, and the North American oil and gas equipment manufacturers were still burdened with excess inventory. It also remained a year of transition as we implemented the new organizational structure announced at the end of fiscal 2013, our new plant in India achieved full production capability, and export sales continued to grow as a percentage of our overall sales. finAnciAl REsul Ts Sales into our Asian and European markets remained essentially flat year-over-year. The difference, though, was that sales into Asia remained historically high, with the China market topping $30 million alone, while Europe remained historically low. The difference versus fiscal 2013 was sales into the North American markets, which fell 15%. Looking at our product markets, we had some carryover of transmission and industrial sales from our record fiscal 2012 into fiscal 2013, which was also a record year for our marine sales, but that momentum did not exist in fiscal 2014, and sales fell 7.5% year-over-year. Oil and gas shipments to Asia continued at a high level, and the majority of our commercial marine markets remained strong, especially the larger offshore crew boat builders. Most of the marine weakness occurred in the lower horsepower sector, whether in Europe, North America or Asia. 3 4 Twin Disc, incORPORATED | AnnuAl RepoRt 2014 OPERATiOns REViEw Despite the lower sales levels in fiscal 2014, gross margins improved from 28.1% in fiscal 2013 to 29.3%. Both a better mix of products in all product areas and improved plant efficiency drove the improvement. While gross margins improved, we continue to look for ways to increase factory utilization, primarily in Europe where we still have excess capacity and rely less on the government-supported rolling layoff plans. Total year marketing, engineering and administrative (ME&A) spending decreased 0.7%, or $490k, over year ago levels, from $67.9 million, or 23.8% of sales, to $67.4 million, or 25.5% of sales. The decrease would have been greater had it not been for some one-time charges, both in the first and fourth quarters, that did not reflect management’s continued effort to operate more efficiently without sacrificing new product development or service to our customers. On a brighter note, most of our product markets improved sequentially through the fiscal quarters, both in terms of shipments and new orders, and our backlog increased the last three quarters, including new transmission system orders for the North American oil and gas market. Additionally, there were a lot of new orders in the second half of the year for our Express Joystick System its cousin: Cat’s pleasure craft builders used the system’s differentiating features to separate themselves from their competition. Three60 Precision Control System, as select ) and (EJS ® ® ® Net earnings for the year were $3.6 million, or $0.32 per share, compared to $3.9 million, or $0.34 per share a year ago. As you recall, the timing of the restructuring negotiations at our Belgian facility could not be completed in fiscal 2013. As a result, a charge of $1.077 million, or $0.09 per diluted share, was taken in the first fiscal quarter of fiscal year 2014. Both fiscal 2013 and 2014 had similar earnings trends in that we had strong first quarters, moderating second quarters, sluggish third quarters and improving fourth quarters. The momentum, though, that we saw in the fourth quarter with respect to orders and shipments for our North American oil and gas customers gives management a lot more optimism than we had a year ago. Chinese oil and gas giant Sinopec utilizes JiangHan Downhole with its Twin Disc 8500 transmission system- equipped trucks to perform fracturing operations in rugged shale gas fields in the Sichuan Basin. Left - The glass Kevlar®/carbon-hulled Couach Hornet 1300 (42 feet/13 meters) can attain 52 knots with its twin MAN 800-hp (597-kW) engines working through Twin Disc QuickShift® marine transmissions to drive Arneson ASD11 Surface Drives™ with Twin Disc trim tabs and Rolla™ Propellers. right - The 90-foot (27-meter) James Dale Robin, another of Florida Marine Transporters’ large fleet of push boats working the inland rivers system, relies on the power of twin Caterpillar 1500-hp (1119-kW) engines and the reliability and control of Twin Disc MGX-5600 QuickShift® marine transmissions to shepherd assemblages of heavy, unwieldy barges to their destinations. nET sAlEs ($ millions) cAPiTAl ExPEn DiTuREs ($ thousands) nET EARnings DiluTED (per share) /DiViDEn Ds nET cAsh PROViDED by operating activities ($ thousands) 0 50 100 150 200 250 300 350 0 3,000 6,000 9,000 12,000 15,000 0.0 0.5 1.0 1.5 2.0 2.5 0 10,000 20,000 30,000 40,000 2014 2013 2012 2011 5 2014 2013 2012 2011 2014 2013 2012 2011 2014 2013 2012 2011 6 John h. Batten President, Chief Executive Officer OuTlOOk The macro economic forecasts for Europe, the United States and the emerging economies continue to suggest slow or moderating growth. Against this backdrop, the fiscal 2015 outlook of all our product areas continues to improve, especially in our transmission and industrial areas but also in marine, where we have some increased pleasure craft activity. As mentioned earlier, the backlog improved the last three quarters of the year, rising 15% in the fourth quarter alone, driven by our North American oil and gas customers. New transmission system orders for these customers were essentially absent for two years as they worked down their excess inventory. Increased productivity and a shift away from horizontal shale gas drilling extended the life of the units in the field. While the new order improvement is not like what we saw in 2010, it is a marked improvement over 2012 and 2013, and when combined with a stable demand from China, it will provide a better base of business in the next twelve to eighteen months. Project backlogs at our global marine customers also give us confidence that we will have another strong shipment year. In our industrial area, we are poised to have the most rollouts of new products, both in newer hydraulic clutch and mechanical clutch technology, that we have had in a long time. As always, we are working on innovative product and market development projects that will enhance our revenue and earning prospects in the future. You may have noticed the cover of the annual report. 2014 marked the 70th anniversary of D-Day and a time for us to reflect on the impact that World War II had on us as a company. Prior to the war, we were essentially a supplier to the domestic agricultural, construction and boat-building OEMs in the Midwest. Our design and production efforts to support the Higgins landing craft forever changed Twin Disc. Most of the 20,000+ LCVPs never made it back to the United States after the war. They stayed in Southeast Asia, Australia and Europe where they were put into commercial service as small crew/supply boats or the stripped power was reused in new fishing boats. Almost over night we had global customers. Operations in Belgium, Australia and Singapore followed as we, too, “emigrated” to support the product. Today, well over half of our sales are export, and more than half of our employees reside outside of the United States, yet more than two-thirds of our manufacturing remains at our Racine, Wisconsin, facility. Continued capital spending focused on increased quality, flexibility, and cost reductions, combined with a workforce committed to our core competencies and culture, has made this possible. While we very much remain a “midwestern” company, our markets continue to take us around the world for new growth opportunities. In 2014 alone, we handed out 56 service awards for 40 years of service: 2,240 years. Many of these employees had fathers who served during the war and take great pride in our effort with the Higgins boat. In their forty years of service with us, they have experienced a lot of changes and encountered many challenges. Their steadfastness and loyalty remain a stabilizing and calming influence on our younger employees. Global macro economic and geopolitical issues seem to change daily, but our employees remain ready to face any challenge and to deliver the best result possible despite the outside factors. Finally, we would like to take this opportunity to thank Michael Batten, who retired as Chief Executive officer last October, for his forty-three years of tireless service to the Company, which included thirty years as our much admired and respected CEO. While he may not be active in day-to- day operations anymore, we are grateful that he remains Chairman of the Board and fully engaged in our long-term and strategic planning. Twin Disc, incORPORATED | AnnuAl RepoRt 2014 MiChaeL e. Batten Chairman of the Board Manufacturers of high-end yachts, offshore racing boats and speed-needy interdiction and patrol craft rely on the potent performance of Twin Disc marine product family members QuickShift® transmissions, Arneson Surface Drives™ and Rolla™ Propellers. 7 8 inDusTRiAl TRAnsMissiOns Left - World-class and world-leading ARFF manufacturer Rosenbauer uses Twin Disc all-wheel-drive power-shift transmission systems on their 6 x 6 Stinger vehicles to meet the acceleration and fire-fighting criteria any airport might require. right - JiangHan Downhole Service Company provides fracturing operations for Sinopec Corp. using SJ Petroleum trucks equipped with MTU 3000-hp (2237-kW) engines working through the Twin Disc 8500 transmission system to extract shale gas in the Jiaoshiba Oilfield near Fuling in Chongqing, China. Twin Disc, incORPORATED | AnnuAl RepoRt 2014 The global market for Twin Disc’s high-horsepower transmissions for pressure-pumping applications essentially was flat year-over-year. In North America, new rig construction continued to languish throughout most of the fiscal year, with a modest increase of activity in the final quarter. We anticipate this increase in activity to continue in fiscal 2015, as oil and gas surpluses draw down and production resumes at a higher level. In Europe, we observed a slight up-tick in pressure-pumping activity in response to tension between Russia and Ukraine. Europe imports about one-third of its natural gas from Russia, which could, depending on geopolitical dynamics, shut down critical pipelines. Europe does have shale reserves of its own that may be more aggressively tapped if natural gas shortages result from the Ukraine situation, and Europe recognizes the need to wean itself from Russian oil and gas. Over the long term we would expect this to translate into growth opportunities for Twin Disc pressure-pumping products. In Asia, shipments for our high-horsepower transmissions remained flat versus fiscal 2013. Although not expected to continue its earlier growth trend in the near term, the developing market in China has provided Twin Disc with a global diversity in oil and gas applications that did not exist a few years ago. Long term, we remain optimistic about the prospects for an increased number of fracturing rig installations and resulting orders for our products worldwide. Globally, the Airport Rescue and Fire Fighting (ARFF) market remained steady, with minimal growth, in fiscal 2014. We are excited about the potential of our new 4000 Series ARFF transmission prototypes currently being tested in the field. They will offer OEMs a more compact, lighter and faster accelerating transmission system. And, as was anticipated with the winding down of two wars, our legacy XT military business declined by 50% during the fiscal year and is expected to remain at the same level for the next few years. These new MG Bryan fracturing units equipped with MTU 2500-hp (1865-kW) diesel engines and Twin Disc TA9-8501 power-shift transmission systems are operated by Basic Energy Services on a well site near Ada, Oklahoma. 9 10 © RosenbaueRTwin Disc, incORPORATED | AnnuAl RepoRt 2014 inDusTRiAl PRODuc Ts Independent irrigation contractor Allen Morrison out of Tupelo, Arkansas, knows that the down-to-earth reliability of Twin Disc TD C110HP3 PTOs, such as this one putting a Deutz 95-hp (71-kW) diesel engine to work, is what makes them the most popular clutches in the land. European and North American sales of our industrial product family, including clutches, pump drives and PTOs, declined by about 10% compared to last year. Only Hydraulic PTOs manufactured in our Twinsa facility showed a year-over-year increase. The reduction in product sold to the North American oil and gas market can be attributed significantly to the diminished production activity there. In Europe, the general economic malaise curtailed equipment builds that would have incorporated our products. Worldwide, we are increasingly involved in the development of new applications in mining, forestry and rail equipment. While demand for our traditional mechanical clutch products moderated during the year, we continued our product development in our hydraulic clutch power take-off line (HPTO), and plan to introduce two new models in the HP1200 line with expanded features and benefits. Additionally, our engineers developed a retrofittable actuator for our SP line of PTO clutches allowing for remote operation. Twin Disc industrial products such as torque converters, pump drives, air clutches and hydraulic and mechanical PTOs bring rugged, reliable performance to hard-working machines serving in critical everyday situations. 11 12 Twin Disc, incORPORATED | AnnuAl RepoRt 2014 cOMMERciAl MARinE Left - Built for speed and security by Penguin International Limited, Singapore, the FLEX-40SL multi-role, 131-foot (40-meter), aluminum- hulled MV Ashley achieves 27 knots with its three 1350-hp (1007-kW) Cummins engines driving through MGX-6690SC QuickShift® transmissions complemented by an impressive array of Twin Disc products including EC300 controls, Twin Disc shafts, rudders and RollaTM submerged propellers. right - Twin Disc’s northern Europe distributor ESCO’s customer Penn Ar Bed operates the 115-foot (35-meter) Enez Sun, equipped with twin CAT® 1810-hp (1350-kW) engines driving through Twin Disc MGX-6848SC QuickShift® transmissions with three-station EC300 controls, to cope with the often tumultuous Atlantic Ocean to transport tourists, residents and business travelers and goods between Audierne, France, and the Ile de Sein. The global commercial marine market continued to show signs of overall good health. The North American demand for both offshore and inland waterway high- horsepower vessels remained strong, due in no small part to the transportation of oil- and gas-related materials and products. The market in Asia was mixed. In Indonesia, we saw a slowdown in the build of coal tows/tugs due to the weak rupiah, soft coal prices resulting from lower demand from China, and the recent Indonesian election. We expect to see improvements in fiscal 2015 as construction activities rebound and the election is concluded. Overall, the offshore vessel market has been buoyant as demand for crew boats and Anchor Handling Tug Supply boats (AHTS) has been strong. While we have had a steady stream of smaller projects, larger patrol boat projects in China did not materialize or have been delayed due to the reorganization of agencies. Nevertheless, we expect to see demand improvements in 2015 as these projects re-emerge. We are pleased to have maintained our leadership position in the crew boat sector in Asia, and are adding to our product offering with the introduction of shafting, electronic controls and propellers. We continue to promote our thruster and steering solutions to this sector, as well. The European commercial marine market continued to suffer this past twelve-month period due to economic uncertainty and cutbacks in infrastructure investment by local governments. Although some major ports have seen modest growth in harbor traffic, overall port activity has been rather low. Traffic on inland waterways is showing some signs of recovery, albeit gradual. Demand for commercial fishing vessels is virtually at a standstill. While market fluctuations have occurred and will continue, the overall European commercial craft market is expected to return to past levels in the long term. The future for Twin Disc remains positive as wind farms and offshore industry continues to evolve. Emphasis continues to be placed on emissions control, driving increasing numbers of customers to search out hybrid solutions, LNG rather than diesel oil, and diesel electric propulsion. Shipments into our patrol boat markets deteriorated slightly year-over-year. While the North American market for patrol and municipal vessels has declined, demand for Fast Interceptor Craft is being driven higher by anti-terrorism and anti-piracy policy in African and Middle Eastern Countries. And the need for speed continues to increase — 50 knots is essentially the minimum requirement. Mandate for these fast patrol vessels provides opportunity for Twin Disc package sales, including Arneson Surface Drives™ and Rolla™ Propellers, recognized as the premier products in the high-speed patrol segment. Our engineers are continuing to develop control and system features to separate them further from the competition. ® New construction in the medium-size range of patrol craft (70’ to 80’) has provided additional opportunity for our QuickShift transmission, steering gear and Rolla™ Propellers. Plus, demand in the 85’ to 195’ range of off shore vessels remains steady. Strengthening of border protection in the Pacific region has driven an increasing number of government patrol vessel projects. QuickShift transmission systems have been progressively popular in oil and gas support vessels, because of their amazing fast and smooth response resulting in superior vessel control. ® Barge traffic on our inland river system has effectively become a petroleum pipeline via vessels such as Florida Marine’s 90-foot (27-meter) push boat Christie Deutsch transporting petroleum-laden barges between Beaumont and Houston, Texas, with the power and reliability of twin Caterpillar 2400-hp (1790 kW) engines driving through Twin Disc MG-5600 marine transmissions. 13 14 PlEAsuRE cRAf T MAR kET Twin Disc, incORPORATED | AnnuAl RepoRt 2014 The global pleasure craft market remains weak overall, with the exception of the Pacific region, where improved optimism has driven a 20% growth in new builds, and we have had continued success with ® our Express Joystick System ), particularly on larger yachts. (EJS ® ® ® (EJS )] has allowed us and its Three60 Precision Control System ® The North American pleasure craft market remains relatively weak and is expected to be frail for the foreseeable future. However, our partnership with CAT [incorporating our Express Joystick System to gain some market share, and this partnership has positioned us for growth when the market does make a rebound. The Asian pleasure craft market also remains fragile, but the long-term, local demand in the region is expected to grow moderately, while the European market for smaller craft continues to shrink. In the short term, we remain optimistic about the opportunities for success in selling our Boat Management systems. While the low- and middle-size range (i.e., less than 80 ft) of the European yacht market has lost 75% of its volume since 2006/07, we are beginning to see an increase in new construction of the larger size hulls. The market for fast yachts has all but disappeared, taking with it European demand for surface drives and water jets. Twin Disc bow and stern thrusters are integral to the precision maneuvering and station-keeping capabilities of the revolutionary Twin Disc Express Joystick System® (EJS®) and linked Express Positioning.® 15 16 This Viking 62, with its twin Caterpillar 1900-hp (1417-kW) engines driving through Twin Disc MGX-6599A QuickShift® marine transmissions, has the added dimension of precision positioning with its Cat® Three60 control system with station keeping. The Cat Three60 system is Twin Disc’s brand Express Joystick System® (EJS®) with Express Positioning.®UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended June 30, 2014 Commission File Number 1-7635 TWIN DISC, INCORPORATED (Exact Name of Registrant as Specified in its Charter) Wisconsin 39-0667110 TABLE OF CONTENTS TWIN DISC, INC. - FORM 10-K FOR THE YEAR ENDED JUNE 30, 2014 PART I. (State or Other Jurisdiction of Incorporation or Organization) 1328 Racine Street, Racine, Wisconsin (I.R.S. Employer Identification Number) 53403 (Address of Principal Executive Office) (262) 638-4000 (Zip Code) Registrant’s Telephone Number, including area code PART II. Securities registered pursuant to Section 12(b) of the Act: Common stock, no par Title of each class Preferred stock purchase rights The NASDAQ Stock Market, LLC Name of each exchange on which registered: The NASDAQ Stock Market, LLC Item 1. Item 1A. Item 1B. Item 2. Item 3. Item 4. Item 5. Item 6. Item 7. Business. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 Risk Factors. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 Unresolved Staff Comments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 Properties. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 Legal Proceedings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 Mine Safety Disclosures. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 Executive Officers of the Registrant. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 Market for the Registrant’s Common Stock and Related Stockholder Matters. . . . . . . . . . . . . . . . . 23 Selected Financial Data. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 Management’s Discussion and Analysis of Financial Condition and Results of Operations. . . . . 25 None Securities registered pursuant to Section 12(g) of the Act: (Title of Class) Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes  [ ]    No  [√] Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes  [ ]    No  [√] Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.       Yes  [√]      No  [ ] Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every In- teractive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  [√]      No  [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by refer- ence in Part III of this Form 10 K or any amendment to this Form 10 K. [ ] Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company (as defined in Rule 12b-2 of the Exchange Act). Large Accelerated Filer  [ ]    Accelerated Filer  [√]    Non-accelerated Filer  [ ]    Smaller Reporting Company  [ ] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).       Yes  [ ]    No  [√] At December 27, 2013, the last business day of the registrant’s second fiscal quarter, the aggregate market value of the common stock held by non-affiliates of the registrant was $219,875,647. Determination of stock ownership by affiliates was made solely for the purpose of responding to this requirement and registrant is not bound by this determination for any other purpose. At August 16, 2014, the registrant had 11,282,815 shares of its common stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE: Portions of the Proxy Statement for the Annual Meeting of Shareholders to be held October 24, 2014, which will be filed pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report, are incorporated by reference into Part III. Item 7(a). Quantitative and Qualitative Disclosure About Market Risk. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37 Item 8. Item 9. Financial Statements and Supplementary Data. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38 Change In and Disagreements With Accountants on Accounting and Financial Disclosure. . . . . 39 Item 9(a). Controls and Procedures. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39 Item 9(b). Other Information. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39 PART III. Item 10.  Item 11. Directors and Executive Officers of the Registrant. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40 Executive Compensation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40 Item 12.   Security Ownership of Certain Beneficial Owners and Management. . . . . . . . . . . . . . . . . . . . . . . . . . 40 Item 13. Item 14. PART IV. Certain Relationships and Related Transactions, Director Independence. . . . . . . . . . . . . . . . . . . . . 40 Principal Accounting Fees and Services. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41 Item 15. Exhibits, Financial Statement Schedules. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41 Signatures. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69 Exhibit Index. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70 17 18 Twin Disc, incORPORATED | AnnuAl RepoRt 2014         PART I ITEM 1. B USINESS Twin Disc was incorporated under the laws of the state of Wisconsin in 1918. Twin Disc designs, manufactures and sells marine and heavy duty off-highway power transmission equipment. Products offered include: marine transmissions, surface drives, propellers and boat management systems as well as power-shift transmissions, hydraulic torque converters, power take-offs, in- dustrial clutches and controls systems. The Company sells its products to customers primarily in the pleasure craft, commercial and military marine markets as well as in the energy and natural resources, government and industrial markets. The Company’s worldwide sales to both domestic and foreign customers are transacted through a direct sales force and a distributor network. The products described above have accounted for more than 90% of revenues in each of the last three fiscal years. Most of the Company’s products are machined from cast iron, forgings, cast aluminum and bar steel which generally are available from multiple sources and which are believed to be in adequate supply. The Company has pursued a policy of applying for patents in both the United States and certain foreign countries on inventions made in the course of its development work for which commercial applications are considered probable. The Company regards its patents collectively as important but does not consider its business dependent upon any one of such patents. The business is not considered to be seasonal except to the extent that employee vacations are taken mainly in the months of July and August, curtailing production during that period. The Company’s products receive direct widespread competition, including from divisions of other larger independent manu- facturers. The Company also competes for business with parts manufacturing divisions of some of its major customers. The primary competitive factors for the Company’s products are design, technology, performance, price, service and availability. The Company’s top ten customers accounted for approximately 41% of the Company’s consolidated net sales during the year ended June 30, 2014. There was one customer, Sewart Supply, Inc., an authorized distributor of the Company, that accounted for 10% or more of consolidated net sales in fiscal 2014. Unfilled open orders for the next six months of $66,102,000 at June 30, 2014, compares to $66,765,000 at June 30, 2013.  Since  orders are subject to cancellation and rescheduling by the customer, the six-month order backlog is considered more representa- tive of operating conditions than total backlog. However, as procurement and manufacturing “lead times” change, the backlog will increase or decrease, and thus it does not necessarily provide a valid indicator of the shipping rate. Cancellations are gener- ally the result of rescheduling activity and do not represent a material change in backlog. Management recognizes that there are attendant risks that foreign governments may place restrictions on dividend payments and other movements of money, but these risks are considered minimal due to the political relations the United States maintains with the countries in which the Company operates or the relatively low investment within individual countries. No material por- tion of the Company’s business is subject to renegotiation of profits or termination of contracts at the election of the Government. Engineering and development costs include research and development expenses for new product development and major im- provements to existing products, and other costs for ongoing efforts to refine existing products.  Research and development costs  charged to operations totaled $3,028,000, $3,058,000 and $2,657,000 in fiscal 2014, 2013 and 2012, respectively.  Total engineer- ing and development costs were $10,900,000, $10,242,000 and $10,316,000 in fiscal 2014, 2013 and 2012, respectively. Compliance with federal, state and local provisions regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, is not anticipated to have a material effect on capital expenditures, earnings or the competitive position of the Company. The number of persons employed by the Company at June 30, 2014, was 970. A summary of financial data by segment and geographic area for the years ended June 30, 2014, 2013 and 2012 appears in Note J  The Company makes available free of charge (other than to the consolidated financial statements. an investor’s own internet access charges) through its website the Company’s Annual Report on Form 10-K, quarterly The Company’s internet website address is www.twindisc.com. reports on Form 10-Q and current reports on Form 8-K, and amendments to those reports, as soon as reasonably practicable after it electronically files such material with, or furnishes such material to, the United States Securities and Exchange Commission. In addition, the Company makes available, through its website, important corporate governance materials. This information is also available from the Company upon request. The Company is not including the information contained on or available through its website as a part of, or incorporating such information by reference into, this Annual Report on Form 10-K. ITEM 1A. RISK F ACTORS The Company’s business involves risk. The following information about these risks should be considered carefully together with other information contained in this report. The risks described below are not the only risks the Company faces. Additional risks not currently known, deemed immaterial or that could apply to any issuer may also result in adverse results for the Company’s As a global company, we are subject to currency fluctuations and any significant movement between the U.S. dollar and the business. euro, in particular, could have an adverse effect on our profitability.   Although the Company’s financial results are reported in  U.S. dollars, a significant portion of our sales and operating costs are realized in euros and other foreign currencies.  The Company’s  profitability is affected by movements of the U.S. dollar against the euro and the other currencies in which we generate revenues  and incur expenses.  Significant long-term fluctuations in relative currency values, in particular a significant change in the relative  Certain of the Company’s products are directly or indirectly used in oil exploration and oil drilling, and are thus dependent values of the U.S. dollar or euro, could have an adverse effect on our profitability and financial condition. upon the strength of those markets and oil prices.   In recent years, the Company has seen a significant growth in the sales of its  products that are used in oil and energy related markets. The growth in these markets has been spurred by the rise in oil prices and the global demand for oil. In addition, there has been a substantial increase in capital investment by companies in these mar- kets.  In fiscal 2009, a significant decrease in oil prices, the demand for oil and capital investment in the oil and energy markets  had an adverse effect on the sales of these products and ultimately on the Company’s profitability.  While this market recovered to  historically high levels in fiscal 2011 and 2012, the Company has experienced a softening in demand through fiscal 2013 and into  fiscal 2014.  The cyclical nature of the global oil and gas market presents the ongoing possibility of a severe cutback in demand,  Many of the Company’s product markets are cyclical in nature or are otherwise sensitive to volatile or variable factors. which would create a significant adverse effect on the sales of these products and ultimately on the Company’s profitability. A downturn or weakness in overall economic activity or fluctuations in those other factors could have a material adverse effect on the Company’s overall financial performance. Historically, sales of many of the products that the Company manufac- tures and sells have been subject to cyclical variations caused by changes in general economic conditions and other factors. In particular, the Company sells its products to customers primarily in the pleasure craft, commercial and military marine mar- kets, as well as in the energy and natural resources, government and industrial markets. The demand for the products may be impacted by the strength of the economy generally, governmental spending and appropriations, including security and defense outlays, fuel prices, interest rates, as well as many other factors. Adverse economic and other conditions may cause the Company’s In the event of an increase in the global demand for steel, the Company could be adversely affected if it experiences short- customers to forego or otherwise postpone purchases in favor of repairing existing equipment. ages of raw castings and forgings used in the manufacturing of its products. With the continued development of certain developing economies, in particular China and India, the global demand for steel has risen significantly in recent years.  