TWIN DISC INC Management’s Discussion and Analysis of Financial Condition and Results of Operations (form 10-K)

Special Note Regarding Smaller Reporting Company Status

Under SEC Release 33-10513; 34-83550, Amendments to Smaller Reporting Company
Definition, the Company qualifies as a smaller reporting company based on its
public float as of the last business day of the second quarter of fiscal 2022.
Accordingly, it has scaled some of its disclosures of financial and
non-financial information in this annual report. The Company will continue to
determine whether to provide additional scaled disclosures of financial or
non-financial information in future quarterly reports, annual reports and/or
proxy statements if it remains a smaller reporting company under SEC rules.




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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 communications 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, including, but not limited to those
factors discussed under Item 1A, Risk Factors, could cause actual results to be
materially different from what is presented in any forward-looking statements.

Fiscal 2022 Compared to Fiscal 2021



Net Sales


Net sales for fiscal 2022 increased 11.1%, or $24.3 million, to $242.9 million
from $218.6 million in fiscal 2021. The Company experienced a broad-based
recovery in demand across most of the markets served, as the impact of the
COVID-19 crisis on the Company’s global markets subsided. While market demand
was strong through the year, supply chain disruption limited the Company’s
ability to deliver product through the first three quarters of fiscal 2022. The
Company was able to overcome many supply chain challenges in the fourth fiscal
quarter of 2022, resulting in revenue of $76.0 million, an increase of $9.8
million
or 14.8% compared to the prior year fourth fiscal quarter. Currency
translation had an unfavorable impact on fiscal 2022 sales compared to the prior
year totaling $8.5 million primarily due to the weakening of the euro and
Australian dollar against the U.S. dollar.

Sales at our manufacturing segment increased 13.4%, or $25.8 million, versus the
same period last year. The largest improvement was seen at the Company’s North
American manufacturing operations, which experienced a 30.7% increase in sales
compared to fiscal 2021. The primary driver for this increase was a broad
recovery in demand following the negative global economic impact of the COVID-19
pandemic. In particular, this operation saw a marked improvement in demand for
its oil and gas related products, both new units and aftermarket volume. The
Company’s Veth Propulsion operation in the Netherlands experienced a 4.6%
decrease in sales in fiscal 2022, primarily the result of an unfavorable
currency translation impact. In constant currency, this entity experienced a
slight increase in sales (1.3%) as recovering market demand was hampered
somewhat by supply chain challenges. The Company’s Italian manufacturing
operations reported an 8.2% increase in sales from fiscal 2021, despite an
unfavorable currency translation impact, thanks to a recovering European
industrial market following the negative impact of the COVID-19 pandemic. The
Company’s Belgian manufacturing operation saw an 11.3% decrease in sales in
fiscal 2022 on an unfavorable foreign exchange impact and supply chain
challenges limiting production. The Company’s Swiss manufacturing operation,
which supplies customized propellers for the global mega yacht and patrol boat
markets, experienced a 6.5% increase in sales, primarily due to a recovering
European marine market.

Sales at our distribution segment were up 6.7%, or $6.7 million, compared to
fiscal 2021, with improving global demand and product delivery from the
manufacturing operations. The Company’s Asian distribution operation in
Singapore, China and Japan experienced a 7.8% increase in sales due to the
recovering global demand following the impacts of COVID-19, partially offset by
an unfavorable currency translation impact. The Company’s European distribution
operation saw essentially flat sales, as improving demand was offset by an
unfavorable currency translation impact and supply chain challenges limiting
shipment of goods from the production operations. The Company’s North American
distribution operation was also relatively unchanged from fiscal 2021, as supply
chain challenges offset an improving demand picture. The Company’s distribution
operation in Australia, which provides boat accessories, propulsion and marine
transmission systems primarily for the pleasure craft market, saw an 18.2% sales
increase, driven by strong demand for the Company’s product in the pleasure
craft market.




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Net sales for the Company’s marine transmission, propulsion and boat management
systems were up 6.1% in fiscal 2022 compared to the prior fiscal year. This
increase reflects a general strengthening of the global economy following the
negative impact of the COVID-19 pandemic in fiscal 2021. Strength was seen
across the commercial, pleasure and defense components of the market. In the
off-highway transmission market, the year-over-year increase of 11.1% can also
be attributed primarily to the global recovery following the impact of the
COVID-19 pandemic, with particular strength in North American aftermarket
product sales for the oil and gas industry. Sale of the Company’s pressure
pumping transmission systems into China also improved over the prior year. The
increase experienced in the Company’s industrial products of 36.9% was also a
function of the recovering global economy, along with the improving performance
of the Company’s new Lufkin, Texas operation, which is focused on growing sales
of industrial products.

Geographically, sales to the U.S. and Canada improved 26% in fiscal 2022
compared to fiscal 2021, representing 36% of consolidated sales for fiscal 2022
compared to 32% in fiscal 2021. The increase is primarily due to the impact of
the economic recovery following the COVID-19 pandemic. Sales into the Asia
Pacific
market improved 8% compared to fiscal 2021 and represented approximately
23% of sales in fiscal 2022, compared to 24% in fiscal 2021. The increase in
fiscal 2022 reflects a continued strong Australian pleasure craft market,
continued demand for the Company’s oil and gas transmissions by the Chinese
market and a general economic recovery following the COVID-19 pandemic. Sales
into the European market declined approximately 6% from fiscal 2021 levels while
accounting for 31% of consolidated net sales in fiscal 2021 compared to 37% of
net sales in fiscal 2021. Despite strengthening demand, the region experienced
significant supply chain challenges and an unfavorable currency exchange impact.
See Note J, Business Segments and Foreign Operations, of the notes to the
consolidated financial statements for more information on the Company’s business
segments and foreign operations.



Gross Profit



In fiscal 2022, gross profit improved $18.0 million, or 35.3%, to $68.8 million
on a sales increase of $24.3 million. Gross profit as a percentage of sales
increased 500 basis points in fiscal 2022 to 28.3%, compared to 23.3% in fiscal
2021. The table below summarizes the gross profit trend by quarter for fiscal
years 2022 and 2021:



                 1st Qtr       2nd Qtr       3rd Qtr       4th Qtr       Year
Gross Profit:
($ millions)
2022            $    13.4     $    13.5     $    17.7     $    24.2     $ 68.8
2021            $     9.7     $     8.9     $    14.0     $    18.3     $ 50.9

% of Sales:
2022                 28.2 %        22.5 %        29.8 %        31.8 %     28.3 %
2021                 21.0 %        18.3 %        24.2 %        27.7 %     23.3 %



There were a number of factors that impacted the Company’s overall gross profit
rate in fiscal 2022. Gross profit for the year was primarily impacted by
improved volumes and a significantly more favorable product mix. This was driven
by the global economic recovery following the impact of the COVID-19 pandemic
and a significant increase in the sales of high-margin oil and gas transmissions
and parts. The Company also experienced a net favorable improvement in margins
from the recording of benefits related to COVID-19 relief programs of the U.S.
and the Netherlands, totaling $1.4 million. The Company estimates the net
favorable impact of increased volumes on gross margin in fiscal 2022 was
approximately $5.7 million. The favorable shift in product mix, primarily
related to the increased shipments of the Company’s high margin oil and gas
transmission units and aftermarket products, had an estimated favorable impact
of $9.6 million.