The  Company selects its suppliers based on a number of criteria, and we expect that they will be able to support our growing needs. However, there can be no assurance that a significant increase in demand, capacity constraints or other issues experienced by  the Company’s suppliers will not result in shortages or delays in their supply of raw materials to the Company. If the Company were to experience a significant or prolonged shortage of critical components from any of its suppliers, particularly those who  are sole sources, and could not procure the components from other sources, the Company would be unable to meet its production schedules for some of its key products and would miss product delivery dates which would adversely affect our sales, profitability  If the Company were to lose business with any key customers, the Company’s business would be adversely affected. and relationships with our customers. there was only one customer, Sewart Supply, Inc., that accounted for  10% or more of consolidated net sales in fiscal 2014,   deterioration of a business relationship with one or more of the Company’s significant customers would cause its sales and   The Company continues to face the prospect of increasing commodity costs, including steel, other raw materials and energy profitability to be adversely affected. that could have an adverse effect on future profitability. Although of increased commodity costs through cost reduction programs and pricing actions. However, if material prices were to continue to increase at a rate that could not be recouped through product pricing, it could potentially have an adverse effect on our future The termination of relationships with the Company’s suppliers, or the inability of such suppliers to perform, could disrupt profitability. its business and have an adverse effect on its ability to manufacture and deliver products. To date, the Company has been successful with offsetting the effects The Company relies on raw mate- rials, component parts, and services supplied by outside third parties.  If a supplier of significant raw materials, component parts  or services were to terminate its relationship with the Company, or otherwise cease supplying raw materials, component parts, or services consistent with past practice, the Company’s ability to meet its obligations to its customers may be affected. Such a disruption with respect to numerous products, or with respect to a few significant products, could have an adverse effect on the  Company’s profitability and financial condition. 19 20 Twin Disc, incORPORATED | AnnuAl RepoRt 2014A significant design, manufacturing or supplier quality issue could result in recalls or other actions by the Company that could adversely affect profitability. As a manufacturer of highly engineered products, the performance, reliability and produc- tivity of the Company’s products is one of its competitive advantages. While the Company prides itself on putting in place proce- dures to ensure the quality and performance of its products and suppliers, a significant quality or product issue, whether due to  design, performance, manufacturing or supplier quality issue, could lead to warranty actions, scrapping of raw materials, finished  goods or returned products, the deterioration in a customer relationship, or other action that could adversely affect warranty and The Company faces risks associated with its international sales and operations that could adversely affect its business, re- quality costs, future sales and profitability. sults of operations or financial condition net sales for fiscal 2014.  We have international manufacturing operations in Belgium, Italy, India and Switzerland.  In addition,  we have international distribution operations in Singapore, China, Australia, Japan, Italy, India and Canada. Our international sales and operations are subject to a number of risks, including: . Sales to customers outside the United States approximated 59% of our consolidated – currency exchange rate fluctuations – export and import duties, changes to import and export regulations, and restrictions on the transfer of funds – problems with the transportation or delivery of our products – issues arising from cultural or language differences and labor unrest – longer payment cycles and greater difficulty in collecting accounts receivables – compliance with trade and other laws in a variety of jurisdictions – changes in tax law A material disruption at the Company’s manufacturing facilities in Racine, Wisconsin, could adversely affect its ability to These factors could adversely affect our business, results of operations or financial condition. generate sales and meet customer demand.   The majority of the Company’s manufacturing, based on fiscal 2014’s sales, came  from its two facilities in Racine, Wisconsin.  If operations at these facilities were to be disrupted as a result of significant equip- ment failures, natural disasters, power outages, fires, explosions, adverse weather conditions or other reasons, the Company’s  business and results of operations could be adversely affected. Interruptions in production would increase costs and reduce sales. Any interruption in production capability could require the Company to make substantial capital expenditures to remedy the situation, which could negatively affect its profitability and financial condition.  The Company maintains property damage  insurance which it believes to be adequate to provide for reconstruction of its facilities and equipment, as well as business inter- ruption insurance to mitigate losses resulting from any production interruption or shutdown caused by an insured loss. How- ever, any recovery under this insurance policy may not offset the lost sales or increased costs that may be experienced during the disruption of operations. Lost sales may not be recoverable under the policy and long-term business disruptions could result in a loss of customers.  If this were to occur, future sales levels and costs of doing business, and therefore profitability, could be  Any failure to meet our debt obligations and satisfy financial covenants could adversely affect our business and financial adversely affected. condition. Beginning in 2008 and continuing into 2010, general worldwide economic conditions experienced a downturn due to the combined effects of the subprime lending crisis, general credit market crisis, collateral effects on the finance and banking  industries, slower economic activity, decreased consumer confidence, reduced corporate profits and capital spending, adverse  business conditions and liquidity concerns. While some recovery was seen in 2011 through 2014, these conditions made it difficult for customers, vendors and the Company to accurately forecast and plan future business activities, and caused U.S. and  foreign businesses to slow spending on products, which delayed and lengthened sales cycles. These conditions led to declining revenues in several of the Company’s divisions in fiscal 2009 and 2010.  The Company’s revolving credit facility and senior notes  agreement require it to maintain specified quarterly financial covenants such as a minimum consolidated net worth amount, a  minimum EBITDA, as defined, for the most recent four fiscal quarters of $11,000,000 and a funded debt to EBITDA ratio of 3.0  or less.  At June 30, 2014, the Company was in compliance with these financial covenants.  Based on its annual financial plan,  the Company believes that it will generate sufficient Earnings Before Interest Taxes Depreciation and Amortization (“EBITDA”)  levels throughout fiscal 2015 in order to maintain compliance with its financial covenants.  However, as with all forward-looking  information, there can be no assurance that the Company will achieve the planned results in future periods especially due to the significant uncertainties flowing from the current economic environment.  If the Company is not able to achieve these objectives  and to meet the required covenants under the agreements, the Company may require forbearance from its existing lenders in the form of waivers and/or amendments of its credit facilities or be required to arrange alternative financing.  Failure to obtain relief  The Company may experience negative or unforeseen tax consequences. from covenant violations or to obtain alternative financing, if necessary, would have a material adverse impact on the Company. realization of our net deferred tax assets each period based on forecasts of taxable income in both the U.S. and foreign jurisdictions. This review uses historical results, projected future operating results based upon approved business plans, eligible carryforward periods, tax planning opportunities and other relevant considerations.  Adverse changes in the profitability and  financial outlook in the U.S. or foreign jurisdictions may require the creation of a valuation allowance to reduce our net deferred  tax assets. Such changes could result in material non-cash expenses in the period in which the changes are made and could have a material adverse impact on the Company’s results of operations and financial condition. The Company reviews the probability of the ITEM 1B. UNRESOL vED STAFF COMMENTS None. ITEM 2. PROPERTIES Manufacturing Segment The Company owns two manufacturing, assembly and office facilities in Racine, Wisconsin, U.S.A., one in Nivelles, Belgium, two  in Decima, Italy, and one in Novazzano, Switzerland.  The aggregate floor space of these six plants approximates 767,000 square  feet.  One of the Racine facilities includes office space, which includes the Company’s corporate headquarters.  The Company  leases additional manufacturing, assembly and office facilities in Italy (Limite sull’Arno) and India (outsourcing office in Chennai  Distribution Segment and manufacturing facility in Kancheepuram). The Company also has operations in the following locations, all of which are leased and are used for sales offices, warehousing  and light assembly or product service: Jacksonville, Florida, U.S.A. Medley, Florida, U.S.A. Tampa, Florida, U.S.A. Coburg, Oregon, U.S.A.  Kent, Washington, U.S.A. Chesapeake, Virginia, U.S.A. Rock Hill, South Carolina, U.S.A. Edmonton, Alberta, Canada Burnaby, British Columbia, Canada Limite sull’Arno, Italy  Brisbane, Queensland, Australia Perth, Western Australia, Australia Sydney, New South Wales, Australia Singapore Shanghai, China Guangzhou, China The Company believes its properties are well maintained and adequate for its present and anticipated needs. ITEM 3. LEGAL PROCEEDINGS Twin Disc is a defendant in several product liability or related claims of which the ultimate outcome and liability to the Company, if any, are not presently determinable.  Management believes that the final disposition of such litigation will not have a material  impact on the Company’s results of operations, financial position or statement of cash flows. ITEM 4. MINE S AFETY DISCLOSURES Executive Officers of the Registrant Not applicable. Pursuant to General Instruction G(3) of Form 10-K, the following list is included as an unnumbered Item in Part I of this Report in  Name lieu of being included in the Proxy Statement for the Annual Meeting of Shareholders to be held on October 24, 2014. Position Age John H. Batten Christopher J. Eperjesy Dean J. Bratel Denise L. Wilcox Jeffrey S. Knutson President – Chief Executive Officer Vice President – Finance, Chief Financial Officer and Treasurer  Vice President – Americas Vice President – Human Resources Corporate Controller and Secretary 49 46 50 57 49 Officers are elected annually by the Board of Directors at the Board meeting held in conjunction with each Annual Meeting of the  Shareholders.  Each officer holds office until a successor is duly elected, or until he/she resigns or is removed from office. John H. Batten, President – Chief Executive Officer.  Effective November 1, 2013, Mr. Batten was named President – Chief Executive  Officer.  Prior to this promotion, Mr. Batten served as President and Chief Operating Officer since July 2008, Executive Vice President  since November 2004, Vice President and General Manager  – Marine and Propulsion since October 2001 and Commercial   Manager – Marine and Propulsion since 1998. Mr. Batten joined Twin Disc in 1996 as an Application Engineer. Mr. Batten is the son of Mr. Michael Batten, Chairman of the Board of Directors. Christopher J. Eperjesy, Vice President – Finance, Chief Financial Officer and Treasurer.  Mr. Eperjesy joined the Company in his  current role in November 2002. Prior to joining Twin Disc, Mr. Eperjesy was Divisional Vice President – Financial Planning & Analysis for Kmart Corporation since 2001, and Senior Manager – Corporate Finance with DaimlerChrysler AG since 1999. 21 22 Twin Disc, incORPORATED | AnnuAl RepoRt 2014    Dean J. Bratel, Vice President - Americas. Mr. Bratel was promoted to his current role in June 2013 after serving as Vice President – Engineering (since November 2004), Director of Corporate Engineering (since January 2003), Chief Engineer (since October 2001) and Engineering Manager (since December 1999). Mr. Bratel joined Twin Disc in 1987. Denise L. Wilcox, Vice President - Human Resources.  After joining the Company as Manager Compensation & Benefits in  September 1998, Ms. Wilcox was promoted to Director Corporate Human Resources in March 2002 and to her current role in November 2004. Prior to joining Twin Disc, Ms. Wilcox held positions with Johnson International and Runzheimer International. Jeffrey S. Knutson, Corporate Controller and Secretary. Mr. Knutson was appointed Corporate Secretary in June 2013, and has been Corporate Controller since his appointment in October 2005 after joining the Company in February 2005 as Controller of North American Operations. Prior to joining Twin Disc, Mr. Knutson held Operational Controller positions with Tower Automotive (since August 2002) and Rexnord Corporation (since November 1998). Michael E. Batten stepped down as Chief Executive Officer effective November 1, 2013, and retired from the employment of the  Company effective December 31, 2013. Mr. Batten was been employed with the Company since 1970, and was named Chairman and Chief Executive Officer in 1991.  Mr. Batten serves as non-executive Chairman of the Board of Directors. PART II ITEM 5. MARKET FOR THE REGISTRANT’S COMMON S TOCK AND RELATED S TOCKHOLDER MATTERS Performance Graph The following table compares total shareholder return over the last five fiscal years to the Standard & Poor’s 500 Machinery  (Industrial) Index and the Russell 2000 index. The S&P 500 Machinery (Industrial) Index consists of a broad range of manufac- turers. The Russell 2000 Index consists of a broad range of 2,000 companies. The Company believes, because of the similarity of its business with those companies contained in the S&P 500 Machinery (Industrial) Index, that comparison of shareholder return with this index is appropriate. Total return values for the Corporation’s common stock, the S&P 500 Machinery (Industrial) Index and the Russell 2000 Index were calculated based upon an assumption of a $100 investment on June 30, 2009, and based upon cumulative total return values assuming reinvestment of dividends on a quarterly basis. The Company’s common stock is traded on the NASDAQ Global Select Market under the symbol TWIN.  The price information  below represents the high and low sales prices from July 1, 2012, through June 30, 2014: Fiscal Year Ended June 30, 2014 Fiscal Year Ended June 30, 2013 First Quarter Second Quarter Third Quarter Fourth Quarter High $27.32 29.00 27.88 34.34 Low $22.67 24.16 18.67 23.41 Dividend $0.09 0.09 0.09 0.09 First Quarter Second Quarter Third Quarter Fourth Quarter High $22.41 18.27 27.72 26.02 Low $17.88 13.70 16.92 20.58 Dividend $0.09 0.09 0.09 0.09 For information regarding the Company’s equity-based compensation plans, see the discussion under Item 12 of this report. As of August 19, 2014, shareholders of record numbered 580. The closing price of Twin Disc common stock as of August 19, 2014, was $33.06. Issuer Purchases of Equity Securities Period March 28, 2014–April 25, 2014 April 26, 2014–May 30, 2014 May 31, 2014–June 30, 2014 Total (a) Total number of shares purchased ____________ 0 0 0 __________ 0 __________ __________ (b) Average price paid per share ____________ N/A N/A N/A __________ N/A __________ __________ (c) Total number of shares purchased as part of publicly announced plans or programs (d) Maximum number of shares that may yet be purchased under the plans or programs ____________________________ 0 0 0 __________ 0 __________ __________ _________________________ 315,000 315,000 315,000 __________ 315,000 __________ __________ On February 1, 2008, the Board of Directors authorized the purchase of up to 500,000 shares of Common Stock at market values, of which 250,000 shares were purchased during fiscal 2009 and 125,000 shares were purchased during fiscal 2012.  On July 27,  2012, the Board of Directors authorized the purchase of an additional 375,000 shares of Common Stock at market values. This authorization has no expiration.  During the second quarter of fiscal 2013, the Company purchased 185,000 shares under this  authorization. ITEM 6. SELECTED FINANCIAL D ATA Financial Highlights (in thousands, except per share amounts) Statement of Operations Data: 2014 Fiscal years ended June 30, 2012 2013 2011 2010 Net sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net earnings attributable to Twin Disc. . . . . . . . . . . . . . . . Basic earnings per share attributable to Twin Disc common shareholders. . . . . . . . . . . . . . . . . . . Diluted earnings per share attributable to Twin Disc common shareholders. . . . . . . . . . . . . . . . . . . Balance Sheet Data (at end of period): Dividends per share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ________ $263,909 3,644 ________ $285,282 3,882 ________ $355,870 26,743 ________ $310,393 17,997 ________ $227,534 597 0.32 0.32 0.36 0.34 0.34 0.36 2.34 1.59 0.05 2.31 0.34 1.57 0.30 0.05 0.28 Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $266,985 14,800 $285,458 23,472 $303,832 28,401 $309,120 25,784 $259,056 27,211 23 24 0255075100125150175200225250275300325350375400425450475500525550575600Russell 2000S&P MachineryTwin DiscJUNE 30, 2014JUNE 30, 2013JUNE 30, 2012JUNE 30, 2011JUNE 30, 2010JUNE 30, 2009COMPARISON OF FIVE-YEAR CUMULATIVE TOTAL RETURNTWIN DISC, INCORPORATED; S&P MACHINERY; AND RUSSELL 2000170.96100.00100.00121.48166.92163.44202.98250.98223.49196.38234.58307.22100.00588.97285.33372.00376.89143.36Twin Disc, incORPORATED | AnnuAl RepoRt 2014 ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Note on Forward-Looking Statements Statements in this report (including but not limited to certain statements in Items 1, 3 and 7) and in other Company communica- tions that are not historical facts are forward-looking statements, which are based on management’s current expectations. These statements involve risks and uncertainties that could cause actual results to differ materially from what appears here. Forward-looking statements include the Company’s description of plans and objectives for future operations and assumptions behind those plans. The words “anticipates,” “believes,” “intends,” “estimates,” and “expects,” or similar anticipatory expressions, usually identify forward-looking statements. In addition, goals established by the Company should not be viewed as guarantees or promises of future performance. There can be no assurance the Company will be successful in achieving its goals. In addition to the assumptions and information referred to specifically in the forward-looking statements, other factors, includ- ing, but not limited to those factors discussed under Item 1A, Risk Factors, could cause actual results to be materially different Results of Operations from what is presented in any forward looking statements. (In thousands) 2014 % 2013 % 2012 % Net sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cost of goods sold . . . . . . . . . . . . . . . . . . . . . . . . . . Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . Marketing, engineering and administrative expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Restructuring of operations . . . . . . . . . . . . . . . . . Impairment charge . . . . . . . . . . . . . . . . . . . . . . . . Earnings from operations . . . . . . . . . . . . . . . . . . Fiscal 2014 Compared to Fiscal 2013 Net Sales ___________ $263,909 186,655 ___________ 77,254 _______ ___________ $285,282 205,257 ___________ 80,025 29.3% 67,406 961 — ___________ $ 8,887 ___________ ___________ 25.5% 0.4% 0.0% 67,899 708 1,405 ___________ 3.4% $ 10,013 _______ ___________ _______ ___________ _______ 28.1% 23.8% 0.2% 0.5% 3.5% _______ _______ ___________ $355,870 234,238 ___________ 121,632 73,091 — 3,670 ___________ $ 44,871 ___________ ___________ _______ 34.2% 20.5% 0.0% 1.0% 12.6% _______ _______ Net sales for fiscal 2014 decreased 7.5%, or $21.4 million, to $263.9 million from $285.3 million in fiscal 2013.  Compared to fis- cal 2013, on average, Asian currencies weakened against the U.S. dollar more than offsetting a strengthening euro against the U.S. dollar. The net translation effect of this on foreign operations was to decrease revenues by approximately $2.2 million versus the prior year, before eliminations. The decrease in sales was primarily the result of lower demand from the Company’s customers in North America and Europe, while sales to customers in Asia Pacific continued at record levels.  Additionally, the severe winter  weather throughout most of the U.S. and Canada, while difficult to quantify, impacted the performance of the supply chain causing  some shipments to be delayed, and there was a general low level of order activity for both new units and spares during the cold winter months.  Coming off a record year in fiscal 2013, commercial marine transmission system shipments were down in fiscal  2014. However, the Company continued to experience favorable demand trends from customers in Asia for both pressure pump- ing and commercial marine products as a result of overall economic growth in the region and market share gains. Towards the end of the third fiscal quarter and continuing into the fourth fiscal quarter, demand for pressure pumping transmission systems  began increasing in North America, and the Company is hopeful that these recent trends will continue as the excess field inven- tory situation continues to improve. Sales to customers serving the global megayacht market remained near historical lows. Sales at our manufacturing segment were down 7.3%, or $18.0 million, versus the same period last year.  Compared to fiscal  2013, on average, the euro strengthened against the U.S. dollar. The net translation effect of this on foreign manufacturing operations was to increase revenues for the manufacturing segment by approximately $2.7 million versus the prior year, before eliminations.  In the current fiscal year, the Company’s North American manufacturing operation, the largest, experienced a 9%  decrease in sales compared to fiscal 2013.  The primary drivers for this decrease were lower sales of legacy military and airport  rescue and fire fighting (“ARFF”) transmission systems, and marine and propulsion systems for the global markets, only partially  offset by increased shipments of aftermarket products.  In the second half of fiscal 2014, the Company began to experience  increased order and shipment activity for its transmission systems for the North American oil and gas market. The Company’s Italian manufacturing operations, which have been adversely impacted by the softness in the European megayacht and industrial markets, experienced a sales decrease of 1.5% compared to the prior fiscal year.  The Company’s Belgian manufacturing  operation, which also continued to be adversely impacted by the softness in the global megayacht market, experienced a brief strike at its facility in the first fiscal quarter.  This operation saw a 12% decrease in sales versus the prior fiscal year, primarily  driven by the continued softness in its markets and the temporary disruption experienced as a result of the strike in the first  fiscal quarter.  The Company’s Swiss manufacturing operation, which supplies customized propellers for the global megayacht  and patrol boat markets, experienced a 4% decrease in sales, primarily due to the timing of shipments for the global patrol boat and Italian megayacht markets. Sales at our distribution segment were down 6.9%, or $9.0 million, compared to fiscal 2013.  Compared to fiscal 2013, on aver- age, the Asian currencies weakened against the U.S. dollar. The net translation effect of this on foreign distribution operations was to decrease revenues for the distribution segment by approximately $5.0 million versus the prior year, before eliminations. The Company’s distribution operation in Singapore, its largest company-owned distribution operation, which continues to experience strong demand for marine transmission products for use in various commercial applications and pressure-pumping transmissions for the Chinese oil and gas market, experienced a less than 2% decrease in sales compared to the prior fiscal year.   This operation acts as the Company’s master distributor for Asia and continues to achieve near record results as the Company’s products gain greater acceptance in the market. The Company’s distribution operation in the Northwest of the United States and Southwest of Canada experienced a decrease in sales of 4.5%.   In the prior fiscal year’s first nine months, this operation experi- enced a 46% decrease in sales versus fiscal 2012 due to weakness in the Canadian oil and gas market as rig operators continued  to adjust to the North American natural gas supply overhang and lower prices. The Canadian oil and gas market remained at depressed levels in fiscal 2014.  The Company’s distribution operation in Italy, which provides boat accessories and propulsion  systems for the pleasure craft market, saw sales decrease slightly due to continued weakness in the global megayacht market. In fiscal 2013’s fourth quarter, the Company committed to a plan to exit the third party distribution agreement of this operation  and entered negotiations to sell the inventory back to the parent supplier.  Those negotiations were completed in the third fiscal  quarter of 2014. The Company’s distribution operation in Australia, which provides boat accessories, propulsion and marine transmission systems for the pleasure craft market, saw an increase in sales of just over 12% from the prior fiscal year, driven by  improved shipments in the Australian megayacht market over the prior fiscal year.   Net sales for the Company’s largest product market, marine transmission and propulsion systems, were down 9.1% compared to the prior fiscal year.  The majority of the decrease was experienced in the first half of fiscal 2014 as the Company experienced  decreased demand in the global commercial marine market, which experienced record shipments in the prior fiscal year, and  continued weakness in the global pleasure craft market. Sales of the Company’s boat management systems manufactured at our Italian operation and servicing the global megayacht market were up approximately 5% versus the prior fiscal year, in spite of the  European megayacht market continuing to experience softness in demand. In the off-highway transmission market, the year- over-year decrease of just over 2% can be attributed primarily to decreased legacy military and ARFF transmissions shipments, largely offset by shipments of the Company’s pressure-pumping transmission systems to the Chinese oil and gas market. The decrease experienced in the Company’s industrial products of just over 14% was due to decreased sales into the agriculture, min- ing and general industrial markets, primarily in the North American and Italian markets, as well as decreased activity related to oil field markets. Geographically, sales to the U.S. and Canada represented 45% of consolidated sales for fiscal 2014 compared to 49% in fiscal 2013.   Fiscal 2014 proved to be another milestone year for our global sales, as China continued to be our second largest end market, after the U.S, at 13% of consolidated sales in fiscal 2014, compared to 10% in fiscal 2013.  Overall sales into the Asian Pacific market  represented approximately 29% of sales in fiscal 2014, compared to just under 27% in fiscal 2013.  See Note J of the Notes to the  consolidated financial statements for more information on the Company’s business segments and foreign operations.  The elimination for net intra-segment and inter-segment sales decreased $5.6 million, or 6.2%, from $90.7 million in fiscal 2013  to $85.1 million in fiscal 2014.  Year-over-year changes in foreign exchange rates had a net favorable impact of $2.0 million on net  Gross Profit intra-segment and inter-segment sales. In fiscal 2014, gross profit decreased $2.8 million, or 3.5%, to $77.3 million.  Gross profit as a percentage of sales increased 120  basis points in fiscal 2014 to 29.3%, compared to 28.1% in fiscal 2013.  The table below summarizes the gross profit trend by  Gross Profit ($ millions) quarter for fiscal years 2014 and 2013: 3rd Quarter 2nd Quarter 4th Quarter 1st Quarter Year 2014 . . . . . . . . . . . . . . . . . . . . . . . . 2013 . . . . . . . . . . . . . . . . . . . . . . . . Percentage of Sales _____________ $20.7 $19.4 ______________ $18.6 $22.3 ______________ $16.5 $17.7 ______________ $21.5 $20.6 ________ $ 77.3 $ 80.0 2014 . . . . . . . . . . . . . . . . . . . . . . . . 2013 . . . . . . . . . . . . . . . . . . . . . . . . 31.1% 28.2% 29.3% 30.8% 27.2% 25.9% 29.2% 27.2% 29.3% 28.1% There were a number of factors that impacted the Company’s overall gross margin rate in fiscal 2014.  Gross margin for the year  was unfavorably impacted by lower volumes, which was largely offset by favorable product mix, lower domestic pension expense, lower warranty expense and favorable manufacturing absorption. The Company estimates the net unfavorable impact of lower volumes on gross margin in fiscal 2014 was approximately $9.3 million.  The favorable shift in product mix related to the modest  growth experienced in the Company’s oil and gas transmission business had an estimated favorable impact of $0.6 million. Do- mestic pension expense included in cost of goods sold decreased from $1.3 million in fiscal 2013 to $0.7 million in fiscal 2014.  In  addition, warranty expense decreased by $2.7 million from $4.9 million in fiscal 2013 to $2.2 in fiscal 2014 (for additional infor- mation on the Company’s warranty expense, see Note F of the Notes to the consolidated financial statements).  The net remaining  favorable year-over-year variance was primarily driven by favorable manufacturing absorption and product mix. 25 26 Twin Disc, incORPORATED | AnnuAl RepoRt 2014   Marketing, Engineering and Administrative (ME A) Expenses Order Rates & Marketing, engineering, and administrative (ME&A) expenses of $67.4 million were down $0.5 million, or 0.7%, compared to the prior fiscal year.  As a percentage of sales, ME&A expenses increased to 25.5% of sales versus 23.8% of sales in fiscal 2013.  In  the fiscal 2014 fourth quarter, the Company incurred expenses related to the investigation, severance costs and additional audit  fees totaling $0.6 million associated with the previously announced discovery of accounting irregularities at its Belgian operation. The investigation was completed in the fourth fiscal quarter and did not identify any additional matters requiring adjustment to  the Company’s financial statements beyond the immaterial amounts recorded in the third quarter of fiscal 2014. In addition, the  Company recorded a $0.6 million net unfavorable adjustment related to the cash surrender value of various employee split-dollar life insurance policies in the fourth fiscal quarter, largely due to the rollout of a policy to the Company’s former Chief Executive  Officer as a result of his retirement.  The Company also recorded a $0.3 million charge in the fiscal 2014 fourth quarter related  to sales and use tax following the completion of a nexus study at its North American distribution operations. Adjusting for these one-time items, ME&A expenses were down year-over-year due to a continued focus on controlled spending at the Company’s North American and European operations and lower stock-based compensation expense (a decrease of $1.5 million), partially Restructuring of Operations offset by increased spending in the Company’s growing Asia operations and on corporate engineering and development projects. During fiscal 2014, the Company recorded a pre-tax restructuring charge of $1.0 million, or $0.09 per diluted share, representing  the incremental cost above the minimum legal indemnity for a targeted workforce reduction at its Belgian operation, following finalization of negotiations with the local labor unions.  The minimum legal indemnity of $0.5 million was recorded in the fourth  quarter of fiscal 2013, upon announcement of the intended restructuring action.  During fiscal 2014, the Company made cash  Impairment Charge payments of $0.9 million, resulting in an accrual balance at June 30, 2014 of $0.8 million. In connection with preparing its financial statements for fiscal 2013, the Company recorded an impairment charge of $1.4 mil- lion, or $0.12 per diluted share, which represented the remaining intangibles and fixed assets of its Italian distribution entity for  which the Company committed to a plan to exit the distribution agreement and entered negotiations to sell the inventory back to the parent supplier. This decision triggered an impairment review of the long lived assets at this entity, resulting in the impair- ment charge of $1.4 million representing a complete impairment of the remaining intangibles ($1.3 million) and fixed assets ($0.1  million) for this entity.  In fiscal 2012, the Company took an impairment charge of $3.7 million, or $0.32 per diluted share, for the  Interest Expense write-down of goodwill at an Italian manufacturing operation due to softness in the Italian megayacht market. Interest expense of $0.9 million for the fiscal 2014 was down 35% versus fiscal 2013.  Total interest on the Company’s $40  million revolving credit facility (“revolver”) decreased 43% to $0.3 million in fiscal 2014.  The decrease can be attributed to an  overall decrease in the average borrowings year-over-year. The average borrowing on the revolver, computed monthly, decreased to $13.2 million in fiscal 2014, compared to $19.8 million in the prior fiscal year.  The interest rate on the revolver was a range  of 1.70% to 1.84% in the prior fiscal year compared to a range of 1.80% to 1.85% in the current year.  The interest expense on  the Company’s $25 million Senior Note decreased $0.2 million, or 26%, at a fixed rate of 6.05%, to $0.6 million, due to a lower  Other, net remaining principal balance. For the fiscal 2014 full year, Other, net declined by $0.5 million due primarily to unfavorable exchange movements related to the  Income Taxes euro, Japanese yen and Indian rupee. The effective tax rate for the twelve months of fiscal 2014 was 52.2%, which is in line with the prior year rate of 54.0%. The  full year effective rates are impacted by the non-deductibility of operating losses in a certain foreign jurisdiction that is subject to a full valuation allowance. Adjusting both fiscal years for the non-deductible losses, the fiscal 2014 full year rate would have  been 32.7% compared to 38.4% for the same period in fiscal 2013. The fiscal 2014 rate was favorably impacted by a change in  the jurisdictional mix of earnings, along with favorable provision to return adjustments recorded in the fiscal 2014 third and  fourth quarters. 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, carryback and carryforward periods, and tax strategies that could potentially enhance the likelihood of realization of a deferred tax asset.  During fiscal 2014, the Company continued to incur operating losses in certain foreign juris- dictions where the loss carryforward period is unlimited. The Company has evaluated the realizability of the net deferred tax as- sets related to these jurisdictions and concluded that based primarily upon continuing losses in these jurisdictions and failure to achieve targeted levels of improvement, a full valuation allowance continues to be necessary. Therefore, the Company recorded an additional valuation allowance of $1.9 million. Management believes that it is more likely than not that the results of future operations will generate sufficient taxable income and foreign source income to realize the remaining deferred tax assets. As of June 30, 2014, the Company’s backlog of orders scheduled for shipment during the next six months (six-month backlog) was $66.1 million, or approximately 1% lower than the six-month backlog of $66.8 million as of June 30, 2013.  In the fourth fiscal  quarter, the backlog increased approximately 15% versus the end of the third fiscal quarter, as the Company continued to experi- Fiscal 2013 Compared to Fiscal 2012 ence increased order activity for its pressure pumping transmission business. Net Sales Net sales for fiscal 2013 decreased 19.8%, or $70.6 million, to $285.3 million from a record $355.9 million in fiscal 2012.  Com- pared to fiscal 2012, on average, the euro and Swiss franc weakened against the U.S. dollar.  The net translation effect of this  on foreign operations was to decrease revenues by approximately $4.0 million versus the prior year, before eliminations. The decrease in sales continued to primarily be driven by lower demand from customers in the pressure pumping sector of the North American oil and gas market. Offsetting weakness in this market was higher demand from customers in the North American and Asian commercial marine markets. Sales to customers serving the global megayacht market remained at historical lows, while demand remained steady for equipment used in the airport rescue and fire fighting (ARFF), and military markets.  Sales to cus- tomers in China increased approximately 46% in fiscal 2013 to $29.1 million, representing 10.2% of total fiscal 2013 sales. In fiscal 2013, sales at our manufacturing segment were down 24.5% versus the prior fiscal year.  Compared to fiscal 2012, on  average, the euro and Swiss franc weakened against the U.S. dollar. The net translation effect of this on foreign manufacturing operations was to decrease revenues for the manufacturing segment by approximately $2.8 million versus the prior year, before eliminations.  In fiscal 2013, our U.S. manufacturing operation saw a decrease of roughly 29% in sales versus fiscal 2012.  The  primary driver for this decrease was the decrease in shipments of transmissions and related products for the North American oil and gas markets. This was only partially offset by an increase in commercial marine transmission shipments. The Company’s Italian manufacturing operations, which have been adversely impacted by the softness in the European megayacht and industrial markets, experienced a 12.5% decrease compared to the prior fiscal year.  Approximately one-third of this decrease can be at- tributed to unfavorable foreign currency translation, with the majority of the remaining decrease due to continued softness and timing of shipments to the Italian megayacht market. The Company’s Belgian manufacturing operation, which also continued to be adversely impacted by the softness in the global megayacht market, saw an approximately 15% decrease in sales versus the prior fiscal year.   The Company’s Swiss manufacturing operation, which supplies customized propellers for the global megayacht  and patrol boat markets, experienced an 11.1% decrease in sales. In fiscal 2013, our distribution segment experienced a slight increase of roughly 1% in sales compared to fiscal 2012. The Company’s  distribution operations in Singapore continued to experience record shipments for marine transmission products for use in various commercial applications.   This operation saw a 33.1% increase in sales versus the prior fiscal year.   In fiscal 2013,   approximately 45% of this operation’s sales were to customers in China. The Company’s distribution operation in the Northwest of the United States and Southwest of Canada experienced a 46% decrease in sales due to continued softness in the Canadian oil and gas market. The Company’s distribution operation in Italy, which provides boat accessories and propulsion systems for the pleasure craft market, continued to experience historic lows due to continued weakness in the global pleasure craft and megayacht markets. The Company’s distribution operation in Australia, which provides boat accessories, propulsion and marine transmission systems for the pleasure craft market, saw a decrease in sales of just over 16%. Net sales for the Company’s largest product market, marine transmission and propulsion systems, were up 11.4% compared to the prior fiscal year.  The majority of the growth was experienced in the first half of fiscal 2013 as the Company experienced  increased demand in the global commercial marine market, which more than offset continued weakness in the global pleasure craft market. Sales of the Company’s boat management systems manufactured at our Italian operation and servicing the global megayacht market were down approximately 30% versus the prior fiscal year, as the European megayacht market continued to  experience softness in demand. In the off-highway transmission market, the year-over-year decrease of just over 50% can be attributed primarily to decreased North American sales of transmission systems for the oil and gas markets. In addition, demand for transmission systems for the military market and vehicular transmissions remained steady. The decrease experienced in the Company’s industrial products of roughly 11% was due to decreased sales into the agriculture, mining and general industrial markets, primarily in the North American and Italian markets, as well as decreased activity related to oil field markets. Geographically, sales to the U.S. and Canada represented roughly 49% of consolidated sales for fiscal 2013 compared to 59% in  fiscal 2012.  This decrease was primarily driven by the softness of the North American pressure pumping market in fiscal 2013,  only partially offset by growing demand in the U.S. Gulf Coast region for commercial marine transmission systems.   Fiscal 2013  proved to be another milestone year for our global sales, as China became our second largest end market, after the U.S. Overall sales into the Asian Pacific market represented approximately 27% of sales in fiscal 2013, compared to just over 18% in fiscal  2012.  See Note J of the Notes to the consolidated financial statements for more information on the Company’s business segments  and foreign operations. The elimination for net intra-segment and inter-segment sales decreased $8.0 million, or 8.1%, from $98.7 million in fiscal 2012  to $90.7 million in fiscal 2013.  Year-over-year changes in foreign exchange rates had a net unfavorable impact of $0.6 million on  net intra-segment and inter-segment sales. 27 28 Twin Disc, incORPORATED | AnnuAl RepoRt 2014Gross Profit Interest Expense In fiscal 2013, gross profit decreased $41.6 million, or 34.2%, to $80.0 million.  Gross profit as a percentage of sales decreased  610 basis points in fiscal 2013 to 28.1%, compared to 34.2% in fiscal 2012.  The table below summarizes the gross profit trend by  Gross Profit ($ millions) 2nd Quarter quarter for fiscal years 2013 and 2012: 3rd Quarter 4th Quarter 1st Quarter Year 2013 . . . . . . . . . . . . . . . . . . . . . . . . 2012 . . . . . . . . . . . . . . . . . . . . . . . . Percentage of Sales ______________ $19.4 $30.8 _______________ $22.3 $29.6 ______________ $17.7 $33.1 ______________ $20.6 $28.2 ________ $ 80.0 $121.6 Interest expense of $1.4 million for the fiscal 2013 was down slightly versus fiscal 2012.  Total interest on the Company’s $40  million revolving credit facility (“revolver”) decreased 6% to $0.4 million in fiscal 2013.  The decrease can be attributed to an  overall decrease in the average borrowings year-over-year and a lower interest rate on the revolver. The average borrowing on the revolver, computed monthly, decreased to $19.8 million in fiscal 2013, compared to $20.4 million in the prior fiscal year.  The  interest rate on the revolver decreased from a range of 1.74% to 2.09% in the prior fiscal year to a range of 1.70% to 1.84% in the  current year.  The interest expense on the Company’s $25 million Senior Note decreased $0.2 million, or 21%, at a fixed rate of  Other, Net 6.05%, to $0.8 million, due to a lower remaining principal balance. 2013 . . . . . . . . . . . . . . . . . . . . . . . . 2012 . . . . . . . . . . . . . . . . . . . . . . . . 28.2% 37.8% 30.8% 35.6% 25.9% 34.6% 27.2% 29.4% 28.1% 34.2% For the fiscal 2013 full year, Other, net declined by $0.7 million due primarily to unfavorable exchange movements related to the  Income Taxes euro, Canadian dollar and Swiss franc. There were a number of factors that impacted the Company’s overall gross margin rate in fiscal 2013.  Gross margin for the year  was unfavorably impacted by lower volumes, unfavorable product mix, higher domestic pension expense, higher warranty ex- pense and unfavorable manufacturing absorption. The Company estimates the net unfavorable impact of lower volumes on gross margin in fiscal 2013 was approximately $33.7 million.  The unfavorable shift in product mix related to the softening experienced  in the Company’s oil and gas transmission business had an estimated unfavorable impact of $7.6 million. Domestic pension expense included in cost of goods sold increased from $0.2 million in fiscal 2012 to $1.3 million in fiscal 2013.  In addition, war- ranty expense increased by $1.3 million from $3.6 million in fiscal 2012 to $4.9 in fiscal 2013 (for additional information on the  Marketing, Engineering and Administrative (ME Company’s warranty expense, see Note F of the Notes to the consolidated financial statements). A) Expenses & Marketing, engineering, and administrative (ME&A) expenses decreased by $5.2 million, or 7%, to $67.9 million in fiscal 2013.  As  a percentage of sales, ME&A expenses increased by 330 basis points to 23.8% in fiscal 2013, compared to 20.5% in fiscal 2012.   The table below summarizes significant changes in certain ME&A expenses for the fiscal year: June 30, 2012 $ thousands – (Income)/Expense Fiscal Year Ended Increase/(Decrease) June 30, 2013 Stock-Based Compensation . . . . . . . . . . . . . . . . . . . . . . Domestic Pension Expense. . . . . . . . . . . . . . . . . . . . . . . Incentive/Bonus Expense . . . . . . . . . . . . . . . . . . . . . . . . ________________ $2,681 596 493 ________________ $1,642 121 5,013 ________________________ $ 1,039 475 (4,520 ) _________ Foreign Currency Translation . . . . . . . . . . All Other, Net . . . . . . . . . . . . . . (3,006 ) (913 ) _________ (3,919 ) (1,273 ) _________ $(5,192 ) _________ _________ The year-over-year net remaining decrease in ME&A expenses of $1.3 million for the year primarily relates to efforts to control Restructuring of Operations global ME&A expenses in light of the current softness in demand experienced in certain of the Company’s markets. During the fourth quarter of fiscal 2013, the Company recorded a pre-tax restructuring charge of $0.7 million related to a work- force reduction at its Belgian operation and the elimination of a Corporate officer position.  The Belgian charge consisted of the  minimum legal indemnity for 22 manufacturing employees, as negotiations with the workforce were ongoing as of June 30, 2013. Subsequently, negotiations were completed in July 2013, resulting in an additional restructuring charge of approximately $1.0 million to be recorded in the first quarter of fiscal 2014.  During fiscal 2013, the Company made no cash payments, resulting in an  Impairment Charge accrual balance at June 30, 2013, of $0.7 million. In connection with preparing its financial statements for fiscal 2013, the Company recorded an impairment charge of $1.4 mil- lion, or $0.12 per diluted share, which represents the remaining intangibles and fixed assets of its Italian distribution entity for  which the Company committed to a plan to exit the distribution agreement and entered negotiations to sell the inventory back to the parent supplier. This decision triggered an impairment review of the long lived assets at this entity, resulting in the impair- ment charge of $1.4 million representing a complete impairment of the remaining intangibles ($1.3 million) and fixed assets ($0.1  million) for this entity. In the prior year, the Company took an impairment charge of $3.7 million, or $0.32 per diluted share, for the write-down of goodwill at an Italian manufacturing operation due to softness in the Italian megayacht market. The effective tax rate for the twelve months of fiscal 2013 was 54.0%, which is significantly higher than the prior year rate of  39.8%. Both years were impacted by non-deductible losses in certain foreign jurisdictions that are subject to a valuation allow- ance, as well as non-deductible impairment charges.  Adjusting for these non-deductible items, the fiscal 2013 rate would have  been 35.0% compared to 33.3% for fiscal 2012.  The effective rate for the fiscal 2013 fourth quarter was 89.2% compared to  76.6% for the same period last fiscal year.  Adjusting both for these non-deductible items results in rates of 30.0% for the fiscal  2013 fourth quarter and 37.8% for the fiscal 2012 fourth quarter.  The fiscal 2013 fourth quarter rate was favorably impacted by  a favorable change in Italian tax law of $0.4 million. 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, carryback and carryforward periods, and tax strategies that could potentially enhance the likelihood of realization of a deferred tax asset.  During fiscal 2013, the Company continued to incur operating losses in certain foreign  jurisdictions where the loss carryforward period is unlimited. The Company has evaluated the realizability of the net deferred tax assets related to these jurisdictions and concluded that based primarily upon recent losses in these jurisdictions and failure to achieve targeted levels of improvement, a full valuation allowance continues to be necessary. Therefore, the Company recorded a net reduction in valuation allowance of $0.1 million. Management believes that it is more likely than not that the results of future Order Rates operations will generate sufficient taxable income and foreign source income to realize the remaining deferred tax assets. As of June 30, 2013, the Company’s backlog of orders scheduled for shipment during the next six months (six-month backlog) was $66.8 million, or approximately 32% lower than the six-month backlog of $98.7 million as of June 30, 2012. The decrease in backlog is primarily a result of decreased orders by North American oil and gas customers for the Company’s 8500 transmission Liquidity and Capital Resources system as rig operators adjust to the natural gas supply overhang and lower prices. Fiscal Years 2014, 2013 and 2012 The net cash provided by operating activities in fiscal 2014 totaled $25.7 million, an increase of $1.3 million, or approximately  5%, versus fiscal 2013.  The increase was driven by a decrease in working capital, primarily inventories and accounts receivable,  partially offset by lower net earnings. Adjusted for the impact of foreign currency translation, net inventory decreased by $7.1 million.  From the end of the fiscal third quarter, inventory decreased $7.6 million.  The majority of the net decrease in inventory  came at the Company’s North American and European manufacturing operations. This decrease was driven by strong shipments to the Company’s global commercial marine transmission and Asian oil and gas markets. Net inventory as a percentage of the six-month backlog decreased from 153.9% as of June 30, 2013, to 147.6% as of June 30, 2014. The decrease in trade accounts receivable was a result of lower sales in the second half of fiscal 2014 compared to the same period in fiscal 2013, $134.3 million  versus $144.2 million, respectively. The increase in trade accounts payable was due to the timing of payments, as both inventory and volume were down in the quarter compared to the prior fiscal year. The net cash provided by operating activities in fiscal 2013 totaled $24.5 million, an increase of $10.0 million, or approximately  70%, versus fiscal 2012.  The increase was driven by a decrease in working capital, primarily accounts receivable, partially offset  by lower net earnings. Adjusted for the impact of foreign currency translation, net inventory decreased by $0.2 million. From the end of the fiscal third quarter, inventory decreased approximately $10 million.  The majority of the net decrease in inventory  came at the Company’s North American manufacturing and Asian distribution operations. This decrease was driven by strong shipments to the Company’s global commercial marine transmission and Asian oil and gas markets. Net inventory as a percent- age of the six-month backlog increased from 104.5% as of June 30, 2012, to 153.9% as of June 30, 2013. The decrease in trade ac- counts receivable was a result of lower sales in the second half of fiscal 2013 compared to the same period in fiscal 2012, $144.2  million versus $191.6 million, respectively. The decrease in trade accounts payable was due to a reduction in purchasing activity related to a significant decrease in inventory in the fourth quarter of fiscal 2013 ($10.2 million). 29 30 Twin Disc, incORPORATED | AnnuAl RepoRt 2014 The net cash provided by operating activities in fiscal 2012 totaled $14.4 million, an increase of $0.6 million, or 4%, versus fiscal  2011. The slight increase was driven by a 39% increase in net earnings to $26.1 million largely offset by an increase in working capital. Adjusted for the impact of foreign currency translation, net inventory increased $9.6 million. The majority of the net in- crease in inventory came at the Company’s North American manufacturing and distribution operations. This increase was driven by strong demand for the Company’s commercial marine transmissions as well as inventory to serve the Company’s North Ameri- can and Asian oil and gas markets. Net inventory as a percentage of the six-month backlog increased from 67.4% as of June 30, 2011 to 104.5% as of June 30, 2012. The increase in trade accounts receivable was a result of higher sales in the second half of fiscal 2012 compared to the same period in fiscal 2011, $191.6 million versus $173.9 million, respectively.  The decrease in trade  accounts payable was due to a reduction in purchasing activity related to significant decrease in inventory in the fourth quarter of  fiscal 2012 ($14.6 million) compared to an increase in inventory in the fourth quarter of fiscal 2011 ($5.8 million). The net cash used for investing activities in fiscal 2014 of $7.1 million consisted primarily of capital expenditures for machinery  and equipment at our U.S. and Belgian manufacturing operations.  In fiscal 2014, the Company spent $7.2 million for capital   expenditures, up from $6.6 million in fiscal 2013 and down from $13.7 million in fiscal 2012. The net cash used for investing activities in fiscal 2013 of $6.5 million consisted primarily of capital expenditures for machinery  and equipment at our U.S., Indian and Belgian manufacturing operations.  In fiscal 2013, the Company spent $6.6 million for capi- tal expenditures, down from $13.7 million and $12.0 million in fiscal years 2012 and 2011, respectively. The net cash used for investing activities in fiscal 2012 of $13.9 million consisted primarily of capital expenditures for machinery  and equipment at our U.S. and Belgian manufacturing operations.  In fiscal 2012, the Company spent $13.7 million for capital  expenditures, up from $12.0 million and $4.5 million in fiscal years 2011 and 2010, respectively. In fiscal 2014, the net cash used by financing activities of $14.9 million consisted primarily of dividends paid to shareholders of  the Company of $4.1 million and net payments of debt of $8.8 million.  During fiscal 2014, the Company did not purchase any  shares as part of its Board-authorized stock repurchase program. The Company has 315,000 shares remaining under its autho- rized stock repurchase plan. In fiscal 2013, the net cash used by financing activities of $12.4 million consisted primarily of the acquisition of treasury stock of  $3.1 million, under a Board-authorized stock repurchase program, dividends paid to shareholders of the Company of $4.1 million and payments of long-term debt of $4.9 million.  During the second quarter of fiscal 2013, the Company purchased 185,000   shares under this authorization, at an average price of $16.59 per share for a total cost of $3.1 million. The Company had 315,000 shares remaining under its authorized stock repurchase plan as of June 30, 2013. In fiscal 2012, the net cash used by financing activities of $3.5 million consisted primarily of the acquisition of treasury stock of  $2.4 million, under a Board authorized stock repurchase program, and dividends paid to shareholders of the Company of $3.9 million, partially offset by proceeds from long-term debt of $2.6 million. On February 1, 2008, the Board of Directors authorized the purchase of 500,000 shares of Common Stock at market values.  In fiscal 2012, the Company purchased 125,000 shares of its  Future Liquidity and Capital Resources outstanding common stock at an average price of $19.40 per share for a total cost of $2.4 million. On June 30, 2014, the Company entered into a revolving loan agreement (the “Credit Agreement”) with Wells Fargo Bank, National Association. Pursuant to the Credit Agreement, the Company may, from time to time, enter into revolving credit loans in amounts not to exceed, in the aggregate, Wells Fargo’s revolving credit commitment of $60,000,000. The revolving credit com- mitment may be increased under the agreement by an additional $10,000,000 in the event that the conditions for “Incremental Loans” (as defined in the agreement) are satisfied.   In general, outstanding revolving credit loans will bear interest at LIBOR plus  1.00%. The rate was 1.16% at June 30, 2014. In addition to principal and interest payments, the Borrowers will be responsible for paying monthly commitment fees equal to 0.15% of the unused revolving credit commitment. The Company has the option of making additional prepayments subject to certain limitations. The Credit Agreement is scheduled to expire on May 31, 2018. The outstanding balance of $11,200,000 at June 30, 2014 is classified as long-term debt.  This agreement contains certain covenants,  including restrictions on investments, acquisitions and indebtedness. Financial covenants include a minimum consolidated ad- justed net worth, a minimum EBITDA for the most recent four fiscal quarters of $11,000,000 at June 30, 2014, and a maximum to- tal funded debt to EBITDA ratio of 3.0 at June 30, 2014.  As of June 30, 2014, the Company was in compliance with these financial  covenants with a four quarter EBITDA total of $19,463,000 and a funded debt to EBITDA ratio of 0.95. The minimum adjusted net worth covenant fluctuates based upon actual earnings, and the Company’s compliance with that covenant is based on the  Company’s shareholders’ equity as adjusted by certain pension accounting items. As of June 30, 2014, the minimum adjusted equity requirement was $120,831,000 compared to an actual result of $185,584,000 after all required adjustments. Prior to June 30, 2014, the Company had a $40,000,000 revolving loan agreement with BMO Harris Bank, N.A. (“BMO”). The Company originally entered into this revolving loan agreement in December 2002 with M&I Marshall & Ilsley Bank, predeces- sor to BMO. At that time, the revolving loan agreement was for $20,000,000 and had an expiration date of October 31, 2005. Through a series of amendments, the last of which was agreed to during the fourth quarter of fiscal 2011, the total commitment  was increased to $40,000,000 and the term was extended to May 31, 2015. This agreement contained certain covenants, includ- ing restrictions on investments, acquisitions and indebtedness. Financial covenants included a minimum consolidated adjusted net worth amount, as defined, a minimum EBITDA for the most recent four fiscal quarters, and a maximum total funded debt to  EBITDA ratio.  As of June 30, 2014, the Company was in compliance with these financial covenants.   The outstanding balance of  $0 and $16,300,000 at June 30, 2014, and June 30, 2013, respectively, is classified as long-term debt.  In accordance with the loan  agreement as amended, the Company could borrow at LIBOR plus an additional “Add-On,” between 1.5% and 2.5%, depending on the Company’s Total Funded Debt to EBITDA ratio. The rate was 1.80% and 1.84% at June 30, 2014, and June 30, 2013, respec- tively. On June 20, 2014, the Company provided written notice to BMO of its intent to terminate the revolving credit agreement with a termination date of June 30, 2014. On June 30, 2014, the agreement was terminated and the facility was paid off. Prior to June 30, 2014, the Company and its wholly-owned subsidiary Twin Disc International, S.A. had a multi-currency revolving Credit Agreement with Wells Fargo Bank, National Association (the “Prior Credit Agreement”). The Company entered into this agreement on November 19, 2012. Pursuant to the Prior Credit Agreement, the Company could, from time to time, enter into revolving credit loans in amounts not to exceed, in the aggregate, Wells Fargo’s revolving credit commitment of $15,000,000. In general, outstanding revolving credit loans (other than foreign currency loans) would bear interest at one of the following rates, as selected by the Company: (1) a “Base Rate,” which is equal to the highest of (i) the prime rate; (ii) the federal funds rate plus 0.50%; or (iii) LIBOR plus 1.00%; or (2) a “LIBOR Rate” (which is equal to LIBOR divided by the difference between 1.00 and the Eurodollar Reserve Percentage (as defined in the Prior Credit Agreement)) plus 1.50%.  Outstanding revolving credit  loans that are foreign currency loans would bear interest at the LIBOR Rate plus 1.50%, plus an additional “Mandatory Cost,” which was designed to compensate Wells Fargo for the cost of compliance with the requirements of the Bank of England and/ or the Financial Services Authority, or the requirements of the European Central Bank. In addition to principal and interest payments, the Borrowers were responsible for paying monthly commitment fees equal to .25% of the unused revolving credit commitment. The Company had the option of making additional prepayments subject to certain limitations. The Prior Credit Agreement included financial covenants regarding minimum net worth, minimum EBITDA for the most recent four fiscal quarters  of $11,000,000, and a maximum total funded debt to EBITDA ratio of 3.0. As of June 30, 2014, the Company was in compliance with these financial covenants.  The Prior Credit Agreement also included certain restrictive covenants that limited, among other  things, certain investments, acquisitions and indebtedness. The Prior Credit Agreement provided that it automatically included any covenants or events of default not previously included in the Prior Credit Agreement to the extent such covenants or events of default are granted to any other lender of an amount in excess of $1,000,000. The Prior Credit Agreement also included customary events of default, including events of default under the BMO agreement or the Prudential Note Agreement. Following an event of default, Wells Fargo could accelerate all amounts outstanding under any revolving credit notes or the Prior Credit Agreement. The Prior Credit Agreement was scheduled to expire on May 31, 2015. However, on June 30, 2014, the Company entered into the new agreement with Wells Fargo discussed above, which includes the ability to borrow up to $15 million in certain foreign currencies. As of June 30, 2014, there were no borrowings under the Prior Credit Agreement. On June 30, 2014, the Company entered into an Amended and Restated Note Purchase and Private Shelf Agreement (the “Prudential Agreement”). Among other things, the Prudential Agreement: (a) amends and restates the “Note Agreement” between the Company and Purchasers dated as of April 10, 2006, as it has been amended from time to time (the “2006 Note Agreement”); and (b) sets forth the terms of the potential sale and purchase of up to $50,000,000 in “Shelf Notes” as defined in the Prudential Agreement (the “Shelf Notes”) by the Company to Prudential.  