Marketing, Engineering and Administrative (ME&A) Expenses

Marketing, engineering, and administrative (ME&A) expenses of $60.1 million were
up $4.3 million, or 7.8%, in fiscal 2022 compared to the prior fiscal year. As a
percentage of sales, ME&A expenses decreased to 24.7% of sales versus 25.5% of
sales in fiscal 2021. The increase in ME&A spending in fiscal 2022 compared to
the prior year was driven by increased domestic salaries and benefits ($2.4
million
), increased marketing activities ($0.4 million), additional engineering
project spending ($0.5 million), increased travel expense ($0.4 million) and bad
debt expense ($0.3 million), higher professional fees ($0.8 million), reduced
benefit from the U.S. employee retention credit program ($0.7 million) and an
inflationary impact estimated at $2.0 million. These increases were partially
offset by an increase in the receipt of Dutch COVID-19 subsidy payments ($1.2
million
), the absence of a prior year one-off product issue ($0.8 million) and
an exchange driven decrease ($1.2 million).




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Restructuring of Operations


During the course of fiscal 2022, the Company incurred $1.0 million in
restructuring charges. These charges relate to a continued restructuring program
at the Company’s Belgian operation to focus resources on core manufacturing
process, while allowing for savings on the outsourcing of non-core processes. In
fiscal 2021, the Company incurred $7.4 million in restructuring charges. These
charges relate to the Belgian restructuring program just mentioned ($2.3
million
), an impairment charge of the Company’s corporate office building ($4.3
million
), and other restructuring activities at the company’s domestic and
European operations ($0.8 million). Restructuring activities since June 2015
have resulted in the elimination of 254 full-time employees in the manufacturing
segment. Accumulated costs to date under these programs within the manufacturing
segment through June 30, 2022 were $16,226.

Income from Extinguishment of Loan

During the fourth fiscal quarter of fiscal 2021, the Company received formal
forgiveness of its PPP Loan in the amount of $8.2 million. The Company recorded
$8.2 million in income from extinguishment of loan in its consolidated statement
of operations in fiscal 2021. See Note G, Debt, of the notes to the consolidated
financial statements for additional information on the PPP loan.



Interest Expense


Interest expense of $2.1 million for fiscal 2022 was $0.3 million lower than
fiscal 2021 on a relatively stable average interest rate and a lower average
balance on the domestic revolver.



Other income (expense), net


In fiscal 2022, other income, net, of $1.3 million improved by $4.7 million from
a prior fiscal year other expense, net, of ($3.4 million). This change is
primarily due to the impact of currency movements related to the euro and Asian
currencies.




Income Taxes



The effective tax rate for fiscal 2022 is 17.8% compared to -200.0% for fiscal
2021. During the prior fiscal year, the Company received full forgiveness of its
PPP loan which resulted in an increase to the effective tax rate of 17.5%.

The Company maintains valuation allowances when it is more likely than not that
all or a portion of a deferred tax asset will not be realized. Changes in
valuation allowances from period to period are included in the tax provision in
the period of change. In determining whether a valuation allowance is required,
the Company takes into account such factors as prior earnings history, expected
future earnings, carry-back and carry-forward periods, and tax strategies that
could potentially enhance the likelihood of realization of a deferred tax asset.
In fiscal 2021, the Company evaluated the likelihood of whether the net domestic
deferred tax assets would be realized and concluded that it is more likely than
not that all of deferred tax assets would not be realized. Management believes
that it is more likely than not that the results of future operations will not
generate sufficient taxable income and foreign source income to realize all the
domestic deferred tax assets, therefore, a valuation allowance in the amount of
$24.4 million, was included in income tax expense (benefit) on the consolidated
statement of operations, for fiscal year 2021. In fiscal year 2022, the
valuation allowance was $23.1 million,



Order Rates


As of June 30, 2022, the Company’s backlog of orders scheduled for shipment
during the next six months (six-month backlog) was $101.2 million or
approximately 44% higher than the six-month backlog of $70.3 million as of June
30, 2021
. The increased backlog is primarily attributable to the improvement in
order rates throughout the fiscal year resulting from the global economic
recovery following the negative impact of the COVID-19 pandemic.