The notes sold by the Company to  the Existing Holders under the 2006 Agreement (the “2006 Notes”) are deemed outstanding under, and are governed by, the terms of the Prudential Agreement.    The 2006 Notes bear interest on the outstanding principal balance at a fixed rate of 6.05%  per annum and mature on April 10, 2016. The 2006 Notes mature and become due and payable in full on April 10, 2016 (the “Payment Date”). Prior to the Payment Date, the Company is obligated to make quarterly payments of interest during the term of the 2006 Notes, plus prepayments of principal of $3,571,429 on April 10 of each year from 2010 to 2015, inclusive. The outstanding balance was $7,142,857 and $10,714,286 at June 30, 2014, and June 30, 2013, respectively. Of the outstanding balance, $3,571,429 was classified as a current maturity of long-term debt at June 30, 2014, and June 30, 2013, respectively.    The remaining $3,571,429 is classified as long-term debt.  In addition to the interest payments and any mandatory principal   payments required under the terms of the Shelf Note, the Company will pay an issuance fee of 0.10% of the aggregate principal balance of each of the Shelf Notes sold to, and purchased by, Prudential. In addition the Company will pay a one-time structuring fee of $25,000 on or before September 30, 2014, unless there is an acceptance of a sale of Shelf Notes prior to such date, in which case the structuring fee will be waived. The Company may prepay the Shelf Notes or the 2006 Notes, subject to certain limitations. At no time during the term of the Prudential Agreement may the aggregate outstanding principal amount of the 2006 Notes and the Shelf Notes exceed $35,000,000.  The Prudential Agreement includes financial covenants regarding minimum net  worth, minimum EBIDTA for the most recent four (4) fiscal quarters of $11,000,000 and a maximum total funded debt to EBIDTA  ratio of 3.0.  As of June 30, 2014, the Company was in compliance with these financial covenants.  In addition, the Company will be  required to make an offer to purchase the 2006 Notes and Shelf Notes upon a Change of Control, and any such offer must include the payment of a Yield-Maintenance Amount. The Prudential Agreement also includes certain covenants that limit, among other things, certain indebtedness, acquisitions and investments. The Prudential Agreement also has a most favored lender provision whereby the Prudential Agreement shall be automatically modified to include any additional covenant or event of default that is  included in any agreement evidencing, securing, guarantying or otherwise related to other indebtedness in excess of $1,000,000. Four quarter EBITDA, total funded debt, and adjusted net worth are non-GAAP measures, and are included herein for the purpose  of disclosing the status of the Company’s compliance with the four quarter EBITDA, total funded debt to four quarter EBITDA ratio, and adjusted net worth covenants described above. In accordance with the Company’s revolving loan agreements and the Prudential Agreement: 31 32 Twin Disc, incORPORATED | AnnuAl RepoRt 2014•  “ Four quarter EBITDA” is defined as “the sum of (i) Net Income plus, to the extent deducted in the calculation of Net Income, (ii)  interest expense, (iii) depreciation and amortization expense, and (iv) income tax expense;” and •  “ Total funded debt” is defined as “(i) all Indebtedness for borrowed money (including without limitation, Indebtedness  evidenced by promissory notes, bonds, debentures and similar interest-bearing instruments), plus (ii) all purchase money Indebtedness, plus (iii) the principal portion of capital lease obligations, plus (iv) the maximum amount which is available to be drawn under letters of credit then outstanding, all as determined for the Company and its consolidated Subsidiaries as of the date of determination, without duplication, and in accordance with generally accepted accounting principles applied on a consistent basis.” •  “ Total funded debt to four quarter EBITDA” is defined as the ratio of total funded debt to four quarter EBITDA calculated in  accordance with the above definitions. •  “ Adjusted net worth” means the Company’s reported shareholder equity, excluding adjustments that result from (i) changes to  the assumptions used by the Company in determining its pension liabilities or (ii) changes in the market value of plan assets up to an aggregate amount of adjustments equal to $34,000,000 (“Permitted Benefit Plan Adjustments”) for purposes of comput- ing net worth at any time. The Company’s total funded debt as of June 30, 2014, and June 30, 2013, was equal to the total debt reported on the Company’s June 30, 2014, and June 30, 2013, Consolidated Balance Sheet, and therefore no reconciliation is included herein. The following table sets forth the reconciliation of the Company’s reported Net Earnings to the calculation of four quarter EBITDA for the four Four Quarter EBITDA Reconciliation quarters ended June 30, 2014: Net Earnings Attributable to Twin Disc . . . . . . . . . Depreciation & Amortization. . . . . . . . . . . . . . . . . . . Interest Expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income Taxes. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Four Quarter EBITDA. . . . . . . . . . . . . . . . . . . . . . . . Total Funded Debt to Four Quarter EBITDA Total Funded Debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Divided by: Four Quarter EBITDA . . . . . . . . . . . . . . Total Funded Debt to Four Quarter EBITDA . . . $ 3,644,000 10,657,000 936,000 4,226,000 _______________ $19,463,000 _______________ _______________ $18,404,000 19,463,000 _______________ 0.95 _______________ _______________ The following table sets forth the reconciliation of the Company’s reported shareholders’ equity to the calculation of adjusted net Total Twin Disc Shareholders’ Equity worth for the quarter ended June 30, 2014: Permitted Benefit Plan Adjustments Adjusted Net Worth . . . . . . . . . . . . . $151,584,000 34,000,000 . . . . . . . . . . . . . ________________ $185,584,000 ________________ ________________ As of June 30, 2014, the Company was in compliance with all of the covenants described above. As of June 30, 2014, the Company’s backlog of orders scheduled for shipment during the next six months (six-month backlog) was $66.1 million, or approximately 1% lower than the six-month backlog of $66.8 million as of June 30, 2013, but up 15% from the end of the third fiscal quarter.  The recent increase in order backlog has been driven primarily by the North American oil and gas market.  The  Company does not expect to violate any of its financial covenants in fiscal 2015.  The current margin surrounding ongoing   compliance with the above covenants, in particular, minimum EBITDA for the most recent four fiscal quarters and total funded  debt to EBITDA, are expected to increase in fiscal 2015.  Based on its annual financial plan, the Company believes it is well   positioned to generate sufficient EBITDA levels throughout fiscal 2015 in order to maintain compliance with the above covenants.   However, as with all forward-looking information, there can be no assurance that the Company will achieve the planned results in future periods due to the uncertainties in certain of its markets. Please see the factors discussed under Item 1A, Risk Factors, of this Form 10-K for further discussion of this topic. The Company’s balance sheet remains very strong, there are no off-balance-sheet arrangements other than the operating leases listed below, and we continue to have sufficient liquidity for near-term needs.  The Company had $48.8 million of available bor- rowings on our $60 million revolving loan agreement as of June 30, 2014. The Company expects to continue to generate enough cash from operations to meet our operating and investing needs. As of June 30, 2014, the Company also had cash of $24.8 million, primarily at its overseas operations. These funds, with some restrictions and tax implications, are available for repatriation as deemed necessary by the Company.  In fiscal 2015, the Company expects to contribute $7.2 million to its defined benefit pension  plans, the minimum contributions required.  However, if the Company elects to make voluntary contributions in fiscal 2015, it  intends to do so using cash from operations and, if necessary, from available borrowings under existing credit facilities. Net working capital decreased $1.9 million, or approximately 2%, in fiscal 2014, and the current ratio increased from 3.0 at June  30, 2013, to 3.2 at June 30, 2014. The decrease in net working capital was primarily driven by a decrease in inventories and accounts receivable in fiscal 2014, partially offset by a decrease in accrued liabilities due to a decrease in deferred revenue and  accrued stock-based compensation due to the first quarter vesting of performance awards. The Company expects capital expenditures to be approximately $15 million in fiscal 2015.  These anticipated expenditures reflect  the Company’s plans to continue investing in modern equipment and facilities, its global sourcing program and new products as well as expanding capacity at facilities around the world. Management believes that available cash, the credit facility, cash generated from future operations, existing lines of credit and Off Balance Sheet Arrangements and Contractual Obligations potential access to debt markets will be adequate to fund the Company’s capital requirements for the foreseeable future. The Company had no off-balance sheet arrangements, other than operating leases, as of June 30, 2014 and 2013. The Company has obligations under non-cancelable operating lease contracts and loan and senior note agreements for certain Less than future payments. A summary of those commitments follows (in thousands): 1 Year Contractual Obligations After 5 Years 3 - 5 Years 1 - 3 Years Total Revolving loan borrowing Long-term debt Operating leases $11,200 $ 7,204 $ 7376 — $3,604 $2,719 — $ 3,571 $ 3,334 $11,200 — $ 1,302 — $29 $21 The table above does not include accrued interest of approximately $139,000 related to the revolving loan borrowing. The table above also does not include tax liabilities for unrecognized tax benefits totaling $1,603,000, excluding related interest and penal- ties, as the timing of their resolution cannot be estimated.  See Note N of the Notes to the consolidated financial statements for  disclosures surrounding uncertain income tax positions. The Company maintains defined benefit pension plans for some of its operations in the United States and Europe.  The Company  has established the Pension Committee to oversee the operations and administration of the defined benefit plans.  The Company  Other Matters estimates that fiscal 2015 contributions to all defined benefit plans will total $7,218,000. Critical Accounting Policies The preparation of this Annual Report requires management’s judgment to make estimates and assumptions that affect the re- ported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the dates of the financial statements, and  the reported amounts of revenues and expenses during the reporting period. There can be no assurance that actual results will not differ from those estimates. The Company’s significant accounting policies are described in Note A to the consolidated financial statements.  Not all of these  significant accounting policies require management to make difficult, subjective, or complex judgments or estimates.  However,  Accounts Receivable the policies management considers most critical to understanding and evaluating our reported financial results are the following: The Company performs ongoing credit evaluations of our customers and adjusts credit limits based on payment history and the customer’s credit-worthiness as determined by review of current credit information. We continuously monitor collections and payments from our customers and maintain a provision for estimated credit losses based upon our historical experience and any specific customer-collection issues.  In addition, senior management reviews the accounts receivable aging on a monthly basis  to determine if any receivable balances may be uncollectible. Although our accounts receivable are dispersed among a large customer base, a significant change in the liquidity or financial position of any one of our largest customers could have a material  Inventory adverse impact on the collectibility of our accounts receivable and future operating results. Inventories are valued at the lower of cost or market.  Cost has been determined by the last-in, first-out (LIFO) method for the  majority of the inventories located in the United States, and by the first-in, first-out (FIFO) method for all other inventories.  Man- agement specifically identifies obsolete products and analyzes historical usage, forecasted production based on future orders,  demand forecasts, and economic trends when evaluating the adequacy of the reserve for excess and obsolete inventory. The ad- justments to the reserve are estimates that could vary significantly, either favorably or unfavorably, from the actual requirements  if future economic conditions, customer demand or competitive conditions differ from expectations. 33 34 Twin Disc, incORPORATED | AnnuAl RepoRt 2014 Goodwill In conformity with U.S. GAAP, goodwill is tested for impairment annually or more frequently if events or changes in circumstances  indicate that an impairment might exist. The Company performs impairment reviews for its four reporting units using a fair- value method based on management’s judgments and assumptions or third party valuations.  The Company is subject to financial  statement risk to the extent the carrying amount of a reporting unit exceeds its fair value. Based upon the goodwill impairment review completed at the end of fiscal 2014, it was determined that the fair value for each of the reporting units exceeded the car- rying value and therefore goodwill was not impaired. In determining the fair value of our reporting units, management is required to make estimates of future operating results, in- cluding growth rates, and a weighted-average cost of capital that reflects current market conditions, among others.  Our develop- ment of future operating results incorporates management’s best estimates of current and future economic and market condi- tions which are derived from a review of past results, current results and approved business plans. Many of the factors used in assessing fair value are outside the control of management, and these assumptions and estimates can change in future periods. While the Company believes its judgments and assumptions were reasonable, different assumptions, economic factors and/or market indicators could materially change the estimated fair values of the Company’s reporting units and, therefore, impairment charges could be required in the future. The following assumptions are key to our discounted cash flow model: Business Projections – We make assumptions about the level of sales for each fiscal year including expected growth, if any.   This assumption drives our planning for volumes, mix, and pricing. We also make assumptions about our cost levels (e.g., capacity utilization, cost performance, etc.).  These assumptions are key inputs for developing our cash flow projections.   These projections are derived using our internal business plans that are reviewed annually during the annual budget process. Discount Rates – When measuring a possible impairment, future cash flows are discounted at a rate that is consistent with a  weighted average cost of capital for a potential market participant. The weighted average cost of capital is an estimate of the overall after-tax rate of return required by equity and debt holders of a business enterprise. There are a number of assump- tions that management makes when calculating the appropriate discount rate, including the targeted leverage ratio. 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, excluding indefinite-lived 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 substantiate the  Warranty discounted cash flow analyses, including third party valuations when necessary.  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 extent of the market affected by the failure and the expense involved in satisfactorily addressing the situation. The warranty reserve is established based on our best estimate of the amounts necessary to settle future and existing claims on products sold as of the balance sheet date. When evaluating the adequacy of the reserve for warranty costs, management takes into consideration the term of the warranty cover- age, historical claim rates and costs of repair, knowledge of the type and volume of new products and economic trends. While we believe the warranty reserve is adequate and that the judgment applied is appropriate, such amounts estimated to be due and Pension and Other Postretirement Benefit Plans payable in the future could differ materially from what actually transpires. The Company provides a wide range of benefits to employees and retired employees, including pensions and postretirement  health care coverage. Plan assets and obligations are recorded annually based on the Company’s measurement date utilizing various actuarial assumptions such as discount rates, expected return on plan assets, compensation increases, retirement and mortality tables, and health care cost trend rates as of that date. The approach used to determine the annual assumptions are as follows: Discount Rate – based on the Towers Watson BOND:Link model at June 30, 2014, as applied to the expected payouts from the pension plans. This yield curve is made up of Corporate Bonds rated AA or better. Expected Return on Plan Assets – based on the expected long-term average rate of return on assets in the pension funds, which is reflective of the current and projected asset mix of the funds and considers historical returns earned on the funds.  Compensation Increase – reflect the long-term actual experience, the near-term outlook and assumed inflation.  Retirement and Mortality Rates – based upon the IRS Generational Mortality Table for Annuitants and Non-Annuitants for fis- cal 2012, 2013 and 2014. Health Care Cost Trend Rates – developed based upon historical cost data, near-term outlook and an assessment of likely long- term trends. Measurements of net periodic benefit cost are based on the assumptions used for the previous year-end measurements of assets  and obligations.  The Company reviews its actuarial assumptions on an annual basis and makes modifications to the assumptions  when appropriate.  As required by U.S. GAAP, the effects of the modifications are recorded currently or amortized over future  periods. Based on information provided by its independent actuaries and other relevant sources, the Company believes that the assumptions used are reasonable; however, changes in these assumptions could impact the Company’s financial position, results  Income Taxes of operations or cash flows. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between financial  statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit car- ryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The Company maintains valuation allow- ances when it is more likely than not that all or a portion of a deferred tax asset will not be realized. In determining whether a valuation allowance is required, the Company takes into account such factors as prior earnings history, expected future earnings, carryback and carryforward periods, and tax strategies that could potentially enhance the likelihood of realization of a deferred tax asset.  During fiscal 2014, the Company concluded that it was more likely than not that certain net deferred tax assets in for- Recently Issued Accounting Standards eign jurisdictions would not be realized, resulting in the recording of a valuation allowance totaling $5,593,000. In June 2014, the Financial Accounting Standards Board (“FASB”) issued stock compensation guidance requiring that a perfor- mance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condi- tion.  The amendments in this guidance are effective for fiscal years, and interim periods within those fiscal years, beginning after  December 15, 2015 (the Company’s fiscal 2017).  The adoption of this guidance is not expected to have a material impact on the  Company’s financial disclosures. In May 2014, the FASB issued updated guidance on revenue from contracts with customers. This revenue recognition guidance supersedes existing US GAAP guidance, including most industry-specific guidance.  The core principle is that an entity should rec- ognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to  which the entity expects to be entitled in exchange for those goods or services.  The guidance identifies steps to apply in achiev- ing this principle.  This updated guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after  December 15, 2016 (the Company’s fiscal 2018).  The Company is currently evaluating the potential impact of this guidance on  the Company’s financial disclosures and results. In April 2014, the FASB issued updated guidance on the reporting for discontinued operations. Under the new guidance, only disposals representing a strategic shift in operations should be presented as discontinued operations. The new guidance also requires expanded financial disclosures about discontinued operations.  The amendments in this updated guidance are effective  for the first quarter of the Company’s fiscal 2016.  The adoption of this guidance is not expected to have a material impact on the  Company’s financial disclosures. In July 2013, the FASB issued guidance stating that, except in certain defined circumstances, an unrecognized tax benefit, or a  portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for  a net operating loss carryforward, a similar tax loss, or a tax credit carryforward.  This guidance is effective for fiscal years, and  interim periods within those fiscal years, beginning after December 15, 2013 (the Company’s fiscal 2015).  The adoption of this  guidance is not expected to have a material impact on the Company’s financial disclosures. In March 2013, the FASB issued guidance on the parent company’s accounting for the cumulative translation adjustment upon derecognition of certain subsidiaries or groups of assets within a foreign entity or of an investment in a foreign entity. This guidance clarifies the circumstances under which the related cumulative translation adjustment should be released into net  income.  This guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15,  2013 (the Company’s fiscal 2015).  The adoption of this guidance is not expected to have a material impact on the Company’s  financial results. 35 36 Twin Disc, incORPORATED | AnnuAl RepoRt 2014     ITEM 7(A). QUANTITATIvE AND QUALITATIvE DISCLOSURE ABOUT MARKET RISK ITEM 8. FINANCIAL S TATEMENTS AND SUPPLEMENTARY D ATA The Company is exposed to market risks from changes in interest rates, commodities and foreign currency exchange rates. To reduce such risks, the Company selectively uses financial instruments and other proactive management techniques.  All hedging  transactions are authorized and executed pursuant to clearly defined policies and procedures, which prohibit the use of financial  instruments for trading or speculative purposes. Discussion of the Company’s accounting policies and further disclosure relating to financial instruments is included in Note A to the consolidated financial statements. Interest rate risk - The Company’s earnings exposure related to adverse movements of interest rates is primarily derived from outstanding floating rate debt instruments that are indexed to the LIBOR interest rate.  The Company currently has a $60 million  revolving loan agreement, which is due to expire on May 31, 2018. In accordance with the loan agreement as amended, the Com- pany borrows at LIBOR plus an additional “Add-On” of 1.0%. Due to the relative stability of interest rates, the Company did not utilize any financial instruments at June 30, 2014, to manage interest rate risk exposure.  A 10 percent increase or decrease in the  applicable interest rate would result in a change in pretax interest expense of approximately $13,000. Commodity price risk - The Company is exposed to fluctuation in market prices for such commodities as steel and aluminum.   The Company does not utilize commodity price hedges to manage commodity price risk exposure. Direct material cost as a percent of total cost of goods sold was 55.6% for fiscal 2014. Currency risk - The Company has exposure to foreign currency exchange fluctuations.  Approximately twenty-three percent   of the Company’s revenues in the year ended June 30, 2014, were denominated in currencies other than the U.S. dollar. Of that total, approximately sixty-nine percent was denominated in euros with the balance comprised of Japanese yen, Indian rupee, Swiss franc and the Australian and Singapore dollars. The Company does not hedge the translation exposure represented by the net assets of its foreign subsidiaries. Foreign currency translation adjustments are recorded as a component of shareholders’ equity.  Forward foreign exchange contracts are used to hedge the currency fluctuations on significant transactions denominated  in foreign currencies. Derivative financial instruments - The Company has written policies and procedures that place all financial instruments under  the direction of the Company corporate treasury department and restrict derivative transactions to those intended for hedging purposes.  The use of financial instruments for trading purposes is prohibited.  The Company uses financial instruments to man- age the market risk from changes in foreign exchange rates. Periodically, the Company 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 Income (Expense),  net in the Consolidated Statement of Operations and Comprehensive Income 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 2014 and 2013 was the euro.  At June 30, 2014 and 2013, the Company had no outstanding  forward exchange contracts. See Consolidated Financial Statements and Financial Statement Schedule. Sales and Earnings by Quarter – Unaudited (in thousands, except per share amounts) 2014 2nd Qtr. 1st Qtr. 3rd Qtr. 4th Qtr. Year Net sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net earnings (loss) attributable to Twin Disc . . . . . . . . . . . . . . . . . . . . . Basic earnings (loss) per share attributable to Twin Disc common shareholders . . . . . . . . . . . . . . . . . . . . . . . . Diluted earnings (loss) per share attributable to Twin Disc common shareholders . . . . . . . . . . . . . . . . . . . . . . . . Dividends per share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . __________ $66,426 20,667 __________ $63,212 18,544 __________ $60,705 16,528 __________ $73,566 21,515 ___________ $263,909 77,254 1,277 518 (475 ) 2,324 3,644 0.11 0.05 (0.04 ) 0.20 0.32 0.11 0.09 0.05 0.09 (0.04 ) 0.09 0.20 0.09 0.32 0.36 2013 1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr. Year Net sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net earnings (loss) attributable to Twin Disc . . . . . . . . . . . . . . . . . . . . . Basic earnings (loss) per share attributable to Twin Disc common shareholders . . . . . . . . . . . . . . . . . . . . . . . . Diluted earnings (loss) per share attributable to Twin Disc common shareholders . . . . . . . . . . . . . . . . . . . . . . . . Dividends per share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . __________ $68,793 19,416 __________ $72,325 22,311 __________ $68,232 17,674 __________ $75,932 20,624 ___________ $285,282 80,025 1,231 3,360 (757 ) 48 3,882 0.11 0.30 (0.07 ) 0.00 0.34 0.11 0.09 0.29 0.09 (0.07 ) 0.09 0.00 0.09 0.34 0.36 37 38 Twin Disc, incORPORATED | AnnuAl RepoRt 2014 ITEM 9. CHANGE IN AND DISAGREEMENTS WITH A CCOUNTANTS ON A CCOUNTING AND FINANCIAL DISCLOSURE PART III None. ITEM 9(A). CONTROLS AND PROCEDURES Conclusion Regarding Disclosure Controls and Procedures As required by Rules 13a-15 and 15d-15 of the Securities Exchange Act of 1934, as of the end of the period covered by this report and under the supervision and with the participation of management, including the Chief Executive Officer and the   Chief Financial Officer, the Company has evaluated the effectiveness of the design and operation of its disclosure controls   and procedures.  Based on such evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that such   disclosure controls and procedures are effective to provide reasonable assurance that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported within  the time periods specified in the Securities and Exchange Commission rules and forms, and to provide reasonable assurance that  information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is accumulated and  communicated to the Company’s management, including its principal executive and principal financial officers, as appropriate, to  Management’s Report on Internal Control Over Financial Reporting allow timely decisions regarding disclosure. Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting.   The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of  financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted ac- counting principles.  The Company’s internal control over financial reporting includes those policies and procedures that: (i)   pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions  of the Company, (ii)  provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in  accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company, and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also,  projections of any evaluation of the effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies and procedures included in such controls may deteriorate. The Company conducted an evaluation of the effectiveness of our internal control over financial reporting based upon the frame- work (1992 edition) in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).  Based upon such evaluation, our management concluded that our internal control over financial  reporting was effective as of June 30, 2014. PricewaterhouseCoopers LLP, an independent registered public accounting firm, has audited the Company’s internal control over  Changes in Internal Controls Over Financial Reporting financial reporting as of June 30, 2014, as stated in their report which appears herein. During the fourth quarter of fiscal 2014, there have not been any changes in the Company’s internal control over financial  reporting that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. ITEM 9(B). O THER INFORMATION Not applicable. ITEM 10. DIRECTORS AND EXECUTIvE OFFICERS OF THE REGISTRANT For information with respect to the executive officers of the Registrant, see “Executive Officers of the Registrant” at the end of  Part I of this report. For information with respect to the Directors of the Registrant, see “Election of Directors” in the Proxy Statement for the Annual Meeting of Shareholders to be held October 24, 2014, which is incorporated into this report by reference. For information with respect to compliance with Section 16(a) of the Securities Exchange Act of 1934, see “Section 16(a) Beneficial Ownership Reporting Compliance” in the Proxy Statement for  the Annual Meeting of Shareholders to be held   October 24, 2014, which is incorporated into this report by reference. For information with respect to the Company’s Code of Ethics, see “Guidelines for Business Conduct and Ethics” in the Proxy  Statement for the Annual Meeting of Shareholders to be held October 24, 2014, which is incorporated into this report by refer- ence.  The Company’s Code of Ethics, entitled, “Guidelines for Business Conduct and Ethics,” is included on the Company’s  website, www.twindisc.com. If the Company makes any substantive amendment to the Code of Ethics, or grants a waiver from a provision of the Code of Ethics for its Chief Executive Officer, Chief Financial Officer, Chief Accounting Officer or Controller (or any  person performing similar functions), it intends to disclose the nature of such amendment on its website within four business days of the amendment or waiver in lieu of filing a Form 8-K with the SEC. For information with respect to procedures by which shareholders may recommend nominees to the Company’s Board of Directors, see “Director Committee Functions: Nominating and Governance Committee” in the Proxy Statement for the Annual  Meeting of Shareholders to be held October 24, 2014, which is incorporated into this report by reference. There were no changes to these procedures since the Company’s last disclosure relating to these procedures. For information with respect to the Audit Committee Financial Expert, see “Director Committee Functions: Audit Committee” in the Proxy Statement for the Annual Meeting of Shareholders to be held October 24, 2014, which is incorporated into this report by reference. For information with respect to the Audit Committee Disclosure, see “Director Committee Functions: Audit Committee” in the Proxy Statement for the Annual Meeting of Shareholders to be held October 24, 2014, which is incorporated into this report by reference. For information with respect to the Audit Committee Membership, see “Director Committee Functions: Committee Membership” in the Proxy Statement for the Annual Meeting of Shareholders to be held October 24, 2014, which is incorporated into this report by reference. ITEM 11. EXECUTIvE COMPENSATION The information set forth under the captions “Executive Compensation,” “Director Compensation,” “Compensation Committee Interlocks and Insider Participation,” and “Compensation Committee Report,” in the Proxy Statement for the Annual Meeting of Shareholders to be held on October 24, 2014, is incorporated into this report by reference. Discussion in the Proxy Statement under the caption “Compensation Committee Report” is incorporated by reference but shall not be deemed “soliciting material” or to be “filed” as part of this report. ITEM 12. SECURITY O WNERSHIP OF CERTAIN BENEFICIAL O WNERS AND MANAGEMENT Security ownership of certain beneficial owners and management is set forth in the Proxy Statement for the Annual Meeting of  Shareholders to be held on October 24, 2014 under the captions “Principal Shareholders” and “Directors and Executive Officers”  and incorporated into this report by reference. For information regarding securities authorized for issuance under equity compensation plans of the Company, see “Equity Compensation Plan Information” in the Proxy Statement for the Annual Meeting of Shareholders to be held on October 24, 2014, which incorporated into this report by reference. There are no arrangements known to the Registrant, the operation of which may at a subsequent date result in a change in control of the Registrant. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, DIRECTOR INDEPENDENCE For information with respect to transactions with related persons and policies for the review, approval or ratification of such  transactions, see “Corporate Governance – Review, Approval or Ratification of Transactions with Related Persons” in the Proxy  Statement for the Annual Meeting of Shareholders to be held October 24, 2014, which is incorporated into this report by reference. For information with respect to director independence, see “Corporate Governance – Board Independence” in the Proxy Statement  for the Annual Meeting of Shareholders to be held October 24, 2014, which is incorporated into this report by reference. 39 40 Twin Disc, incORPORATED | AnnuAl RepoRt 2014ITEM 14. PRINCIPAL ACCOUNTING FEES AND SER vICES REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Company incorporates by reference the information contained in the Proxy Statement for the Annual Meeting of Shareholders to be held October 24, 2014, under the heading “Fees to Independent Registered Public Accounting Firm.” PART IV ITEM 15. EXHIBITS, FINANCIAL S TATEMENT SCHEDULES (a)(1) Consolidated Financial Statements See “Index to Consolidated Financial Statements and Financial Statement Schedule”, the Report of Independent Registered Public Accounting Firm and the Consolidated Financial Statements, all of which are incorporated by reference. (a)(2) Consolidated Financial Statement Schedule See “Index to Consolidated Financial Statements and Financial Statement Schedule”, and the Consolidated Financial Statement Schedule, all of which are incorporated by reference. (a)(3) Exhibits. See Exhibit Index included as the last page of this form, which is incorporated by reference. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page Report of Independent Registered Public Accounting Firm . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42 Consolidated Balance Sheets as of June 30, 2014 and 2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43 Consolidated Statements of Operations and Comprehensive Income for the years ended June 30, 2014, 2013 and 2012 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44 Consolidated Statements of Cash Flows for the years ended June 30, 2014, 2013 and 2012 . . . . . . . . . . . . . . . . . . . . . . . . . . 45 Consolidated Statements of Changes in Equity for the years ended June 30, 2014, 2013 and 2012 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46 Notes to Consolidated Financial Statements. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .47–68 INDEX TO FINANCIAL STATEMENT SCHEDULE Schedule II – Valuation and Qualifying Accounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68 Schedules, other than those listed, are omitted for the reason that they are inapplicable, are not required, or the information required is shown in the financial statements or the related notes. To the Board of Directors and Shareholders of Twin Disc, Incorporated: In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects,  the financial position of Twin Disc, Incorporated and its subsidiaries at June 30, 2014 and June 30, 2013, and the results of their  operations and their cash flows for each of the three years in the period ended June 30, 2014 in conformity with accounting  principles generally accepted in the United States of America.  In addition, in our opinion, the financial statement schedule listed  in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.  Also in our opinion, the Company maintained, in all material respects, effec- tive internal control over financial reporting as of June 30, 2014, based on criteria established in Internal Control - Integrated  Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements and financial statement schedule, for maintaining effective internal  control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in  Management’s Report on Internal Control over Financial Reporting appearing under Item 9(a). Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company’s internal control over financial  reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over  financial reporting was maintained in all material respects.  Our audits of the financial statements included examining, on a test  basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and  significant estimates made by management, and evaluating the overall financial statement presentation.  Our audit of internal  control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the  risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstanc- es. We believe that our audits provide a reasonable basis for our opinions. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the  reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally  accepted accounting principles.  A company’s internal control over financial reporting includes those policies and procedures that  (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions  of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the  company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.  Also, pro- jections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Milwaukee, Wisconsin September 15, 2014 41 42 Twin Disc, incORPORATED | AnnuAl RepoRt 2014 TWIN DISC, INCORPORATED AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS June 30, 2014 and 2013 ASSETS (In thousands, except share amounts) Current assets: Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Trade accounts receivable, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Property, plant and equipment, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Goodwill, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Intangible assets, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . LIABILITIES and EQUITY Current liabilities: Short-term borrowings and current maturities of long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accrued liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accrued retirement benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other long-term liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Twin Disc shareholders’ equity: Preferred shares authorized: 200,000; issued: none; no par value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Common shares authorized: 30,000,000; issued: 13,099,468; no par value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accumulated other comprehensive loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less treasury stock, at cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1,837,595 and 1,886,516 shares, respectively) Total Twin Disc shareholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Noncontrolling interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total equity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . The notes to consolidated financial statements are an integral part of these statements. 2014 2013 ___________ ___________ $ 24,757 40,219 97,579 4,779 12,763 ___________ 180,097 60,267 13,463 2,556 2,797 7,805 ___________ $266,985 ___________ ___________ $ 3,604 22,111 31,265 ___________ 56,980 14,800 37,006 1,778 4,110 ___________ 114,674 $ 20,724 46,331 102,774 5,280 13,363 ___________ 188,472 62,315 13,232 7,614 3,149 10,676 ___________ $285,458 ___________ ___________ $ 3,681 20,651 39,171 ___________ 63,503 23,472 48,290 2,925 3,706 ___________ 141,896 — — 11,973 183,695 (15,943 ) ___________ 179,725 28,141 ___________ 151,584 727 ___________ 152,311 ___________ $266,985 ___________ ___________ 13,183 184,110 (25,899 ) ___________ 171,394 28,890 ___________ 142,504 1,058 ___________ 143,562 ___________ $285,458 ___________ ___________ TWIN DISC, INCORPORATED AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIvE INCOME for the years ended June 30, 2014, 2013 and 2012 (In thousands, except per share data) Net sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cost of goods sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                 Gross profit. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Marketing, engineering and administrative expenses . . . . . . . . . . . . . . . . . . . Restructuring of operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Impairment charge. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Earnings from operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other income (expense): Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other, net. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Earnings before income taxes and noncontrolling interest . . . . . . . . . Income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: Net earnings attributable to noncontrolling interest . . . . . . . . . . . . . . . Net earnings attributable to Twin Disc . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2014 2013 2012 ___________ $263,909 186,655 ___________ 77,254 67,406 961 — ___________ 8,887 121 (936 ) 24 ___________ (791 ) ___________ 8,096 4,226 ___________ 3,870 (226 ) ___________ $ 3,644 ___________ ___________ ___________ $285,282 205,257 ___________ 80,025 67,899 708 1,405 ___________ 10,013 102 (1,435 ) 557 ___________ (776 ) ___________ 9,237 4,986 ___________ 4,251 (369 ) ___________ $ 3,882 ___________ ___________ ___________ $355,870 234,238 ___________ 121,632 73,091 — 3,670 ___________ 44,871 95 (1,475 ) 1,265 ___________ (115 ) ___________ 44,756 17,815 ___________ 26,941 (198 ) ___________ $ 26,743 ___________ ___________ Earnings per share data: Basic earnings per share attributable to Twin Disc common shareholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 0.32 $ 0.34 $ 2.34 Diluted earnings per share attributable to Twin Disc common shareholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.32 0.34 2.31 Weighted average shares outstanding data: Basic shares outstanding. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Dilutive stock awards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Diluted shares outstanding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Comprehensive income: Net earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign currency translation adjustment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Benefit plan adjustments, net of income taxes of $3,806, $4,163 and ($6,769), respectively . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Comprehensive income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Comprehensive income attributable to noncontrolling interest . . . . . . . Comprehensive income attributable to Twin Disc . . . . . . . . . . . . . . . . . . 11,258 6 ___________ 11,264 ___________ ___________ $ 3,870 3,760 6,126 ___________ 13,756 (156 ) ___________ $ 13,600 ___________ ___________ 11,304 73 ____________ 11,377 ____________ ____________ $ 4,251 447 8,322 ___________ 13,020 (240 ) ___________ $ 12,780 ___________ ___________ 11,410 146 ___________ 11,556 ___________ ___________ $ 26,941 (11,738 ) (11,690 ) ___________ 3,513 (184 ) ___________ $ 3,329 ___________ ___________ The notes to consolidated financial statements are an integral part of these statements. 43 44 Twin Disc, incORPORATED | AnnuAl RepoRt 2014 TWIN DISC, INCORPORATED AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS TWIN DISC, INCORPORATED AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY for the years ended June 30, 2014, 2013 and 2012 (in thousands) Cash flows from operating activities: 2014 2013 2012 _________ _________ _________ for the years ended June 30, 2014, 2013 and 2012 (in thousands) $ 3,870 $ 4,251 $26,941 Balance at June 30, 2011 Net earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Loss on sale of plant assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Impairment charge . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Stock compensation expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Restructuring of operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Provision for deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Changes in operating assets and liabilities: Trade accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accrued liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accrued/prepaid retirement benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cash flows from investing activities: Net cash provided by operating activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Proceeds from sale of plant assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Capital expenditures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cash flows from financing activities: Net cash used by investing activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Proceeds from senior notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Payments of senior notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Borrowings under revolving loan agreement . . . . . . . . . . . . . . . . . . . . . . . . . Repayments under revolving loan agreement . . . . . . . . . . . . . . . . . . . . . . . . Proceeds from exercise of stock options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Acquisition of treasury stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Dividends paid to shareholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Dividends paid to noncontrolling interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . Excess tax benefits from stock compensation . . . . . . . . . . . . . . . . . . . . . . . . Payments of withholding taxes on stock compensation . . . . . . . . . . . . . . . Net cash used by financing activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Effect of exchange rate changes on cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net change in cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cash: Beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . End of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Supplemental cash flow information: Cash paid during the year for: Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,657 26 — 1,184 961 634 7,076 6,972 2,198 1,364 (8,531 ) (662 ) _________ 25,749 _________ 103 (7,245 ) 34 _________ (7,108 ) _________ — (3,651 ) 70,443 (75,544 ) — — (4,059 ) (487 ) 524 (2,169 ) _________ (14,943 ) _________ 335 _________ 4,033 20,724 _________ $24,757 _________ _________ 10,838 287 1,405 2,681 708 687 17,636 176 (3,136 ) (2,457 ) (4,969 ) (3,631 ) _________ 24,476 _________ 315 (6,582 ) (231 ) _________ (6,498 ) _________ 32 (96 ) 83,450 (88,382 ) 189 (3,069 ) (4,078 ) (204 ) 1,451 (1,700 ) _________ (12,407 ) _________ (548 ) _________ 5,023 15,701 _________ $20,724 _________ _________ 10,756 315 3,670 1,642 — 7,486 (5,982 ) (9,563 ) (915 ) (13,279 ) (2,904 ) (3,723 ) _________ 14,444 _________ 116 (13,733 ) (293 ) _________ (13,910 ) _________ 3 (145 ) 99,635 (97,045) 169 (2,425 ) (3,886 ) (131 ) 535 (184 ) _________ (3,474 ) _________ (1,526 ) _________ (4,466 ) 20,167 _________ $15,701 _________ _________ $ 989 3,691 $ 1,536 2,545 $ 1,507 13,629 Accumulated Other Retained Comprehensive Income (Loss) Earnings Non- Treasury controlling Interest Stock Total Equity ___________ $161,449 26,743 — —    (3,886 ) _________________ $(11,383 ) — (11,724 ) (11,690 )   — ___________ $(25,252 ) — — —    — ________ $969 198 (14 ) —    (131 ) ___________ $136,646 26,941 (11,738 ) (11,690 ) (4,017 ) Common Stock __________ $10,863 — — —    — 2,808    (912 ) __________ —    — ___________ —     — ___________ —     (1,529 ) ___________ —     — ________ 2,808 (2,441 ) ___________ 12,759 — — —    — 184,306 3,882 — —    (4,078 ) (34,797 ) — 576 8,322     — (26,781 ) — — —    — 1,022 369 (129 ) —    (204 ) 136,509 4,251 447 8,322 (4,282 ) 2,894    (2,470 ) __________ —    — ___________ —     — ___________ —     (2,109 ) ___________ —     — ________ 2,894 (4,579 ) ___________ 13,183 — — —    — 184,110 3,644 — —    (4,059 ) (25,899 ) — 3,830 6,126     — (28,890 ) — — —    — 1,058 226 (70 ) —    (487 ) 143,562 3,870 3,760 6,126 (4,546 ) 1,708    (2,918 ) __________ $11,973 __________ __________ —    — ___________ $183,695 ___________ ___________ —     — ___________ $(15,943 ) ___________ ___________ —     749 ___________ $(28,141 ) ___________ ___________ —     — ________ $727 ________ ________ 1,708 (2,169 ) ___________ $152,311 ___________ ___________ Net earnings Translation adjustments Benefit plan adjustments, net of tax  Cash dividends Compensation expense and   windfall tax benefits  Shares (acquired) issued, net Balance at June 30, 2012 Net earnings Translation adjustments Benefit plan adjustments, net of tax  Cash dividends Compensation expense and   windfall tax benefits  Shares (acquired) issued, net Balance at June 30, 2013 Net earnings Translation adjustments Benefit plan adjustments, net of tax  Cash dividends Compensation expense and   windfall tax benefits  Balance at June 30, 2014 Shares (acquired) issued, net 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. 45 46 Twin Disc, incORPORATED | AnnuAl RepoRt 2014             TWIN DISC, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS A. SIGNIFICANT ACCOUNTING POLICIES Consolidation Principles The following is a summary of the significant accounting policies followed in the preparation of these financial statements:  – The consolidated financial statements include the accounts of Twin Disc, Incorporated and its wholly  and partially owned domestic and foreign subsidiaries.  Certain foreign subsidiaries are included based on fiscal years ending  May 31, to facilitate prompt reporting of consolidated accounts. The Company also has a controlling interest in a Japanese joint venture, which is consolidated based upon a fiscal year ending March 31.  All significant intercompany transactions have been  Translation of Foreign Currencies eliminated.  – The financial statements of the Company’s non-U.S. subsidiaries are translated using the cur- rent 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 income (expense) are  Receivables foreign currency transaction gains (losses) of $293,000, $642,000 and $1,103,000 in fiscal 2014, 2013 and 2012, respectively. – Trade accounts receivable are stated net of an allowance for doubtful accounts of $3,637,000 and $2,884,000 at June 30, 2014 and 2013, respectively. The Company records an allowance for doubtful accounts provision 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 but not yet clearly associated with a specific customer.  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 our 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 Fair Value of Financial Instruments higher levels of customer defaults and bad debt expense in future periods. – The carrying amount reported in the consolidated balance sheets for cash, trade accounts receivable, accounts payable and short term borrowings 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 described in Note M.  The fair value of the Company’s 6.05% Senior Notes  due April 10, 2016, was approximately $7,605,000 and $11,536,000 at June 30, 2014 and 2013, respectively. The fair value of the Senior Notes is estimated by discounting the future cash flows at rates offered to the Company for similar debt instruments of  comparable maturities.  This rate was represented by the US Treasury Three-Year Yield Curve Rate (0.88% and 0.66% for fiscal  2014 and 2013, respectively), plus the current add-on related to the Company’s revolving loan agreement (1.00% and 1.65% for fiscal 2014 and 2013, respectively) resulting in a total rate of 1.88% and 2.31% for fiscal 2014 and 2013, respectively.  See Note  G, “Debt” for the related book value of this debt instrument.  The Company’s revolving loan agreement approximates fair value at  June 30, 2014.  If measured at fair value in the financial statements, long-term debt (including the current portion) would be clas- Derivative Financial Instruments sified as Level 2 in the fair value hierarchy, as described in Note M.  – The Company has written policies and procedures that place all financial instruments under  the direction of the Company’s corporate treasury and restricts all derivative transactions to those intended for hedging purpos- es.  The use of financial instruments for trading purposes is prohibited.  The Company uses financial instruments to manage the  market risk from changes in foreign exchange rates. Periodically, the Company 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 income (expense) 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 2014 and 2013 was the euro.  At June 30, 2014 and  Inventories 2013, the Company had no outstanding forward exchange contracts.  – Inventories are valued at the lower of cost or market.  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. Property, Plant and Equipment and Depreciation – Assets are stated at cost. Expenditures for maintenance, repairs and minor re- newals are charged against earnings as incurred. Expenditures for major renewals and betterments are capitalized and depreci- ated.  Depreciation is provided on the straight-line method over the estimated useful lives of the assets for financial reporting and  on accelerated methods for income tax purposes. 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 equip- ment, the cost of the asset and the related accumulated depreciation are removed from the accounts and the resulting gain or loss Impairment of Long-lived Assets is reflected in earnings.  Fully depreciated assets are not removed from the accounts until physically disposed. – 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, excluding indefinite-lived 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  Revenue Recognition to substantiate the discounted cash flow analyses, including third-party valuations when necessary.   – Revenue is recognized by the Company when all of the following criteria are met: persuasive evidence of an arrangement exists; delivery has occurred and ownership has transferred to the customer; the price to the customer is fixed  or determinable; and collectability is reasonably assured. Revenue is recognized at the time product is shipped to the customer, except for certain domestic shipments to overseas customers where revenue is recognized upon receipt by the customer. A significant portion of our consolidated net sales is transacted through a third party distribution network.  Sales to third party  distributors are subject to the revenue recognition criteria described above.  Goods sold to third party distributors are subject to  Goodwill and Other Intangibles an annual return policy, for which a provision is made at the time of shipment based upon historical experience.  – Goodwill and other indefinite-lived intangible assets, primarily tradenames, are tested for  impairment at least annually on the last day of the Company’s fiscal year and more frequently if an event occurs which indicates  the asset may be impaired. If applicable, goodwill and other indefinite-lived intangible assets not subject to amortization have  been assigned to reporting units for purposes of impairment testing based upon the relative fair value of the asset to each reporting unit. A significant amount of judgment is involved in determining if an indicator of impairment has occurred.  Such indicators may  include, among others: a significant decline in expected future cash flows; a sustained, significant decline in the Company’s stock  price and market capitalization; a significant adverse change in legal factors or in the business climate; unanticipated competi- tion; the testing for recoverability of a significant asset group within a reporting unit; and slower growth rates.  Any adverse  change in these factors could have a significant impact on the recoverability of these assets and could have a material impact on  the Company’s consolidated financial statements. Impairment of goodwill is measured according to a two-step approach.  In the first step, the fair value of a reporting unit, as  defined, is compared to the carrying value of the reporting unit, including goodwill.  The fair value is primarily determined using  discounted cash flow analyses; however, other methods may be used to substantiate the discounted cash flow analyses, including  third party valuations.  For purposes of the June 30, 2014, impairment analysis, the Company has utilized discounted cash flow  analyses. If the carrying amount exceeds the fair value, the second step of the goodwill impairment test is performed to measure the amount of the impairment loss, if any. In the second step, the implied value of the goodwill is estimated as the fair value of the reporting unit less the fair value of all other tangible and identifiable intangible assets of the reporting unit.  If the carrying  amount of the goodwill exceeds the implied fair value of the goodwill, an impairment loss is recognized in an amount equal to that excess, not to exceed the carrying amount of the goodwill. Based upon the goodwill impairment review completed in conjunction with the preparation of the annual financial statements at  the end of fiscal 2014, which incorporates management’s best estimates of economic and market conditions over the projected  period and a weighted-average cost of capital that reflects current market conditions, it was determined that the fair value of  goodwill for each of the reporting units exceeded the carrying value and therefore goodwill was not impaired. The fair value of the Company’s other intangible assets with indefinite lives, primarily tradenames, is estimated using the relief- from-royalty method, which requires assumptions related to projected revenues; assumed royalty rates that could be payable if the Company did not own the asset; and a discount rate.  The Company completed the impairment testing of indefinite-lived  intangibles as of June 30, 2014, and concluded there were no impairments. Changes in circumstances, existing at the measurement date or at other times in the future, or in the numerous estimates associ- ated with management’s judgments, assumptions and estimates made in assessing the fair value of goodwill and other indefi- nite-lived intangibles, could result in an impairment charge in the future.  The Company will continue to monitor all significant  estimates and impairment indicators, and will perform interim impairment reviews as necessary. Any cost incurred to extend or renew the term of an indefinite lived intangible asset are expensed as incurred. 47 48 Twin Disc, incORPORATED | AnnuAl RepoRt 2014Deferred Taxes Recently Issued Accounting Standards – The Company recognizes deferred tax liabilities and assets for the expected future income tax consequences of events that have been recognized in the Company’s financial statements.  Under this method, deferred tax liabilities and assets  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 Management Estimates benefit of such assets.  – The preparation of financial statements in conformity with generally accepted accounting principles re- quires 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  Shipping and Handling Fees and Costs reporting periods. Actual amounts could differ from those estimates. Out-of-Period Adjustments associated with shipping and handling of products is reflected in cost of goods sold. – The Company records revenue from shipping and handling costs in net sales. The cost During the first quarter of fiscal 2014, the Company recorded out-of-period adjustments related to the correction of errors identi- fied late in the year-end closing process of fiscal 2013 that were deemed immaterial for adjustment to the fiscal 2013 financial  statements.  The impact of these corrections to the fiscal 2014 first quarter and full year results was to increase earnings before  income taxes and noncontrolling interest by $437,000 and increase net earnings attributable to Twin Disc by $69,000 (after con- sidering applicable tax effects). The nature of these errors is as follows: •   The Company had over accrued for certain payroll related items totaling $337,000 as of June 30, 2013, resulting in an increase  to earnings from operations. •   The Company had overstated its warranty accrual by $217,000 as of June 30, 2013, resulting in an increase to earnings from  operations. •   The Company determined that work-in-process inventory had been overstated by $117,000 as of June 30, 2013.  As a result,  additional cost of goods sold was recorded in the first quarter of fiscal 2014, resulting in a decrease to earnings from operations. •   The Company’s deferred tax liabilities were understated by $285,000 as of June 30, 2013, resulting in additional tax expense. The Company does not believe these errors are material to its financial statements for any prior period, nor that the correction of  these errors is material to the year ended June 30, 2014. In June 2014, the Financial Accounting Standards Board (“FASB”) issued stock compensation guidance requiring that a perfor- mance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condi- tion.  The amendments in this guidance are effective for fiscal years, and interim periods within those fiscal years, beginning after  December 15, 2015 (the Company’s fiscal 2017).  The adoption of this guidance is not expected to have a material impact on the  Company’s financial disclosures. In May 2014, the FASB issued updated guidance on revenue from contracts with customers. This revenue recognition guidance supersedes existing US GAAP guidance, including most industry-specific guidance.  The core principle is that an entity should rec- ognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to  which the entity expects to be entitled in exchange for those goods or services.  The guidance identifies steps to apply in achiev- ing this principle.  This updated guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after  December 15, 2016 (the Company’s fiscal 2018).  The Company is currently evaluating the potential impact of this guidance on  the Company’s financial disclosures and results. In April 2014, the FASB issued updated guidance on the reporting for discontinued operations. Under the new guidance, only disposals representing a strategic shift in operations should be presented as discontinued operations. The new guidance also requires expanded financial disclosures about discontinued operations.  The amendments in this updated guidance are effective  for the first quarter of the Company’s fiscal 2016.  The adoption of this guidance is not expected to have a material impact on the  Company’s financial disclosures. In July 2013, the FASB issued guidance stating that, except in certain defined circumstances, an unrecognized tax benefit, or a  portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for  a net operating loss carryforward, a similar tax loss, or a tax credit carryforward.  