Liquidity and Capital Resources



Fiscal Years 2022 and 2021


The net cash used by operating activities in fiscal 2022 totaled $8.3 million, a
change of ($14.8 million) from the prior fiscal year cash provided by operating
activities of $6.5 million. The negative operating cash flow was created
primarily by an increase to inventory ($12.2 million) and trade accounts
receivable ($5.9 million) compared to the prior year end. The increased
inventory is the result of the global volume increase, along with rampant supply
chain disruptions creating imbalanced inventory at our operations. These
disruptions were mitigated somewhat during the fourth quarter, but remain a
significant challenge. The increase in trade accounts receivable reflects a very
strong shipping month in June, with collection to follow in fiscal 2023. These
increases were partially offset by an increase in accrued liabilities compared
to the prior year end.




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The net cash provided by investing activities for fiscal 2022 primarily
represents the proceeds from the sale of real property in Switzerland and Italy
($9.5 million), partially offset by capital spending activity totaling $4.7
million
. The capital spending amount reflects a continued focus on cash
conservation as we navigated through the extreme economic uncertainty brought on
by the COVID-19 pandemic, along with extended lead times on equipment resulting
from global supply chain challenges.

The net cash provided by financing activities relates primarily to borrowings of
long-term debt ($3.9 million), partially offset by payments for withholding
taxes on stock compensation ($0.5 million), payments on finance lease
obligations ($0.9 million) and dividends paid to a non-controlling interest
($0.2 million). During fiscal 2022, 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 authorized stock repurchase plan.

Future Liquidity and Capital Resources

On June 29, 2018, the Company entered into a Credit Agreement (the “Credit
Agreement”) with BMO Harris Bank N.A. (“BMO”) that provided for the assignment
and assumption of the previously existing loans between the Company and Bank of
Montreal (the “2016 Credit Agreement”) and subsequent amendments into a term
loan (the “Term Loan”) and revolving credit loans (each a “Revolving Loan” and,
collectively, the “Revolving Loans,” and, together with the Term Loan, the
“Loans”). Pursuant to the Credit Agreement, BMO agreed to make the Term Loan to
the Company in a principal amount not to exceed $35.0 million and the Company
may, from time to time prior to the maturity date, enter into Revolving Loans in
amounts not to exceed, in the aggregate, $50.0 million (the “Revolving Credit
Commitment”). The Credit Agreement also allows the Company to obtain Letters of
Credit from BMO, which if drawn upon by the beneficiary thereof and paid by BMO,
would become Revolving Loans. Under the Credit Agreement, the Company may not
pay cash dividends on its common stock in excess of $3.0 million in any fiscal
year.

On March 4, 2019, the Company entered into a second amendment (the “Second
Amendment”) to the Credit Agreement. The Second Amendment reduced the principal
amount of the term loan commitment under the Credit Agreement from $35.0 million
to $20.0 million. In connection with the Second Amendment, the Company issued an
amended and restated term note in the amount of $20.0 million to the Bank, which
amended the original $35.0 million note provided under the Credit Agreement.

Prior to entering into the Second Amendment, the outstanding principal amount of
the term loan (the “Term Loan”) under the Credit Agreement was $10.8 million. On
the date of the Second Amendment, the Bank made an additional advance on the
Term Loan to the Company in the amount of $9.2 million. The Second Amendment
also extended the maturity date of the Term Loan from January 2, 2020 to March
4, 2026
, and added a requirement that the Company make principal installments of
$0.5 million per quarter starting with the quarter ending June 30, 2019.

The Second Amendment also reduced the applicable margin for purposes of
determining the interest rate applicable to the Term Loan. Previously, the
applicable margin was 3.00%, which was added to the Monthly Reset LIBOR Rate or
the Adjusted LIBOR, as applicable. Under the Second Amendment, the applicable
margin was between 1.375% and 2.375%, depending on the Company’s total funded
debt to EBITDA ratio.