This guidance is effective for fiscal years, and  interim periods within those fiscal years, beginning after December 15, 2013 (the Company’s fiscal 2015).  The adoption of this  guidance is not expected to have a material impact on the Company’s financial disclosures. In March 2013, the FASB issued guidance on the parent company’s accounting for the cumulative translation adjustment upon derecognition of certain subsidiaries or groups of assets within a foreign entity or of an investment in a foreign entity. This guidance clarifies the circumstances under which the related cumulative translation adjustment should be released into net   income.  This guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after  December 15,  2013 (the Company’s fiscal 2015).  The adoption of this guidance is not expected to have a material impact on the Company’s   financial results. B. INvENTORIES The major classes of inventories at June 30 were as follows (in thousands): Finished parts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Work-in-process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Raw materials . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2014 2013 ___________ $ 66,418 12,419 18,742 ___________ $ 97,579 ___________ ___________ ___________ $ 68,594 11,880 22,300 ___________ $102,774 ___________ ___________ Inventories stated on a LIFO basis represent approximately 28% and 30% of total inventories at June 30, 2014 and 2013, respec- tively. The approximate current cost of the LIFO inventories exceeded the LIFO cost by $27,180,000 and $25,101,000 at June 30, 2014 and 2013, respectively. The Company had reserves for inventory obsolescence of $7,591,000 and $7,122,000 at June 30, 2014 and 2013, respectively. C. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment at June 30 were as follows (in thousands): Land. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Buildings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Machinery and equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: accumulated depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2014 2013 _________ $ 5,310 44,540 141,665 _________ 191,515 131,248 _________ $60,267 __________ __________ __________ $ 4,977 42,712 138,223 __________ 185,912 123,597 __________ $62,315 __________ __________ 49 Depreciation expense for the years ended June 30, 2014, 2013 and 2012, was $10,180,000, $10,120,000 and $9,947,000, respectively. 50 Twin Disc, incORPORATED | AnnuAl RepoRt 2014 D. GOODWILL AND OTHER INTANGIBLES The changes in the carrying amount of goodwill, substantially all of which is allocated to the manufacturing segment, for the years ended June 30, 2014 and 2013, were as follows (in thousands): Gross Carrying Amount Accumulated Impairment Net Book Value Balance at June 30, 2012 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Translation adjustment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Balance at June 30, 2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Translation adjustment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Balance at June 30, 2014 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ___________ $16,786 116 _________ 16,902 231 _________ $17,133 _________ _________ ________________ $(3,670 ) — ___________ (3,670 ) — ___________ $(3,670 ) ___________ ___________ ___________ $13,116 116 _________ 13,232 231 _________ $13,463 _________ _________ The Company conducted its annual assessment for goodwill impairment during the fourth fiscal quarter of 2014 and concluded  these assets are not impaired. The Company conducted its annual assessment for goodwill impairment in the fourth quarter of fiscal 2012 by applying a fair  value based test using discounted cash flow analyses, in accordance with ASC 350-10, “Intangibles – Goodwill and Other.”  The  inputs utilized in the discounted cash flow analysis used to measure the fair value of goodwill are considered Level 3 in the fair  value hierarchy.  The result of this assessment identified that one of the Company’s reporting units goodwill was fully impaired,  necessitating a non-cash charge of $3,670,000. The impairment was due to a declining outlook in the global pleasure craft/mega- yacht market, the weakened European economy, few signs of significant near-term recovery in the markets served by this report- ing unit and the heightened economic risk profile of this Italian reporting unit as of June 30, 2012.  These factors were identified  as the Company conducted its annual budget review process during the fourth fiscal quarter, and the Company concluded that the  impairment charge was necessary in connection with the preparation of the year end financial statements.  The fair value of the  goodwill for the remaining reporting units exceeds the respective carrying values. At June 30, the following acquired intangible assets have definite useful lives and are subject to amortization (in thousands): 2014 Licensing agreements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Non-compete agreements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Trade name . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Licensing agreements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Non-compete agreements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Gross _______________________________________________________________________ Carrying Accumulated Accumulated Net Book Value Impairment Amount Amortization ___________ $ 3,015 2,128 2,009 6,482 ___________ $13,634 ___________ ___________ ________________ $(2,445 ) (2,045 ) (100 ) (5,193 ) ___________ $(9,783 ) ___________ ___________ ________________ $ — (83 ) — (1,194 ) ___________ $1,277 ___________ ___________ 2013 ___________ $ 570 — 1,909 95 ___________ $2,574 ___________ ___________ Gross _______________________________________________________________________ Carrying Accumulated Accumulated Net Book Value Impairment Amount Amortization ___________ $ 3,015 2,124 6,468 ___________ $11,607 ___________ ___________ ________________ $(2,385 ) (1,939 ) (4,982 ) ___________ $(9,306 ) ___________ ___________ ________________ $ — (83 ) (1,194 ) ___________ $(1,277 ) ___________ ___________ ___________ $ 630 102 292 ___________ $1,024 ___________ ___________ Other intangibles consist of certain amortizable acquisition costs, proprietary technology, computer software, certain customer relationships and debt issuance costs on the 6.05% notes. During the fourth quarter of fiscal 2013, the Company committed to a plan and entered negotiations to exit the distribution  agreement and sell the inventory of its Italian distributor back to the parent supplier. This decision triggered an impairment re- view of the long lived assets at this entity, resulting in an impairment charge of $1,405,000, representing a complete impairment of the remaining intangibles ($1,277,000) and fixed assets ($128,000) for this entity.  The impairment charge was determined  by deriving the fair value of the asset group utilizing a discounted cash flow model.  Significant inputs to this model include the  discount rate, sales projections and profitability estimates.  These inputs would be considered Level 3 in the fair value hierarchy. The weighted average remaining useful life of the intangible assets included in the table above is approximately 16 years. Intangible amortization expense for the years ended June 30, 2014, 2013 and 2012, was $477,000, $718,000 and $809,000, respectively.  Estimated intangible amortization expense for each of the next five fiscal years is as follows (in thousands): Fiscal Year 2015 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2016 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2017 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2018 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2019 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Thereafter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 251 165 160 160 160 1,678 ________ $2,574 ________ ________ The gross carrying amount of the Company’s intangible assets that have indefinite lives and are not subject to amortization as of  June 30, 2014 and 2013, are $223,000 and $2,125,000, respectively. These assets are comprised of acquired tradenames. Based on the Company’s reassessment of the useful lives assigned to intangible assets during the first quarter of fiscal 2014, it was   determined that certain indefinite lived trade names should be reclassified to definite lived.  As such, the Company assigned a   20-year useful life to the trade names. E. ACCRUED LIABILITIES Accrued liabilities at June 30 were as follows (in thousands): Salaries and wages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Retirement benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Warranty . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Customer advances/deferred revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accrued income tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Distributor rebate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F. WARRANTY 2014 2013 _________ $ 6,648 4,909 3,917 3,082 1,913 3,242 7,554 _________ $31,265 _________ _________ _________ $ 9,513 3,973 3,910 7,234 2,541 3,636 8,364 _________ $39,171 _________ _________ 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 process- es, including actively monitoring and evaluating the quality of its suppliers. However, its warranty obligation is affected by prod- uct failure rates, the number of units affected by the failure and the expense involved in satisfactorily addressing the situation. The warranty reserve is established based on our best estimate of the amounts necessary to settle future and existing claims on products sold as of the balance sheet date. When evaluating the adequacy of the reserve for warranty costs, management takes into consideration the term of the warranty coverage, historical claim rates and costs of repair, knowledge of the type and volume of new products and economic trends. While we believe the warranty reserve is adequate and that the judgment applied is appropriate, such amounts estimated to be due and payable in the future could differ materially from what actually transpires. The following is a listing of the activity in the warranty reserve during the years ended June 30 (in thousands): 2014 2013 Reserve balance, July 1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Current period expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Payments or credits to customers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Translation adjustment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Reserve balance, June 30 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ________ $5,701 2,214 (2,055 ) 108 ________ $5,968 ________ ________ ________ $5,745 4,864 (4,953 ) 45 ________ $5,701 ________ ________ The current portion of the warranty accrual ($3,917,000 and $3,910,000 for fiscal 2014 and 2013, respectively) is reflected in accrued liabilities, while the long-term portion ($2,051,000 and $1,791,000 for fiscal 2014 and 2013, respectively) is included in other long-term liabilities on the Consolidated Balance Sheets. 51 52 Twin Disc, incORPORATED | AnnuAl RepoRt 2014 G. DEBT Notes Payable Notes payable consists of amounts borrowed under unsecured line of credit agreements. These lines of credit may be withdrawn at the option of the banks. The following is aggregate borrowing information at June 30 (in thousands): 2014 2013 Available credit lines. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Unused credit lines . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total notes payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Weighted-average interest rates on credit lines . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Long-Term Debt Long-term debt consisted of the following at June 30 (in thousands): Revolving loan agreement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10-year unsecured senior notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Capital lease obligations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Subtotal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: current maturities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . __________ $ 3,372 3,372 __________ $    —  __________ __________ 2.9% ________ $18,072 18,072 ________ $        — ________ ________ 2.1% 2014 2013 __________ $11,200 7,143 29 32 __________ 18,404 (3,604 ) __________ $14,800 __________ __________ __________ $16,300 10,714 44 95 __________ 27,153 (3,681 ) __________ $23,472 __________ __________ On June 30, 2014, the Company and its wholly-owned subsidiary, Twin Disc International S.A. (“Twinsa”) entered into a multi-currency revolving loan agreement with Wells Fargo Bank, National Association (“Wells Fargo”). Pursuant to the Credit Agreement, the Company and Twinsa may, from time to time, enter into revolving credit loans in amounts not to exceed, in the aggregate, Wells Fargo’s revolving credit commitment of $60,000,000. In general, outstanding revolving credit loans will bear interest at LIBOR plus 1.00%. The rate was 1.16% at June 30, 2014. In addition to principal and interest payments, the Company and Twinsa will be responsible for paying a quarterly commitment fee equal to 0.15% of the average daily unused revolving credit commitment. The Company and Twinsa have the option of making additional prepayments subject to certain limitations. The Credit Agreement is scheduled to expire on May 31, 2018. The outstanding balance of $11,200,000 at June 30, 2014, is classified as long-term debt. This agreement contains certain covenants, including restrictions on investments, acquisitions and  indebtedness. Financial covenants include a minimum consolidated adjusted net worth amount, a minimum EBITDA for the most recent four fiscal quarters of $11,000,000 at June 30, 2014, and a maximum total funded debt to EBITDA ratio of 3.0 at June 30,  2014.  As of June 30, 2014, the Company was in compliance with these financial covenants.  The minimum adjusted net worth  covenant fluctuates based upon actual earnings, and the Company’s compliance with that covenant is based on the Company’s  shareholders’ equity as adjusted by certain pension accounting items. As of June 30, 2014, the minimum adjusted equity requirement was $120,831,000, and the Company was in compliance with this covenant. Prior to June 30, 2014, the Company had a revolving loan agreement with BMO Harris Bank NA (BMO), successor by merger to M&I Marshall & Ilsley Bank.  During the fourth quarter of fiscal 2011, the total commitment was increased to $40,000,000 from  $35,000,000 and the term was extended to May 31, 2015. The outstanding balance of $16,300,000 at June 30, 2013, was clas- sified as long-term debt.  In accordance with the loan agreement, as amended, the Company could borrow at LIBOR plus an ad- ditional “Add-On,” between 1.5% and 2.5%, depending on the Company’s total funded debt to EBITDA ratio. The rate was 1.84% at June 30, 2013. This agreement contained certain covenants, including restrictions on investments, acquisitions and indebt- edness.  Financial covenants included a minimum consolidated net worth amount, as defined, a minimum EBITDA for the most  recent four fiscal quarters, and a maximum total funded debt to EBITDA ratio.  As of June 30, 2013, the Company was in compli- ance with these financial covenants.  On June 30, 2014, the Company terminated the BMO agreement  and paid the full outstand- ing amounts owed as of June 30, 2014, which totaled $14,042,534. The Company did not incur any early termination penalties in connection with the termination of the BMO agreement. On June 30, 2014, the Company entered into an Amended and Restated Note Purchase and Private Shelf Agreement (the “Prudential Agreement”). Among other things, the Prudential Agreement: (a) amends and restates the “Note Agreement” between the Company and Purchasers dated as of April 10, 2006, as it has been amended from time to time (the “2006 Agreement”); and (b) sets forth the terms of the potential sale and purchase of up to $50,000,000 in “Shelf Notes” as defined in the Prudential  Agreement (the “Shelf Notes”) by the Company to Prudential. The notes sold by the Company to the Existing Holders under the 2006 Agreement (the “2006 Notes”) are deemed outstanding under, and are governed by, the terms of the Prudential Agreement. The 2006 Notes bear interest on the outstanding principal balance at a fixed rate of 6.05% per annum and mature on April 10, 2016.   The 2006 Notes mature and become due and payable in full on April 10, 2016 (the “Payment Date”). Prior to the Payment Date, the Company is obligated to make quarterly payments of interest during the term of the 2006 Notes, plus prepayments of principal of $3,571,429 on April 10 of each year from 2010 to 2015, inclusive. The outstanding balance was $7,142,857 and $10,714,286 at June 30, 2014 and June 30, 2013, respectively.  Of the outstanding balance, $3,571,429 was classified as a current maturity of long- term debt at June 30, 2014 and June 30, 2013, respectively.  The remaining $3,571,429 is classified as long-term debt.  In addition  to the interest payments and any mandatory principal payments required under the terms of the Shelf Note, the Company will pay an issuance fee of 0.10% of the aggregate principal balance of each of the Shelf Notes sold to, and purchased by, Prudential. In addition the Company will pay a one-time structuring fee of $25,000 on or before September 30, 2014, unless there is an acceptance of a sale of Shelf Notes prior to such date, in which case the structuring fee will be waived. The Company may prepay the Shelf Notes or the 2006 Notes, subject to certain limitations. At no time during the term of the Prudential Agreement may the aggregate outstanding principal amount of the 2006 Notes and the Shelf Notes exceed $35,000,000. The Prudential Agreement includes financial covenants regarding minimum net worth, minimum EBIDTA for the most recent four (4) fiscal quarters of   $11,000,000 and a maximum total funded debt to EBIDTA ratio of 3.0. As of June 30, 2014, the Company was in compliance with these financial covenants.  In addition, the Company will be required to make an offer to purchase the 2006 Notes and Shelf  Notes upon a Change of Control, and any such offer must include the payment of a Yield-Maintenance Amount. The Prudential Agreement also includes certain covenants that limit, among other things, certain indebtedness, acquisitions and investments. The Prudential Agreement also has a most favored lender provision whereby the Prudential Agreement shall be automatically modified to include any additional covenant or event of default that is included in any agreement evidencing, securing, guarantying  or otherwise related to other indebtedness in excess of $1,000,000. Prior to June 30, 2014, the Company and its wholly-owned subsidiary Twin Disc International, S.A. had a multi-currency revolving Credit Agreement with Wells Fargo Bank, National Association (the “Prior Credit Agreement”). The Company entered into this agreement on November 19, 2012. Pursuant to the Prior Credit Agreement, the Company could, from time to time, enter into revolving credit loans in amounts not to exceed, in the aggregate, Wells Fargo’s revolving credit commitment of $15,000,000. In general, outstanding revolving credit loans (other than foreign currency loans) would bear interest at one of the following rates, as selected by the Company: (1) a “Base Rate,” which is equal to the highest of (i) the prime rate; (ii) the federal funds rate plus 0.50%; or (iii) LIBOR plus 1.00%; or (2) a “LIBOR Rate” (which is equal to LIBOR divided by the difference between 1.00 and the Eurodollar Reserve Percentage (as defined in the Prior Credit Agreement)) plus 1.50%.  Outstanding revolving credit loans that are  foreign currency loans would bear interest at the LIBOR Rate plus 1.50%, plus an additional “Mandatory Cost,” which was designed to compensate Wells Fargo for the cost of compliance with the requirements of the Bank of England and/or the Financial Services Authority, or the requirements of the European Central Bank. In addition to principal and interest payments, the Borrowers were responsible for paying monthly commitment fees equal to 0.25% of the unused revolving credit commitment. The Company had the option of making additional prepayments subject to certain limitations.  The Prior Credit Agreement included financial covenants  regarding minimum net worth, minimum EBITDA for the most recent four fiscal quarters of $11,000,000, and a maximum total  funded debt to EBITDA ratio of 3.0. As of June 30, 2014, the Company was in compliance with these financial covenants.  The Prior  Credit Agreement also included certain restrictive covenants that limit, among other things, certain investments, acquisitions and indebtedness. The Prior Credit Agreement provided that it shall automatically include any covenants or events of default not previously included in the Prior Credit Agreement to the extent such covenants or events of default were granted to any other lender of an amount in excess of $1,000,000. The Prior Credit Agreement also included customary events of default, including events of default under the BMO agreement or the Prudential Note Agreement. Following an event of default, Wells Fargo could accelerate all amounts outstanding under any revolving credit notes or the Prior Credit Agreement. The Prior Credit Agreement was scheduled to expire on May 31, 2015. However, by entering into the $60,000,000 Wells Fargo multi-currency revolving Credit Agreement noted above, the Company also terminated this $15,000,000 multi-currency revolving Credit Agreement. As of June 30, 2014, there were no borrowings under the Prior Credit Agreement. Fiscal Year The aggregate scheduled maturities of outstanding long-term debt obligations in subsequent years are as follows (in thousands): 2015 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2016 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2017 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2018 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2019 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Thereafter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 3,604 3,571 — 11,200 — 29 _________ $18,404 _________ _________ 53 54 Twin Disc, incORPORATED | AnnuAl RepoRt 2014 H. LEASE COMMITMENTS Fiscal Year Approximate future minimum rental commitments under noncancellable operating leases are as follows (in thousands): 2015 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2016 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2017 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2018 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2019 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Thereafter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2,719 1,751 1,583 1,153 149 21 __________ $ 7,376 __________ __________ Total rent expense for operating leases approximated $3,920,000, $3,863,000 and $3,657,000 in fiscal 2014, 2013 and 2012, respectively. I. SHAREHOLDERS’ EQUITY The total number of shares of common stock outstanding at June 30, 2014, 2013 and 2012 was 11,261,873, 11,212,952 and 11,304,487, respectively. At June 30, 2014, 2013 and 2012, treasury stock consisted of 1,837,595, 1,886,516 and 1,794,981 shares of common stock, respectively. The Company issued 51,921, 123,997 and 69,593 shares of treasury stock in fiscal 2014, 2013 and 2012, respectively, to fulfill its obligations under the stock option plans and restricted stock grants. The Company also recorded a forfeiture of 3,000 shares of previously issued restricted stock in the fourth quarter of fiscal 2014. The difference between the cost of treasury shares and the option price is recorded in common stock. On February 1, 2008, the Board of Directors authorized the purchase of 500,000 shares of common stock at market values. In fiscal 2009, the Company purchased 250,000 shares of its outstanding common stock at an average price of $7.25 per share for a total cost of $1,812,500. In fiscal 2012, the Company purchased 125,000 shares of its outstanding common stock at an average price of $19.40 per share for a total cost of $2,425,000. On July 27, 2012, the Board of Directors authorized the purchase of an additional 375,000 shares of common stock at market values. This authorization has no expiration. In fiscal 2013, the Company purchased 185,000 shares of its outstanding common stock at an average price of $16.59 per share for a total cost of $3,068,652. Cash dividends per share were $0.36, $0.36 and $0.34 in fiscal 2014, 2013 and 2012, respectively. Effective June 30, 2008, the Company’s Board of Directors established a Shareholder Rights Plan and distributed to shareholders one preferred stock purchase right (a “Right’) for each outstanding share of common stock. This Shareholder Rights Plan was amended on May 1, 2012. Under certain circumstances, a Right can be exercised to purchase one four-hundredth of a share of Series A Junior Preferred Stock at an exercise price of $125, subject to certain anti-dilution adjustments. The Rights will become exercisable on the earlier of: (i) ten business days following a public announcement that a person or group of affiliated or as- sociated persons (an “Acquiring Person”) has acquired, or obtained the right to acquire from shareholders, beneficial owner- ship of 20% or more of the outstanding Company’s common stock (or 30% or more in the case of any person or group which currently owns 20% or more of the shares or who shall become the beneficial owner of 20% or more of the shares as a result of any transfer by reason of the death of or by gift from any other person who is an affiliate or an associate of such existing holder or by succeeding such a person as trustee of a trust existing on the Record Date (“Existing Holder”)) or (ii) ten business days following the commencement of a tender offer or exchange offer that would result in a person or group beneficially owning 20% or more of such outstanding Common Stock (or 30% or more for an Existing Holder), as such periods may be extended pursu- ant to the Rights Agreement. In the event that any person or group becomes an Acquiring Person, each holder of a Right shall thereafter have the right to receive, upon exercise, in lieu of Preferred Stock, common stock of the Company having a value equal to two times the exercise price of the Right. However, Rights are not exercisable as described in this paragraph until such time as the Rights are no longer redeemable by the Company as set forth below. Notwithstanding any of the foregoing, if any person becomes an Acquiring Person all Rights that are, or (under certain circumstances specified in the Rights Agreement) were, ben- eficially owned by an Acquiring Person will become null and void. The Rights will expire at the close of business on June 30, 2018, unless earlier redeemed or exchanged by the Company. At any time before a person becomes an Acquiring Person, the Company may redeem the Rights in whole, but not in part, at a price of $.01 per Right, appropriately adjusted to reflect any stock split, stock dividend or similar transaction occurring after the date hereof. Immediately upon the action of the Board of Directors ordering redemption of the Rights, the Rights will terminate and the only right of the holders of Rights will be to receive the $.01 redemption price. The Company is authorized to issue 200,000 shares of preferred stock, none of which have been issued. The Company has desig- nated 150,000 shares of the preferred stock for the purpose of the Shareholder Rights Plan. The components of accumulated other comprehensive loss included in equity as of June 30, 2014 and 2013, are as follows (in 2013 thousands): 2014 Translation adjustments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Benefit plan adjustments, net of income taxes of $21,436 and $25,242, respectively . . . . . . . . . Accumulated other comprehensive loss. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ___________ $ 20,779 (36,722 ) ___________ $(15,943 ) ___________ ___________ ___________ $ 16,949 (42,848 ) ___________ $(25,899 ) ___________ ___________ A reconciliation for the changes in accumulated other comprehensive income (loss), net of tax, by component for the year ended June 30, 2014, is as follows: Translation Adjustment Benefit Plan Adjustment Balance at June 30, 2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other comprehensive loss before reclassifications . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Amounts reclassified from accumulated other comprehensive income (loss) . . . . . . . . . . . . . . . . Net current period other comprehensive income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Balance at June 30, 2014 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ______________ $ 16,949 3,830 — ___________ 3,830 ___________ $ 20,779 ___________ ___________ _______________ $ (42,848 ) 3,950 2,176 ___________ 6,126 ___________ $ (36,722 ) ___________ ___________ A reconciliation for the reclassifications out of accumulated other comprehensive income (loss), net of tax for the year ended June  30, 2014, is as follows: Amortization of benefit plan items Amount Reclassified Actuarial losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Transition asset and prior service benefit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total before tax benefit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Tax benefit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total reclassification, net of tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . J. BUSINESS SEGMENTS AND FOREIGN OPERATIONS ______________ $ (3,496 ) (31 ) ___________ (3,527 ) 1,351 ___________ $ (2,176 ) ___________ ___________ The Company and its subsidiaries are engaged in the manufacture and sale of marine and heavy duty off-highway power trans- mission equipment. Principal products include marine transmissions, surface drives, propellers and boat management systems, as well as power-shift transmissions, hydraulic torque converters, power take-offs, industrial clutches and controls systems. The Company sells to both domestic and foreign customers in a variety of market areas, principally pleasure craft, commercial and military marine markets, as well as in the energy and natural resources, government and industrial markets. Net sales by product group is summarized as follows (in thousands): 2014 ______ Industrial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Land-based transmissions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Marine and propulsion systems. . . . . . . . . . . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 41,188 67,055 149,432 6,234 ___________ $263,909 ___________ ___________ 2013 ______ $ 48,110 68,535 162,823 5,814 ___________ $285,282 ___________ ___________ 2012 ______ $ 54,062 146,686 151,407 3,715 ___________ $355,870 ___________ ___________ 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 fire fighting. The marine and propulsion systems include marine transmission, controls, surface drives, propellers and boat management systems for the global commercial, pleasure craft and patrol boat markets. Other products includes non-Twin Disc manufactured product sold through our Company-owned distribution entities. 55 56 Twin Disc, incORPORATED | AnnuAl RepoRt 2014 The Company has two reportable segments: manufacturing and distribution. These segments are managed separately because each provides different services and requires different technology and marketing strategies. The accounting practices of the segments are the same as those described in the summary of significant accounting policies. Transfers among segments are at established inter-company selling prices. Management evaluates the performance of its segments based on net earnings. Information about the Company’s segments is summarized as follows (in thousands): Manufacturing 2014 Net sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Intra-segment sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Inter-segment sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Depreciation and amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net earnings attributable to Twin Disc . . . . . . . . . . . . . . . . . . . . . Assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Expenditures for segment assets . . . . . . . . . . . . . . . . . . . . . . . . . . 2013 __________________ $227,590 18,416 53,960 311 2,565 6,233 8,566 7,029 254,652 6,429 Net sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Intra-segment sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Inter-segment sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Depreciation and amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net earnings attributable to Twin Disc . . . . . . . . . . . . . . . . . . . . . Assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Expenditures for segment assets . . . . . . . . . . . . . . . . . . . . . . . . . . 2012 Net sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Intra-segment sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Inter-segment sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Depreciation and amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net earnings attributable to Twin Disc . . . . . . . . . . . . . . . . . . . . Assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Expenditures for segment assets . . . . . . . . . . . . . . . . . . . . . . . . . . $245,592 16,140 55,746 479 3,248 5,112 8,817 10,141 258,617 5,705 $325,174 16,189 71,134 688 3,798 19,444 8,373 29,572 272,098 11,821 Distribution Total _______________ $121,389 9,926 2,768 22 45 1,432 549 6,285 57,233 315 $130,360 15,127 3,657 19 62 1,630 497 5,840 56,965 349 $129,411 7,672 3,720 39 64 2,460 871 7,196 58,275 1,158 ___________ $348,979 28,342 56,728 333 2,610 7,665 9,115 13,314 311,885 6,744 $375,952 31,267 59,403 498 3,310 6,742 9,314 15,981 315,582 6,054 $454,585 23,861 74,854 727 3,862 21,904 9,244 36,768 330,373 12,979 The following is a reconciliation of reportable segment net sales, net earnings and assets to the Company’s consolidated totals (in thousands): 2014 2013 2012 ___________ ___________ ___________ Net sales Total net sales from reportable segments . . . . . . . . . . . . . . . . . . . . . . . . . . . . Elimination of intercompany sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total consolidated net sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net earnings attributable to Twin Disc Total net earnings from reportable segments . . . . . . . . . . . . . . . . . . . . . . . . Other corporate expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total consolidated net earnings attributable to Twin Disc . . . . . . . . . . Assets Total assets for reportable segments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Corporate assets and eliminations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total consolidated assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $348,979 (85,070 ) ___________ $263,909 ___________ ___________ $ 13,314 (9,670 ) ___________ $ 3,644 ___________ ___________ $311,885 (44,900 ) ___________ $266,985 ___________ ___________ $375,952 (90,670 ) ___________ $285,282 ___________ ___________ $ 15,981 (12,099 ) ___________ $ 3,882 ___________ ___________ $315,582 (30,124 ) ___________ $285,458 ___________ ___________ $454,585 (98,715 ) ___________ $355,870 ___________ ___________ $ 36,768 (10,025 ) ___________ $ 26,743 ___________ ___________ 2014 Other significant items (in thousands): Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Depreciation and amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Expenditures for segment assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2013 Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Depreciation and amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Expenditures for segment assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2012 Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Depreciation and amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Expenditures for segment assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Segment Totals Adjustments Consolidated Totals ___________ $ 333 2,610 7,665 9,115 6,744 _______________ $ (212 ) (1,674 ) (3,439 ) 1,542 501 ____________ $ 121 936 4,226 10,657 7,245 $ 498 3,310 6,742 9,314 6,054 $ 727 3,862 21,904 9,244 12,979 $ (396 ) (1,875 ) (1,756 ) 1,524 528 $ (632 ) (2,387 ) (4,089 ) 1,512 754 $ 102 1,435 4,986 10,838 6,582 $ 95 1,475 17,815 10,756 13,733 All adjustments represent inter-company eliminations and corporate amounts. Geographic information about the Company is summarized as follows (in thousands): 2014 2013 2012 Net sales United States . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . China . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Italy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Canada . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net sales by geographic region are based on product shipment destination. Long-lived assets United States . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Switzerland . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Belgium . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Italy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ___________ ___________ ___________ $165,658 19,955 27,075 44,889 98,293 ___________ $355,870 ___________ ___________ $108,380 33,830 17,396 9,277 95,026 ___________ $263,909 ___________ ___________ 2014 _________ $46,821 8,196 7,450 3,531 2,074 _________ $68,072 _________ _________ $127,844 29,119 19,140 10,846 98,333 ___________ $285,282 ___________ ___________ 2013 _________ $51,618 7,964 7,262 3,817 2,330 _________ $72,991 _________ _________ One customer, Sewart Supply, Inc. (a distributor of Twin Disc), accounted for approximately 11% and 11% of consolidated net sales in fiscal 2014 and 2013, respectively. There were no customers that accounted for 10% or more of consolidated net sales in fiscal 2012. 57 58 Twin Disc, incORPORATED | AnnuAl RepoRt 2014 K. STOCK-BASED COMPENSATION During fiscal 2011, the Company adopted the Twin Disc, Incorporated 2010 Stock Incentive Plan for Non-Employee Directors (the “Directors’ Plan”), a plan to grant non-employee directors equity based awards up to 250,000 shares of common stock, and the Twin Disc, Incorporated 2010 Long-Term Incentive Compensation Plan (the “Incentive Plan”), a plan under which of- ficers and key employees may be granted equity based awards up to 650,000 shares of common stock. The Directors’ Plan may grant options to purchase shares of common stock, at the discretion of the board, to non-employee directors who are elected or reelected to the board, or who continue to serve on the board. Such options carry an exercise price equal to the fair market value of the Company’s common stock as of the date of grant, vest immediately, and expire ten years after the date of grant. Op- tions granted under the Incentive Plan are determined to be non-qualified or incentive stock options as of the date of grant, and may carry a vesting schedule. For options under the Incentive Plan that are intended to qualify as incentive stock options, if the optionee owns more than 10% of the total combined voting power of the Company’s stock, the price will not be less than 110% of the grant date fair market value and the options expire five years after the date of grant. There were no incentive options granted to a greater than 10% shareholder during the years presented. There were no options outstanding under the Directors’ Plan and the Incentive Plan as of June 30, 2014 and 2013. The Company has 21,600 non-qualified stock options outstanding as of June 30, 2014, under the Twin Disc, Incorporated Plan for Non-Employee Directors and Twin Disc, Incorporated 2004 Stock Incentive Plans. The 2004 plans were terminated during 2011, except options then outstanding will remain so until exercised or until they expire. 2014 2013 Shares available for future options as of June 30 were as follows: 2010 Long-term Stock Incentive Compensation Plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2010 Stock Incentive Plan for Non-employee Directors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . __________ 500,121 193,858 __________ 539,566 204,988 Weighted Stock option transactions under the plans during 2014 were as follows: Average Price 2014 Weighted Average Remaining Contractual Life (Years) Aggregate Intrinsic Value _________ ___________ ___ ___________________________ ____________ Non-qualified stock options: Options outstanding at beginning of year . . . 21,600 —     Granted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — Canceled/Expired . . . . . . . . . . . . . . . . . . . . . . . . . . — Exercised . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . _________ 21,600 _________ _________ Options outstanding at June 30. . . . . . . . . . . . . . $14.88 — — — ________ $14.88 ________ ________ Options price range ($5.73 – $7.19) 2,400 Number of shares . . . . . . . . . . . . . . . . . . . . . . . . Weighted average price . . . . . . . . . . . . . . . . . . $ 6.23 Weighted average remaining life . . . . . . . . . 1.00 years Options price range ($10.01 – $27.55) Number of shares . . . . . . . . . . . . . . . . . . . . . . . . 19,200 Weighted average price . . . . . . . . . . . . . . . . . . $ 15.96 Weighted average remaining life . . . . . . . . . 4.31 years _____ 3.94 _____ _____ ___________ $392,298 ___________ ___________ The Company accounts for stock based compensation in accordance with ASC Topic 718-10, “Compensation – Stock Compen- sation.” In addition, the Company computes its windfall tax pool using the shortcut method. ASC Topic 718-10 requires the Company to expense the cost of employee services received in exchange for an award of equity instruments using the fair-value- based method. All options were 100% vested at the adoption of this statement. During fiscal 2014, 2013 and 2012 the Company granted no non-qualified stock options. As a result, no compensation cost has been recognized in the Consolidated Statements of Operations and Comprehensive Income for fiscal 2014, 2013 and 2012, respectively. The total intrinsic value of options exercised during the years ended June 30, 2014, 2013 and 2012, was approximately $0, $539,000 and $1,002,000, respectively. In fiscal 2014, 2013 and 2012, the Company granted a target number of 43,154, 28,255 and 15,449 performance stock unit awards, respectively, to various employees of the Company, including executive officers. The performance stock unit awards granted in fiscal 2014 will vest if the Company achieves a specified target objective relating to consolidated economic profit (as defined in the Performance Stock Unit Award Grant Agreement) in the cumulative three fiscal year period ending June 30,  2016. The performance stock unit awards granted in fiscal 2014 are subject to adjustment if the Company’s economic profit for the period falls below or exceeds the specified target objective, and the maximum number of performance stock units that can be awarded if the target objective is exceeded is 25,943. Based upon actual results to date and the low probability of achieving the threshold performance levels, the Company is not accruing the performance stock unit awards granted in fiscal 2014. The performance stock unit awards granted in fiscal 2013 will vest if the Company achieves a specified target objective relating to consolidated economic profit (as defined in the Performance Stock Unit Award Grant Agreement) in the cumulative three fiscal  year period ending June 30, 2015. The performance stock unit awards granted in fiscal 2013 are subject to adjustment if the Company’s economic profit for the period falls below or exceeds the specified target objective, and the maximum number of performance stock units that can be awarded if the target objective is exceeded is 23,449. Based upon actual results to date and the low probability of achieving the threshold performance levels, the Company is not accruing the performance stock unit awards granted in fiscal 2013 and has reversed previously recognized expenses related to these awards during the second quarter of fiscal 2013. The performance stock unit awards granted in fiscal 2012 are subject to adjustment if the Company’s economic profit for the period falls below or exceeds the specified target objective, and the maximum number of performance stock units that can be awarded if the target objective is exceeded is 16,457. Based upon actual results to date and the low probability of achieving the threshold performance levels, the Company is not accruing the performance stock unit awards granted in fiscal 2012 and has reversed previously recognized expenses related to these awards during the second quarter of fiscal 2013. There were 41,160, 42,962 and 133,479 unvested performance stock unit awards outstanding at June 30, 2014, 2013 and 2012, respectively. The weighted average grant date fair value of the unvested awards at June 30, 2014 was $23.18. The performance stock unit awards are remeasured at fair-value based upon the Company’s stock price at the end of each reporting period. The fair-value of the stock unit awards are expensed over the performance period for the shares that are expected to ultimately vest. The compensation expense (income) for the year ended June 30, 2014, 2013 and 2012 related to the performance stock unit award grants, approximated $0, $1,238,000 and $(631,000), respectively. At June 30, 2014, the Company had $1,331,000 of unrecognized compensation expense related to the unvested shares that would vest if the specified target objective was achieved for the fiscal 2014 and 2013 awards. The total fair value of performance stock unit awards vested in fiscal 2014, 2013 and 2012 was $0, $2,787,000 and $2,068,000, respectively. The performance stock unit awards are cash based, and are thus recorded as a liability on the Company’s Consolidated Balance Sheets. As of June 30, 2014, there were no awards included in “Liabilities” due to actual results to date and the low probability of achieving any of the threshold performance levels. As of June 30, 2013, these awards are included in “Accrued liabilities” ($2,787,000) due to the awards having a performance period ending in less than one year. In fiscal 2014, 2013 and 2012, the Company granted a target number of 17,312, 28,535 and 15,335 performance stock awards, respectively, to various employees of the Company, including executive officers. The performance stock awards granted in fiscal 2014 will vest if the Company achieves a specified target objective relating to consolidated economic profit (as defined in the Performance Stock Award Grant Agreement) in the cumulative three fiscal year period ending June 30, 2016.  The   performance stock awards granted in fiscal 2014 are subject to adjustment if the Company’s economic profit for the period falls below or exceeds the specified target objective, and the maximum number of performance shares that can be awarded if the target objective is exceeded is 20,774. Based upon actual results to date and the low probability of achieving the threshold performance levels, the Company is not accruing the performance stock awards granted in fiscal 2014. The performance stock awards granted in fiscal 2013 will vest if the Company achieves a specified target objective relating to consolidated economic profit (as defined in the Performance Stock Award Grant Agreement) in the cumulative three fiscal year period ending June 30, 2015. The performance stock awards granted in fiscal 2013 are subject to adjustment if the Company’s economic profit for the period falls below or exceeds the specified target objective, and the maximum number of performance shares that can be awarded if the target objective is exceeded is 32,880. Based upon actual results to date and the low probability of achieving the threshold performance levels, the Company is not accruing the performance stock awards granted in fiscal 2013 and has reversed previously recognized expenses related to these awards during the second quarter of fiscal 2013. The performance stock awards granted in fiscal 2012 are subject to adjustment if the Company’s economic profit for the period falls below or exceeds the specified target objective, and the maximum number of performance shares that can be awarded if the target objective is exceeded is 17,689. Based upon actual results to date and the low probability of achieving the threshold performance levels, the Company is not accruing the performance stock awards granted in fiscal 2012 and has reversed previously recognized expenses related to these awards during the second quarter of fiscal 2013. There were 44,712, 42,141 and 102,391 unvested performance stock awards outstanding at June 30, 2014, 2013 and 2012, respectively. The fair value of the stock awards (on the date of grant) is expensed over the performance period for the shares that are expected to ultimately vest. The compensation expense for the year ended June 30, 2014, 2013 and 2012, related to performance stock awards, approximated $0, $209,000 and $838,000, respectively. The weighted average grant date fair value of the unvested awards at June 30, 2014 was $22.51. At June 30, 2014, the Company had $1,007,000 of unrecognized compensation expense related to the unvested shares that would vest if the specified target objective was achieved for the fiscal 2014 and 2013 awards. The total fair value of performance stock awards vested in fiscal 2014, 2013 and 2012 was $0, $2,055,000 and $1,671,000, respectively. 59 60 Twin Disc, incORPORATED | AnnuAl RepoRt 2014 In addition to the performance shares mentioned above, the Company has unvested restricted stock outstanding that will vest if certain service conditions are fulfilled. The fair value of the restricted stock grants is recorded as compensation over the vesting period, which is generally 1 to 3 years. During fiscal 2014, 2013 and 2012, the Company granted 51,004, 83,729 and 43,620 service based restricted shares, respectively, to employees and non-employee directors in each year. A total of 3,000 and 30,532 shares of restricted stock were forfeited during fiscal 2014 and 2013, respectively. There were 116,297, 186,469 and 250,323 unvested shares outstanding at June 30, 2014, 2013 and 2012, respectively. Compensation expense of $1,184,000, $1,234,000 and $1,435,000 was recognized during the year ended June 30, 2014, 2013 and 2012, respectively, related to these service- based awards. The total fair value of restricted stock grants vested in fiscal 2014, 2013 and 2012 was $3,053,000, $2,177,000 and $977,000, respectively. As of June 30, 2014, the Company had $1,145,000 of unrecognized compensation expense related to restricted stock which will be recognized over the next three years. 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 $3,028,000, $3,058,000 and $2,657,000 in fiscal 2014, 2013 and 2012, respectively. Total engineering and development costs were $10,900,000, $10,242,000 and $10,316,000 in fiscal 2014, 2013 and 2012, 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 ben- efits earned after January 1, 1997. The Company’s funding policy for the plans covering domestic employees is to contribute an actuarially determined amount which falls between the minimum and maximum amount that can be deducted for federal income tax purposes. On June 3, 2009, the Company announced it would freeze future accruals under the domestic defined benefit pension plans effec- tive August 1, 2009. 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 either on final average compensation or 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 health care and life insurance benefits for certain domestic retirees. All employees retiring after December 31, 1992, and electing to continue health care 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 2014 and 2013 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 income as of June 30 (in thousands): Other Postretirement Benefits Pension Benefits Change in benefit obligation: Benefit obligation, beginning of year . . . . . . . . . . . . . . . . Service cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Actuarial loss (gain) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Contributions by plan participants . . . . . . . . . . . . . . . . . . Settlements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Benefits paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Benefit obligation, end of year . . . . . . . . . . . . . . . . . . . . . . 2014 2013 2014 2013 ___________ ___________ ___________ ___________ $125,846 536 5,425 1,221 174 (121 ) (9,249 ) ___________ $123,832 ___________ ___________ $133,261 367 5,399 (4,123 ) 162 — (9,220 ) ___________ $125,846 ___________ ___________ $ 17,739 37 659 (60 ) 581 — (2,372 ) ___________ $ 16,584 ___________ ___________ $ 19,645 34 766 (938 ) 677 — (2,445 ) ___________ $ 17,739 ___________ ___________ Change in plan assets: Fair value of assets, beginning of year . . . . . . . . . . . . . . . Actual return on plan assets . . . . . . . . . . . . . . . . . . . . . . . . Employer contribution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Contributions by plan participants . . . . . . . . . . . . . . . . . . Benefits paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Fair value of assets, end of year . . . . . . . . . . . . . . . . . . . . . $ 94,723 14,031 2,816 174 (9,249 ) ___________ $102,495 ___________ ___________ $ 88,775 10,500 4,506 162 (9,220 ) ___________ $ 94,723 ___________ ___________ $ — — 1,791 581 (2,372 ) ___________ $ — ___________ ___________ $ — — 1,768 677 (2,445 ) ___________ $ — ___________ ___________ Funded status . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $(21,337 ) ___________ ___________ $ (31,123 ) ___________ ___________ $ (16,584 ) __________ __________ $ (17,739 ) ___________ ___________ Amounts recognized in the balance sheet consist of: Other assets – noncurrent . . . . . . . . . . . . . . . . . . . . . . . . . . Accrued liabilities – current . . . . . . . . . . . . . . . . . . . . . . . . Accrued retirement benefits – noncurrent . . . . . . . . . . Net amount recognized . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Amounts recognized in accumulated other comprehensive loss consist of (net of tax): Net transition obligation . . . . . . . . . . . . . . . . . . . . . . . . . . . Actuarial net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net amount recognized . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 680 (1,189 ) (20,828 ) ___________ $ (21,337 ) ___________ ___________ $ 566 (389 ) (31,300 ) ___________ $ (31,123 ) ___________ ___________ $ — (2,418 ) (14,166 ) ___________ $ (16,584 ) ___________ ___________ $ — (2,470 ) (15,269 ) ___________ $ (17,739 ) ___________ ___________ $ 340 33,220 ___________ $ 33,560 ___________ ___________ $ 345 38,933 ___________ $ 39,278 ___________ ___________ $ — 3,163 ___________ $ 3,163 ___________ ___________ $ — 3,570 ___________ $ 3,570 ___________ ___________ 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 domestic defined benefit and other postretirement benefit plans are as follows (in thousands): Other Postretirement Benefits Pension Benefits Net transition obligation . . . . . . . . . . . . . . . . . . . . . . . . . . . Actuarial net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net amount to be recognized . . . . . . . . . . . . . . . . . . . . . . . . . . ___________________ $ 38 2,437 ________ $2,475 ________ ________ __________________________________ $ — 638 ______ $638 ______ ______ The accumulated benefit obligation for all defined benefit pension plans was approximately $123,832,000 and $125,846,000 at June 30, 2014 and 2013, respectively. Information for pension plans with an accumulated benefit obligation in excess of plan assets (in thousands): June 30, 2014 Projected and accumulated benefit obligation . . . . . . . . . . . . . . . . . . . . . . . . Fair value of plan assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Components of Net Periodic Benefit Cost ________________ $122,045 100,028 June 30, 2013 ________________ $123,933 92,244 (in thousands) Service cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Expected return on plan assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Settlement loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Amortization of transition obligation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Amortization of actuarial net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net periodic benefit cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2014 ________ $ 536 5,425 (6,591 ) — 32 2,894 ________ $2,296 ________ ________ Pension Benefits 2013 ________ $ 367 5,399 (6,382 ) 5 35 3,357 ________ $2,781 ________ ________ 2012 ________ $ 292 6,231 (7,766 ) 11 34 2,319 ________ $1,121 ________ ________ 61 62 Twin Disc, incORPORATED | AnnuAl RepoRt 2014 Service cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Amortization of prior service cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Amortization of actuarial net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net periodic benefit cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other Postretirement Benefits 2014 2013 2012 ________ $ 37 659 — 602 ________ $1,298 ________ ________ ________ $ 34 766 — 792 ________ $1,592 ________ ________ ________ $ 41 985 (508 ) 929 ________ $1,447 ________ ________ Other Changes in Plan Assets and Benefit Obligations Recognized in Other Comprehensive Income for Fiscal 2014 (Pre-tax, in thousands): Other Postretirement Benefits Pension Net gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Amortization of prior service benefit . . . . . . . . . . . . . . . . . . . . . . Amortization of transition asset . . . . . . . . . . . . . . . . . . . . . . . . . . . Amortization of net (loss) gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total recognized in other comprehensive income . . . . . . . . . . Net periodic benefit cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total recognized in net periodic benefit cost and other comprehensive income . . . . . . . . . . . . . . . . . . . . . . . . . Additional Information Assumptions (as of June 30, 2014 and 2013) Weighted average assumptions used to determine benefit obligations at June 30: Discount rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Expected return on plan assets . . . . . . . . . . . . . . . . . . . . . . . . . . 2014 ___________________ $ (6,303 ) 7 (38 ) (2,894 ) ___________ (9,228 ) 2,296 ___________ $ (6,932 ) ___________ ___________ __________________________________ $ (59 ) — — (602 ) _______ (661) 1,298 _______ $ 637 _______ _______ Pension Benefits 2014 2013 Other Postretirement Benefits 2014 2013 _______ _______ _______ _______ 4.06% 7.39% Pension Benefits 2013 4.35% 7.41% 3.76% — Other Postretirement Benefits 3.99% — 2012 2014 2013 2012 Weighted average assumptions used to determine net periodic benefit cost for years ended June 30: Discount rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Expected return on plan assets . . . . . . . . . . . . . . . . 4.35% 7.41% 4.20% 7.50% 5.16% 8.50% 3.99% 4.20% 5.16% _______ _______ _______ _______ _______ _______ The assumed weighted-average health-care cost trend rate was 8.0% in 2014, grading down to 5% in 2023. A 1% increase in the assumed health-care cost trend would increase the accumulated postretirement benefit obligation by approximately $351,000 and the service and interest cost by approximately $13,000. A 1% decrease in the assumed health-care cost trend would decrease the accumulated postretirement benefit obligation by approximately $316,000 and the service and interest cost by ap- Plan Assets proximately $12,000. The Company’s Pension Committee (“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 invest- ment 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 ad- dress other cash requirements of the pension plans. The Committee has established an Investment Policy Statement which pro- vides 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. 63 The Company’s pension plan weighted-average asset allocations at June 30, 2014 and 2013 by asset category are as follows: 2013 2014 Target Allocation June 30 Asset Category Equity securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Debt securities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Real estate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . _____________ 65% 25% 10% __________ 100% __________ __________ ________ 65% 23% 12% ________ 100% ________ ________ ________ 64% 26% 10% ________ 100% ________ ________ Due to market conditions and other factors, actual asset allocation may vary from the target allocation outlined above. The domestic pension plans held 98,211 shares of Company stock with a fair market value of $3,245,874 (3.2 percent of total plan assets) at June 30, 2014, and 98,211 shares with a fair market value of $2,327,601 (2.5 percent of total plan assets) at June 30, 2013. The plans have a long-term return assumption of 7.50%. This rate was derived based upon historical experience and forward- looking return expectations for major asset class categories. 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 transac- tion between market participants at the measurement date. The inputs used to measure fair value are classified into the follow- ing 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 tables present plan assets using the fair value hierarchy as of June 30, 2014 and 2013 (in thousands): Total Level I Level II Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Equity securities: U.S. (a). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . International (b) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Fixed income (c) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Annuity contracts (d). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Real estate (e). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other (f) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ___________ $ 965 _________ $ 965 _________ $  — 30,727 16,676 21,892 6,340   11,206         14,689 ___________ $102,495 ___________ ___________ 30,727 10,785 7,603 —  —      — _________ $50,080 _________ _________  — 5,891 14,289 — 11,206      — _________ $31,386 _________ _________ The following table presents plan assets using the fair value hierarchy as of June 30, 2013 (in thousands): Total Level I Level II Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Equity securities: U.S. (a). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . International (b) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Fixed income (c) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Annuity contracts (d). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Real estate (e). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other (f ). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ___________ $ 2,376 _________ $ 2,376 _________ $  — 28,334 15,409 20,935 5,819   8,697         13,153 _________ $ 94,723 ___________ ___________ 28,334 9,315 7,240 —  —      — _________ $47,265 _________ _________  — 6,094 13,695 — 5,685      — _________ $25,474 _________ _________ Level III _________ $ — — — — 6,340 — 14,689 _________ $21,029 _________ _________ Level III _________ $ — — — — 5,819 3,012 13,153 _________ $21,984 _________ _________ (a) U.S. equity securities include companies that are well diversified by industry sector and equity style (i.e., growth and value strategies). Investments are primarily in large capitalization stocks and, to a lesser extent, mid- and small-cap stocks. These securities are valued at the closing price reported on the active market on which the individual securities are traded. (b) International equities are invested in companies that are traded on exchanges outside the U.S. and are well diversified by industry sector, country, capitalization and equity style (i.e., growth and value strategies). Certain assets are invested in international commingled equity funds. The vast majority of the investments are made in companies in developed markets with a smaller percentage in emerging markets. Securities traded on exchanges are valued at the closing price reported on the active market on which the individual securities are traded. International commingled funds are valued at the net asset value (“NAV”) as determined by the custodian of the fund. The NAV is based on the fair value of the underlying assets owned by the fund, minus its liabilities, divided by the number of units outstanding. 