The Second Amendment also adjusted certain financial covenants made by the
Company under the Credit Agreement. Specifically, the Company covenanted (i) not
to allow its total funded debt to EBITDA ratio to be greater than 3.00 to 1.00
(the cap had previously been 3.50 to 1.00 for quarters ending on or before
September 30, 2019 and 3.25 to 1.00 for quarters ending on or about December 31,
2019
through September 30, 2020), and (ii) that its tangible net worth will not
be less than $100.0 million plus 50% of net income for each fiscal year ending
on and after June 30, 2019 for which net income is a positive number (the $100.0
million
figure had previously been $70.0 million).

On January 28, 2020, the Company entered into a third amendment (the “Third
Amendment”) to the Credit Agreement. The Third Amendment restated the financial
covenant provisions related to the maximum allowable ratio of total funded debt
to EBITDA from 3.00 to 1.00 to 4.00 to 1.00 for the quarter ended December 27,
2019
, 5.00 to 1.00 for the quarter ending March 27, 2020, 4.00 to 1.00 for the
quarter ending June 30, 2020, 3.50 to 1.00 for the quarter ending September 25,
2020
, and 3.00 to 1.00 for quarters ending on or after December 25, 2020. For
purposes of determining EBITDA, the Third Amendment added back extraordinary
expenses (not to exceed $3.9 million) related to the previously reported
isolated product performance issue on one of the Company’s oil and gas
transmission models at certain installations. Under the Third Amendment, the
applicable margin for revolving loans, letters of credit, and term loans was
between 1.25% and 3.375%, depending on the Company’s total funded debt to EBITDA
ratio.




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On July 22, 2020, the Company entered into a fifth amendment (the “Fifth
Amendment”) to the Credit Agreement that amends the Credit Agreement dated as of
June 29, 2018, as amended, between the Company and BMO. The Fifth Amendment
reduced BMO’s Revolving Credit Commitment from $50.0 million to $45.0 million.
The Fifth Amendment also gives the Company the option to make interest-only
payments on the Term Loan for quarterly payments occurring on September 30, 2020
and December 31, 2020, and limits the Company’s Capital Expenditures for the
fiscal year ending June 30, 2021 to $10.0 million.

The Fifth Amendment provides the Company with relief from its Total Funded Debt
to EBITDA ratio financial covenant under the Credit Agreement through (and
including) the earlier of June 30, 2021 or a date selected by the Company.
During the financial covenant relief period:



  ? The "Applicable Margin" to be applied to Revolving Loans, the Term Loan, and
    the Commitment/Facility Fee increased to 3.25%, 3.875%, and 0.20%,
    respectively.




  ? The Company may not make certain restricted payments (specifically, cash
    dividends, distributions, purchases, redemptions or other acquisitions of or
    with respect to shares of its common stock or other common equity interests).




  ? The Company must maintain liquidity (as defined in the Fifth Amendment) of at
    least $15.0 million.




  ? The Company must maintain minimum EBITDA of at least (1) $1.0 million for the
    fiscal quarter ending June 30, 2020 and the two fiscal quarters ending on or
    about September 30, 2020; (2) $2.5 million for the three fiscal quarters
    ending on or about December 31, 2020; (3) $6.0 million for the four fiscal
    quarters ending on or about March 31, 2021; and (4) $10.0 million for the four
    fiscal quarters ending June 30, 2021.



For purposes of the minimum EBITDA covenant and the Total Funded Debt to EBITDA
ratio, the Fifth Amendment clarified that EBITDA shall exclude any gain that is
realized on the forgiveness of the Small Business Administration Paycheck
Protection Program loan that the Company previously received.

The Fifth Amendment also changed the definition of “LIBOR” (used in calculating
interest on Eurodollar Loans), “Monthly Reset LIBOR Rate” (used in calculating
interest on LIBOR Loans), and “LIBOR Quoted Rate” (used in the definition of
“Base Rate,” which is used in calculating interest on Letters of Credit that are
drawn upon and not timely reimbursed).