64 Twin Disc, incORPORATED | AnnuAl RepoRt 2014       (c) Fixed income consists of corporate bonds with investment grade BBB or better from diversified industries, as well as govern- ment debt securities. Corporate and government debt investments are valued utilizing a market approach that includes various valuation techniques and sources such as value generation models, broker quotes in active and inactive markets, benchmark yields and securities, reported trades, issuer spreads, and/or other applicable reference data. (d) 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 the net present value of future cash flows. (e) Real estate investments invested in common collective trusts and other mutual funds holding real estate investments. They are valued at the net asset value (“NAV”) as determined by the custodian of the fund. The NAV is based on the fair value of the underlying assets owned by the fund, minus its liabilities, divided by the number of units outstanding. Level 2 investments represent funds where regular opportunities exist for the Company to sell the holdings, whereas Level 3 investments repre- sent funds where less frequent opportunities exist during the year for the Company to sell its holding in the funds. (f) Other consists of hedged equity mutual funds. These investments are valued at the net asset value (“NAV”) as determined by the custodian of the fund. The NAV is based on the fair value of the underlying assets owned by the fund, minus its liabilities, divided by the number of units outstanding. The following tables present a reconciliation of the fair value measurements using significant unobservable inputs (Level III) as of June 30, 2014 and 2013 (in thousands): Annuity Contracts Real Estate Other Balance – June 30, 2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Actual return on plan assets: Relating to assets still held at reporting date. . . . . . . . . . . . . Relating to assets sold during the period . . . . . . . . . . . . . . . . Purchases, sales and settlements, net . . . . . . . . . . . . . . . . . . . . . . Transfers in and/or out of Level III . . . . . . . . . . . . . . . . . . . . . . . . Balance – June 30, 2014 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Balance – June 30, 2012 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Actual return on plan assets: Relating to assets still held at reporting date. . . . . . . . . . . . . Relating to assets sold during the period . . . . . . . . . . . . . . . . Purchases, sales and settlements, net . . . . . . . . . . . . . . . . . . . . . . Transfers in and/or out of Level III . . . . . . . . . . . . . . . . . . . . . . . . Balance – June 30, 2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cash Flows Contributions _____________________ $5,819 _____________ $3,012 433  — —     88 — ________ $6,340 ________ ________ Annuity Contracts _____________________ $5,333 298 —     188 — ________ $5,819 ________ ________ 257     (3,269 )  — ________ $       —     ________ ________ Real Estate _____________ $5,324 391 —    (2,518 )  (185 ) ________ $3,012 ________ ________ _________ $13,153 1,536 — —  — _________ $14,689 _________ _________ Other _________ $11,988 1,165 — —  — _________ $13,153 _________ _________ Estimated Future Benefit Payments The Company expects to contribute $7,218,000 to its defined benefit pension plans in fiscal 2015. The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid (in thousands): Part D Net Benefit Payments Gross Benefits Pension Benefits Reimbursement Other Postretirement Benefits 2015 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2016 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2017 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2018 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2019 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Years 2020–2024 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . __________ $10,926 10,167 9,902 11,206 9,772 42,184 __________ $2,418 2,109 1,774 1,621 1,453 5,486 ___________________ $ — — — — — — _____________ $2,418 2,109 1,774 1,621 1,453 5,486 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 $2,218,000, $2,074,000 and $2,411,000 in fiscal 2014, 2013 and 2012, respectively. N. INCOME TAXES 2013 United States and foreign earnings before income taxes and minority interest were as follows (in thousands): 2014 2012 United States . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . _________ $ 1,107 6,989 _________ $ 8,096 _________ _________ _________ $ 3,935 5,302 _________ $ 9,237 _________ _________ _________ $43,335 1,421 _________ $44,756 _________ _________ The provision (benefit) for income taxes is comprised of the following (in thousands) 2014 2013 2012 _________ _________ _________ Currently payable: Federal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . State . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deferred: Federal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . State . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 651 104 2,837 _________ 3,592 _________ 1,309 (95 ) (580 ) _________ 634 _________ $ 4,226 _________ _________ $ 1,745 (234 ) 2,788 _________ 4,299 _________ 1,122 439 (874 ) _________ 687 _________ $ 4,986 _________ _________ The components of the net deferred tax asset as of June 30 are summarized in the table below (in thousands). 2014 Deferred tax assets: Retirement plans and employee benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign tax credit carryforwards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Federal tax credits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . State net operating loss and other state credit carryforwards . . . . . . . . . . . . . . . . . . . . . . . . . . . . Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Reserves . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign NOL carryforwards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accruals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deferred tax liabilities: Property, plant and equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Intangibles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Valuation allowance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total net deferred tax assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . _________ $13,692 706 160 348 1,672 2,578 6,090 681 (54 ) _________ 25,873 _________ 8,650 5,528 711 _________ 14,889 _________ (5,593 ) _________ $ 5,391 _________ _________ $ 7,310 188 2,831 _________ 10,329 _________ $ 7,653 662 (829 ) _________ 7,486 _________ $17,815 _________ _________ 2013 __________ $20,675 — — 91 1,421 2,388 4,311 822 98 __________ 29,806 __________ 10,295 5,595 439 __________ 16,329 __________ (3,724 ) __________ $ 9,753 __________ __________ Note: $166,000 and $216,000 of this net deferred tax position is included in Accrued Liabilities at June 30, 2014 and 2013, respectively. 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, carryback and carryforward periods, and tax strategies that could potentially enhance the likelihood of realization of a deferred tax asset. During fiscal 2014, the Company continued to incur operating losses in certain foreign jurisdictions where the loss carryforward period is unlimited. The Company has evaluated the realizability of the net deferred tax assets related to these jurisdictions and concluded that based primarily upon continuing losses in these jurisdictions and failure to achieve targeted levels of improvement, a full valuation allowance continues to be necessary. Therefore, the Company recorded an additional valuation allowance of $1,869,000. Management believes that it is more likely than not that the results of 65 66 Twin Disc, incORPORATED | AnnuAl RepoRt 2014 future operations will generate sufficient taxable income and foreign source income to realize the remaining deferred tax assets. Following is a reconciliation of the applicable U.S. federal income taxes to the actual income taxes reflected in the statements of operations (in thousands): 2014 2013 2012 U.S. federal income tax at 35% . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Increases (reductions) in tax resulting from: Foreign tax items . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . State taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Valuation allowance. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Research and development tax credits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Change in prior year estimate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Section 199 deduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .         Goodwill impairment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Unrecognized tax benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ________ $2,754 (291 ) 228 1,551 (267 ) 139 (109 ) — 183 38 ________ $4,226 ________ ________ _________ $3,104 88 296 1,216 (526 ) 309 (84 ) — 539 44 _________ $4,986 _________ _________ __________ $15,595 169 797 1,060 (215 ) 96 (908 ) 1,292 (217 ) 146 __________ $17,815 __________ __________ The Company has not provided additional U.S. income taxes on cumulative earnings of consolidated foreign subsidiaries that are considered to be reinvested indefinitely. The Company reaffirms its position that these earnings remain permanently invested, and has no plans to repatriate funds to the U.S. for the foreseeable future. These earnings relate to ongoing operations and were approximately $2,700 000 at June 30, 2014. Such earnings could become taxable upon the sale or liquidation of these foreign subsidiaries or upon dividend repatriation. It is not practicable to estimate the amount of unrecognized withholding taxes and deferred tax liability on such earnings. 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, we file income tax returns in various taxing jurisdictions inside and outside the United States. In general, the tax years that remain subject to examination are 2010 through 2014 for our major operations in Italy, Belgium and Japan. The tax years open to examination in the U.S. are for years subsequent to fiscal 2012. The Company has approximately $1,603,000 of unrecognized tax benefits as of June 30, 2014, which, if recognized would impact the effective tax rate. During the fiscal year the amount of unrecognized tax benefits increased primarily due to the tax positions taken during the fiscal year partially offset by settlements with various taxing authorities. During the next twelve months, the Company believes it is reasonably possible that the amount of unrecognized tax benefits could be reduced by up to $800,000 as a result of the resolution of worldwide tax matters and the lapses of statutes of limitations. 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 (in thousands): June 30, 2014 Unrecognized tax benefits, beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Additions based on tax positions related to the prior year . . . . . . . . . . . . . . . . . . . . . . . . . . Additions based on tax positions related to the current year . . . . . . . . . . . . . . . . . . . . . . . Subtractions due to statutes closing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Settlements with taxing authorities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Unrecognized tax benefits, end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ________________ $1,556 7 173 (1 ) (132 ) ________ $1,603 ________ ________ June 30, 2013 ________________ $1,163 351 361 (40 ) (279 ) ________ $1,556 ________ ________ Substantially all of the Company’s unrecognized tax benefits as of June 30, 2014, if recognized, would affect the effective tax rate. As of June 30, 2014 and 2013, the amounts accrued for interest and penalties totaled $309,000 and $296,000, 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 deter- minable. Management believes that final disposition of such litigation will not have a material impact on the Company’s results of operations or financial position. P. RESTRUCTURING OF OPERATIONS During fiscal 2014, the Company recorded a pre-tax restructuring charge of $961,000 representing the incremental cost above the minimum legal indemnity for a targeted workforce reduction at its Belgian operation, following finalization of negotiations with the local labor unions. The minimum legal indemnity of $548,000 was recorded in the fourth quarter of fiscal 2013, upon announcement of the intended restructuring action. During fiscal 2014, the Company made cash payments of $857,000, resulting in an accrual balance at June 30, 2014 of $785,000. TWIN DISC, INCORPORATED AND SUBSIDIARIES SCHEDULE II – vALUATION AND QUALIFYING ACCOUNTS for the years ended June 30, 2014, 2013 and 2012 (in thousands) Balance at Beginning of Period —— Additions —— Charged to Costs and Expenses Net Acquired Deductions1 Balance at End of of Period Description 2014: Allowance for losses on accounts receivable Deferred tax valuation allowance 2013: $2,884 $3,724 $ 1,169 $ 2,140 Allowance for losses on accounts receivable Deferred tax valuation allowance 2012: $2,194 $3,811 $ 1,385 $ 1,112 Allowance for losses on accounts receivable Deferred tax valuation allowance $2,093 $2,751 $ 549 $ 1,060 $ — $ — $ — $ — $ — $ — $ 416 $ 271 $ 3,637 $ 5,593 $ 695 2 $ 1,199 $ 2,884 $ 3,724 $ 448 $ — $ 2,194 $ 3,811 1 Amounts primarily represent accounts receivable written-off during the year along with other adjustments (primarily foreign currency translation adjustments). 2 Represents adjustments resulting from foreign tax audits. 67 68 Twin Disc, incORPORATED | AnnuAl RepoRt 2014 SIGNATURES EXHIBIT INDEX TWIN DISC, INCORPORATED Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. Exhibit No. 10-K for Year Ended June 30, 2014 Description Included Herewith TWIN DISC, INCORPORATED JOHN H. BATTEN September 15, 2014 By /s/ John H. Batten President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. September 15, 2014 By /s/ MICHAEL E. BATTEN Michael E. Batten Chairman of the Board JOHN H. BATTEN September 15, 2014 By /s/ John H. Batten President and Chief Executive Officer CHRISTOPHER J. EPERJESY September 15, 2014 By /s/ Christopher J. Eperjesy, Vice President – Finance, Chief Financial Officer and Treasurer JEFFREY S. KNUTSON September 15, 2014 By /s/ Jeffrey S. Knutson Corporate Controller and Secretary (Chief Accounting Officer) September 15, 2014 Michael Doar, Director Malcolm F. Moore, Director David B. Rayburn, Director Michael C. Smiley, Director Harold M. Stratton II, Director David R. Zimmer, Director JEFFREY S. KNUTSON By /s/ Jeffrey S. Knutson Corporate Controller and Secretary (Attorney In Fact) 3a) 3b) 4a) 4b) Restated Articles of Incorporation of Twin Disc, Incorporated (Incorporated by reference to Exhibit 3.1 of the Company’s Form 8-K dated December 6, 2007). File No. 001-07635. Restated Bylaws of Twin Disc, Incorporated, as amended through January 19, 2010 (Incorporated by reference to Exhibit 3.1 of the Company’s Form 8-K dated December 17, 2013). File No. 001-07635. Description of Shareholder Rights Plan and Form of Rights Agreement dated as of December 20, 2007, by and between the Company and Mellon Investor Services, LLC, as Rights Agent, with Form of Rights Certificate  (Incorporated by reference to Item 3.03 and Exhibit 4 of the Company’s Form 8-K dated December 20, 2007). File No. 001-07635. First Amendment to Rights Agreement, effective as of May 1, 2012, between Twin Disc, Incorporated and Computershare Shareowner Services, LLC (Incorporated by reference to Exhibit 4.1 of the Company’s Form 8-K dated May 1, 2012). File No. 001-07635. Material Contracts Exhibit 10 a) Director Tenure and Retirement Policy (Incorporated by reference to Exhibit 10a of the Company’s Form 10-K/A filed September 19, 2011, for the year ended June 30, 2011). File No. 001-07635.  b) The 2004 Stock Incentive Plan as amended (Incorporated by reference to Exhibit B of the Proxy Statement for the Annual Meeting of Shareholders held on October 20, 2006). File No. 001-07635. c) The 2004 Stock Incentive Plan for Non-Employee Directors as amended (Incorporated by reference to Exhibit 99 of the Company’s Form 10-K for the year ended June 30, 2007). File No. 001-07635. d) The 2010 Long-Term Incentive Compensation Plan (Incorporated by reference to Appendix A of the Proxy Statement for the Annual Meeting of Shareholders held on October 15, 2010). File No. 001-07635. e) f)  g) The 2010 Stock Incentive Plan for Non-Employee Directors (Incorporated by reference to Appendix B of the Proxy Statement for the Annual Meeting of Shareholders held on October 15, 2010). File No. 001-07635.  Form of Performance Stock Award Grant Agreement for award of performance shares on July 26, 2012  (Incorporated by reference to Exhibit 10.1 of the Company’s Form 8-K dated August 1, 2012). File No. 001-07635. Form of Performance Stock Unit Award Agreement for award of performance stock units on July 26, 2012 (Incorporated by reference to Exhibit 10.2 of the Company’s Form 8-K dated August 1, 2012). File No. 001-07635.   h)   Form of Restricted Stock Grant Agreement for restricted stock grants on July 26, 2012 (Incorporated by reference  to Exhibit 10.3 of the Company’s Form 8-K dated August 1, 2012). File No. 001-07635. i)  j)  Form of Performance Stock Award Grant Agreement for award of performance shares on July 25, 2013  (Incorporated by reference to Exhibit 10.1 of the Company’s Form 8-K dated July 31, 2013). File No. 001-07635. Form of Performance Stock Unit Award Agreement for award of performance stock units on July 25, 2013 (Incorporated by reference to Exhibit 10.2 of the Company’s Form 8-K dated July 31, 2013). File No. 001-07635.   k)   Form of Restricted Stock Grant Agreement for restricted stock grants on July 25, 2013 (Incorporated by reference  to Exhibit 10.3 of the Company’s Form 8-K dated July 31, 2013). File No. 001-07635. l)   Form of Performance Stock Award Grant Agreement for award of performance shares on July 30, 2014  (Incorporated by reference to Exhibit 10.1 of the Company’s Form 8-K dated August 5, 2014). File No. 001-07635. 69 70 Twin Disc, incORPORATED | AnnuAl RepoRt 2014       EXHIBIT INDEX TWIN DISC, INCORPORATED Exhibit No. 10-K for Year Ended June 30, 2014 Material Contracts Included Herewith m)   n)  o) p) q) r) s) Form of Performance Stock Unit Award Agreement for award of performance stock units on July 30, 2014 (Incorporated by reference to Exhibit 10.2 of the Company’s Form 8-K dated August 5, 2014). File No. 001-07635.  Form of Restricted Stock Grant Agreement for restricted stock grants on July 30, 2014 (Incorporated by reference to  Exhibit 10.3 of the Company’s Form 8-K dated August 5, 2014). File No. 001-07635. Twin Disc, Incorporated Supplemental Executive Retirement Plan, amended and restated as of July 29, 2010 (Incorporated by reference to Exhibit 10.4 of the Company’s Form 8-K dated August 4, 2010). File No. 001-07635. Forms of Change in Control Severance Agreements (Incorporated by reference to Exhibits 10.4, 10.5 and 10.6 of the Company’s Form 8-K dated August 5, 2014). File No. 001-07635. Form of Indemnity Agreement (Incorporated by reference to Exhibit 10.5 of the Company’s Form 8-K dated August 2, 2005). File No. 001-07635. Credit Agreement Between Twin Disc, Incorporated, Twin Disc International, S.A., and Wells Fargo Bank, National Association, dated June 30, 2014 (Incorporated by reference to Exhibit 10.1 of the Company’s Form 8-K dated July 3, 2014). File No. 001-07635. Amended and Restated Note Purchase and Private Shelf Agreement Between Twin Disc, Incorporated, Prudential Investment Management, Inc., The Prudential Insurance Company of America, Pruco Life Insurance Company, Pruco Life Insurance Company of New Jersey, Security Benefit Life Insurance Company, Inc., Prudential Annuities Life   Assurance Corporation, and Mutual of Omaha Insurance Company, dated June 30, 2014 (Incorporated by reference to Exhibit 10.1 of the Company’s Form 8-K dated July 3, 2014). File No. 001-07635. Exhibit Description 21 23 24   31a    31b    32a    32b  Subsidiaries of the Registrant Consent of Independent Registered Public Accounting Firm Power of Attorney Certification  Certification  Certification pursuant to 18 U.S.C. Section 1350  Certification pursuant to 18 U.S.C. Section 1350  Included Herewith X X X X X X X EXHIBIT 21 SUBSIDIARIES OF THE REGISTRANT Twin Disc, Incorporated, the registrant (a Wisconsin Corporation) owns directly or indirectly 100% of the following subsidiaries: Twin Disc International, S.A. (a Belgian corporation) Twin Disc Srl (an Italian corporation) Rolla SP Propellers SA (a Swiss corporation) Twin Disc (Pacific) Pty. Ltd. (an Australian corporation) Twin Disc (Far East) Ltd. (a Delaware corporation operating in Singapore and Hong Kong) Twin Disc (Far East) Pte. Ltd. (a Singapore corporation) Mill Log Equipment Co., Inc. (an Oregon corporation) Mill Log Marine, Inc. (an Oregon corporation) Mill Log Wilson Equipment Ltd. (a Canadian corporation) Twin Disc Southeast, Inc. (a Florida corporation) 1. 2. 3. 4.  5. 6. 7. 8. 9. 10. 11. Vetus Italia Srl (an Italian corporation) 12. 13. 14. Twin Disc Japan (a Japanese corporation) Twin Disc Power Transmission Private, Ltd. (an Indian limited liability corporation) Twin Disc Power Transmission (Shanghai) Co. Ltd. (a Chinese corporation) Twin Disc, Incorporated also owns 66% of Twin Disc Nico Co. LTD. (a Japanese corporation). The registrant has neither a parent nor any other subsidiaries. All of the above subsidiaries are included in the consolidated financial statements. EXHIBIT 23 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (Nos. 333-99229, 333-119770, 333-119771, 333-69361, 333-69015, 333-169965, 333-169963 and 333-169962) of Twin Disc, Incorporated of our report dated September 15, 2014 relating to the financial statements, financial statement schedule and the effectiveness of internal control  over financial reporting, which appears in this Form 10-K. /s/ PricewaterhouseCoopers LLP Milwaukee, Wisconsin September 15, 2014 71 72 Twin Disc, incORPORATED | AnnuAl RepoRt 2014 EXHIBIT 24 POWER OF ATTORNEY The undersigned directors of Twin Disc, Incorporated hereby severally constitute John H. Batten and Jeffrey S. Knutson, and each of them singly, true and lawful attorneys with full power to them, and each of them, singly, to sign for us and in our names as directors the Form 10-K Annual Report for the fiscal year ended June 30, 2014 pursuant to Section 13 or 15(d) of the Securities  Exchange Act of 1934, and generally do all such things in our names and behalf as directors to enable Twin Disc, Incorporated to comply with the provisions of the Securities and Exchange Act of 1934 and all requirements of the Securities and Exchange Commission, hereby ratifying and confirming our signatures so they may be signed by our attorneys, or either of them, as set  forth below. July 31, 2014 MICHAEL E. BATTEN /s/ Michael E. Batten, Director MICHAEL DOAR /s/ Michael Doar, Director MALCOLM F. MOORE /s/ Malcolm F. Moore, Director DAVID B. RAYBURN /s/ David B. Rayburn, Director MICHAEL C. SMILEY /s/ Michael C. Smiley, Director HAROLD M. STRATTON II /s/ Harold M. Stratton II, Director DAVID R. ZIMMER /s/ David R. Zimmer, Director EXHIBIT 31A CERTIFICATIONS I, John H. Batten, certify that: I have reviewed this annual report on Form 10-K of Twin Disc, Incorporated; 1. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 2.   Based on my knowledge, the financial statements, and other financial information included in this report, fairly present  in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the peri- ods presented in this report; 3.   The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and  procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as  defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be  designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the  preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this annual report based on such evaluation; and d) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the  registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of this annual report) that has  materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; 4.   The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over  financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons  performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial report- ing which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report finan- cial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the  registrant’s internal control over financial reporting. Date: September 15, 2014 JOHN H. BATTEN /s/ John H. Batten President and Chief Executive Officer 73 74 Twin Disc, incORPORATED | AnnuAl RepoRt 2014   EXHIBIT 31B CERTIFICATIONS I, Christopher J. Eperjesy, certify that: I have reviewed this annual report on Form 10-K of Twin Disc, Incorporated; 1. 2. 3. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in  all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods  presented in this report; The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and  procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as  defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be  designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the  preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this annual report based on such evaluation; and d) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the  registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of this annual report) that has  materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; 4. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over  financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons  performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial  reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the  registrant’s internal control over financial reporting. Date: September 15, 2014 CHRISTOPHER J. EPERJESY /s/ Christopher J. Eperjesy Vice President – Finance, Chief Financial Officer and Treasurer EXHIBIT 32A CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Twin Disc, Incorporated (the “Company”) on Form 10-K for the fiscal year ending June 30, 2014, as filed with the Securities and Exchange Commission as of the date hereof (the “Report”), I, John H. Batten, President and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of my knowledge: (1) the Report fully complies with Section 13(a) of the Securities Exchange Act of 1934, and (2)  the information contained in the report fairly presents, in all material respects, the financial condition and results of  operations of the Company. Date: September 15, 2014 JOHN H. BATTEN /s/ John H. Batten President and Chief Executive Officer EXHIBIT 32B CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Twin Disc, Incorporated (the “Company”) on Form 10-K for the fiscal year ending June 30, 2014, as filed with the Securities and Exchange Commission as of the date hereof (the “Report”), I, Christopher J. Eperjesy, Vice President – Finance, Chief Financial Officer and Treasurer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of my knowledge: (1) the Report fully complies with Section 13(a) of the Securities Exchange Act of 1934, and (2)  the information contained in the report fairly presents, in all material respects, the financial condition and results of  operations of the Company. Date: September 15, 2014 CHRISTOPHER J. EPERJESY /s/ Christopher J. Eperjesy Vice President – Finance, Chief Financial Officer and Treasurer 75 76 Twin Disc, incORPORATED | AnnuAl RepoRt 2014       DIRECTORS MICHAEL E. BATTEN Chairman of the Board JOHN H. BATTEN President and Chief Executive Officer MICHAEL DOAR Chairman and Chief Executive Officer Hurco Companies, Inc. (A global manufacturer of machine tools) Indianapolis, Indiana MALCOLM F. MOORE President and Chief Executive Officer Digi-Star, LLC (A provider of weighing systems for Precision Agriculture) Fort Atkinson, Wisconsin President and Chief Executive Officer Port Royal Partners, LLC (An enterprise focusing on investments in the marine industry) Naples, Florida DAVID B. RAYBURN Retired President and Chief Executive Officer Modine Manufacturing Company (A manufacturer of heat exchange equipment) Racine, Wisconsin MICHAEL C. SMILEY Chief Financial Officer Zebra Technologies Corporation (A global provider of asset management solutions) Lincolnshire, Illinois HAROLD M. STRATTON II Chairman STRATTEC SECURITY CORPORATION (A manufacturer of security and access control products for the global automotive industry) Milwaukee, Wisconsin DAVID R. ZIMMER Retired Managing Partner Stonebridge Equity, LLC (A merger, acquisition and finance value consulting firm) Troy, Michigan OFFICERS JOHN H. BATTEN DENISE L. WILCOX President and Chief Executive Officer CHRISTOPHER J. EPERJESY Vice President – Human Resources JEFFREY S. KNUTSON Vice President – Finance, Chief Financial Officer and Treasurer DEAN J. BRATEL Corporate Controller and Secretary Vice President – Americas CORPORATE D ATA ANNUAL MEETING Twin Disc Corporate Offices Racine, Wisconsin 2:00 P.M. October 24, 2014 SHARES TRADED NASDAQ: Symbol TWIN ANNUAL REPORT ON SECURITIES AND EXCHANGE COMMISSION FORM 10-K Single copies of the Company’s 2014 Annual Report on Securities and Exchange Commission Form 10-K, including exhibits, will be provided without charge to shareholders after September 15, 2014, upon written request directed to Secretary, Twin Disc, Incorporated, 1328 Racine Street, Racine, Wisconsin 53403. TRANSFER AGENT & REGISTRAR Computershare 250 Royall Street Canton, Massachusetts 02021 Toll Free: 800-839-2614 Web: www.computershare.com/investor INDEPENDENT ACCOUNTANTS PricewaterhouseCoopers LLP Milwaukee, Wisconsin CORPORATE OFFICES Twin Disc, Incorporated Racine, Wisconsin 53403 Telephone: (262) 638-4000 WHOLLY-OWNED SUBSIDIARIES Twin Disc International S.A. Nivelles, Belgium Twin Disc Srl Decima, Italy Rolla SP Propellers SA Novazzano, Switzerland Twin Disc (Pacific) Pty. Ltd. Brisbane, Queensland, Australia Twin Disc (Far East) Ltd. Singapore Twin Disc (Far East) Pte. Ltd. Singapore Mill Log Equipment Co., Inc. Coburg, Oregon Mill Log Marine, Inc. Coburg, Oregon Mill Log Wilson Equipment Ltd. Burnaby, British Columbia Twin Disc Southeast, Inc. Jacksonville, Florida Vetus Italia Srl Limite sull’Arno, Italy Twin Disc Japan Saitama, Japan Twin Disc Power Transmission Private, Ltd. Chennai, India Twin Disc Power Transmission (Shanghai) Co. Ltd. Shanghai, China PARTIALLY OWNED SUBSIDIARIES Twin Disc Nico Co. Ltd. MANUFACTURING FACILITIES Racine, Wisconsin Nivelles, Belgium Decima, Italy Novazzano, Switzerland Limite sull’Arno, Italy Kancheepuram, India SALES OFFICES Domestic Racine, Wisconsin Coburg, Oregon Kent, Washington Medley, Florida Jacksonville, Florida Tampa, Florida Chesapeake, Virginia Foreign Rock Hill, South Carolina Nivelles, Belgium Brisbane, Australia Perth, Australia Singapore Decima, Italy Limite sull’Arno, Italy Novazzano, Switzerland Edmonton, Canada Burnaby, Canada Chennai, India Saitama, Japan Shanghai, China Guangzhou, China MANUFACTURING LICENSES Hitachi-Nico Transmission Co., Ltd. Tokyo, Japan 77 78 Twin Disc, incORPORATED | AnnuAl RepoRt 2014 5-YEAR FINANCIAL SUMMARY STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) (In thousands of dollars, except where noted) 2014 2013 2012 2011 2010 Net sales Costs and expenses, including marketing, engineering and administrative Earnings from operations Other expense Earnings before income taxes and minority interest Income taxes Noncontrolling interest BALANCE SHEET Net earnings attributable to Twin Disc $263,909 255,022 8,887 (791 ) 8,096 4,226 (226 ) 3,644 $285,282 275,269 10,013 (776 ) 9,237 4,986 (369 ) 3,882 $355,870 310,999 44,871 (115 ) 44,756 17,815 (198 ) 26,743 Assets Cash Receivables, net Inventories, net Other current assets Total current assets Investments and other assets Fixed assets less accumulated depreciation Total assets Liabilities and Equity Current liabilities Long-term debt Deferred liabilities Shareholders’ equity Noncontrolling interest Total liabilities and equity Comparative Financial Information Per share statistics: Basic earnings Diluted earnings Dividends Shareholders’ equity Return on equity Return on assets Return on sales Average shares outstanding Diluted shares outstanding Number of shareholder accounts Number of employees Additions to plant and equipment Depreciation Net working capital 24,757 40,219 97,579 17,542 180,097 26,621 60,267 266,985 56,980 14,800 42,894 151,584 727 266,985 0.32 0.32 0.36 13.46 2.4 % 1.4 % 1.4 % 20,724 46,331 102,774 18,643 188,472 34,671 62,315 285,458 63,503 23,472 54,921 142,504 1,058 285,458 0.34 0.34 0.36 12.61 2.7 % 1.4 % 1.4 % 15,701 63,438 103,178 14,844 197,161 40,315 66,356 303,832 66,625 28,401 72,297 135,487 1,022 303,832 2.34 2.31 0.34 11.88 19.7 % 8.6 % 7.5 % 11,258,342 11,264,421 580 970 7,245 10,180 123,117 11,304,280 11,377,091 617 990 6,582 10,120 124,969 11,409,467 11,555,561 651 1,029 13,733 9,947 130,536 $310,393 275,677 34,716 (2,687 ) 32,029 13,897 (135 ) 17,997 20,167 61,007 99,139 14,855 195,168 48,161 65,791 309,120 84,660 25,784 62,030 135,677 969 309,120 $227,534 224,449 3,085 (1,363 ) 1,722 1,013 (133 ) 576 19,022 43,014 72,799 12,615 147,450 53,363 58,243 259,056 63,307 27,211 79,682 88,080 859 259,056 1.59 1.57 0.30 11.99 13.3 % 5.8 % 5.8 % 0.05 0.05 0.28 7.96 0.7 % 0.2 % 0.3 % 11,319,081 11,462,562 699 941 12,028 9,110 111,208 11,063,417 11,159,282 736 913 4,456 9,021 84,143 79 80 Twin Disc, incORPORATED | AnnuAl RepoRt 2014 an n u a l re p o r T 2 0 1 4 T w i n D i s c , i n c o r p o r a T e D | A n n u A l r e p o r t 2 0 1 4 1328 Racine Street Racine, Wisconsin 53403 United States of America www.twindisc.com 0 0 1 c s n 1 8eB 

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