The Company also entered into a Deposit Account Control Agreement with the Bank,
reflecting the Bank’s security interest in deposit accounts the Company
maintains with the Bank. Under the Fifth Amendment, the Bank may not provide a
notice of exclusive control of a deposit account (thereby obtaining exclusive
control of the account) prior to the occurrence or existence of a Default or an
Event of Default under the Credit Agreement or otherwise upon the occurrence or
existence of an event or condition that would, but for the passage of time or
the giving of notice, constitute a Default or an Event of Default under the
Credit Agreement.

On January 27, 2021, the Company entered into a Forbearance Agreement and
Amendment No. 6 to the Credit Agreement (the “Forbearance Agreement”) that
further amended the Credit Agreement.

The Company entered into the Forbearance Agreement because the Company was not
in compliance with its financial covenant to maintain a minimum EBITDA of at
least $2.5 million for the three fiscal quarters ended as of December 25, 2020.
In the Forbearance Agreement, the Bank agreed to forbear from exercising its
rights and remedies against the Company under the Credit Agreement with respect
to the Company’s noncompliance with the minimum EBITDA covenant during the
period (the “Forbearance Period”) commencing January 27, 2021 and ending on the
earlier of (i) September 30, 2021, and (ii) the date on which a default under
the Forbearance Agreement or Credit Agreement occurs. During the Forbearance
Period, the Bank agreed to continue to honor requests of the Company for draws
on the revolving note provided by the Bank under the Credit Agreement, except
that the revolving credit commitment was reduced from $45.0 million to $42.5
million
during the Forbearance Period.




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The Forbearance Agreement also added to the Company’s financial reporting
requirements under the Credit Agreement by requiring the Company to provide the
Bank with monthly forecasts of the Company’s financial statements, and monthly
reports on the Company’s six-month backlog.

On September 30, 2021, the Company entered into a First Amended and Restated
Forbearance Agreement and Amendment No. 7 to Credit Agreement (the “Amended and
Restated Forbearance Agreement”) that amends the Credit Agreement dated as of
June 29, 2018, as amended between the Company and the Bank.

The Amended and Restated Forbearance Agreement extended the Forbearance Period
through February 28, 2022, or if earlier, through the date on which a default
under the Amended and Restated Forbearance Agreement or Credit Agreement occurs.
During the extended Forbearance Period, the Bank agreed to continue to forbear
from exercising its rights and remedies against the Company under the Credit
Agreement with respect to the Company’s noncompliance with its minimum EBITDA
covenants. The Amended and Restated Forbearance Agreement also made certain
adjustments to the Credit Agreement, including:



  ? Permitting the Company to sell its manufacturing facility in Novazzano,
    Switzerland for a gross sales price of approximately $10 million, resulting in
    Net Cash Proceeds of approximately $8.7 million (the "Rolla Disposition").


  ? Requiring the Company to promptly repatriate approximately $7 million of the
    Net Cash Proceeds from the Rolla Disposition (the "Rolla Repatriation"), and
    to apply $1 million of such Net Cash Proceeds to the Term Loan and the
    remainder to the revolving Loans under the Credit Agreement.


  ? Upon completion of the Rolla Repatriation: (1) reducing the portion of the
    Borrowing Base that is based on Eligible Inventory from the lesser of $35
    million or 50% of the value of Eligible Inventory to the lesser of $30 million
    or 50% of the value of Eligible Inventory; and (2) reducing the Revolving
    Credit Commitment from a maximum of $42.5 million to a maximum of $40 million.



On February 28, 2022, the Company entered into a Second Amended and Restated
Forbearance Agreement and Amendment No. 8 to Credit Agreement (the “Second
Amended and Restated Forbearance Agreement”) that amended the Credit Agreement
dated as of June 29, 2018, as amended between the Company and the Bank.

The Second Amended and Restated Forbearance Agreement extended the Forbearance
Period through June 30, 2022, or if earlier, through the date on which a default
under the Amended and Restated Forbearance Agreement or Credit Agreement occurs.
During the extended Forbearance Period, the Bank continued to forbear from
exercising its rights and remedies against the Company under the Credit
Agreement with respect to the Company’s noncompliance with its minimum EBITDA
covenants. The Second Amended and Restated Forbearance Agreement also made
certain adjustments to the Credit Agreement, including:



  ? Reduced the portion of the Borrowing Base that is based on Eligible Inventory
    from the lesser of $35,000,000 or 50% of the value of Eligible Inventory to
    the lesser of $30,000,000 or 50% of the value of Eligible Inventory. This
    change was already in effect under the terms of the Amended and Restated
    Forbearance Agreement, due to the Company's previously reported sale of its
    manufacturing facility in Novazzano, Switzerland for a gross sales price of
    approximately $10,000,000, resulting in Net Cash Proceeds (as defined in the
    Amended and Restated Forbearance Agreement) of approximately $8,700,000 (the
    "Rolla Disposition") and repatriation of approximately $7,000,000 of those Net
    Cash Proceeds (the "Rolla Repatriation").




  ? Reduced the Revolving Credit Commitment from a maximum of $42,500,000 to a
    maximum of $40,000,000. This change was also already in effect under the terms
    of the Amended and Restated Forbearance Agreement due to the Rolla Disposition
    and Rolla Repatriation.



The Company also executed a Third Amended and Restated Revolving Note with the
Bank, reflecting the maximum Revolving Credit Commitment of $40,000,000.

On June 30, 2022, the Company entered into Amendment No. 9 to Credit Agreement
(the “Ninth Amendment”) that amends and extends the Credit Agreement dated as of
June 29, 2018, as amended (the “Credit Agreement”) between the Company and the
Bank.

Pursuant to the Credit Agreement, as in effect prior to the Ninth Amendment, the
Bank made a Term Loan to the Company in the principal amount of $20,000,000, and
the Company may, from time to time prior to the maturity date, enter into
Revolving Loans in amounts not to exceed, in the aggregate and subject to a
Borrowing Base, $40,000,000 (the “Revolving Credit Commitment”). The Credit
Agreement also allows the Company to obtain Letters of Credit from the Bank,
which if drawn upon by the beneficiary thereof and paid by the Bank, would
become Revolving Loans.




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The Ninth Amendment extended the Credit Agreement through June 30, 2025. Prior
to the Ninth Amendment, the Credit Agreement was scheduled to terminate as of
June 30, 2023.

The Ninth Amendment also formally terminated the January 27, 2021 Forbearance
Agreement, which had been entered into because the Company had not been in
compliance with a requirement to maintain a minimum EBITDA of $2,500,000 for the
three fiscal quarters ended as of December 25, 2020. The Bank also waived the
Company’s compliance with the minimum EBITDA requirements under the Credit
Agreement and any Event of Default associated with the Company’s noncompliance
with the minimum EBITDA requirements.

The Ninth Amendment also replaced LIBOR-based interest rates with different
benchmark rates based on the secured overnight financing rate (“SOFR”) or the
euro interbank offered rate (the “EURIBO Rate”). Loans under the Credit
Agreement are designated either as “SOFR Loans,” which accrue interest at an
Adjusted Term SOFR plus an Applicable Margin, or “Eurodollar Loans,” which
accrue interest at the EURIBO Rate plus an Applicable Margin. Amounts drawn on a
Letter of Credit that are not timely reimbursed to the Bank bear interest at a
Base Rate plus an Applicable Margin. The Company also pays a commitment fee on
the average daily Unused Revolving Credit Commitment equal to an Applicable
Margin.

The Ninth Amendment also reduced the Applicable Margins from the rates that had
been in effect during the period of the Forbearance Agreement. During the period
covered by the Forbearance Agreement, the Applicable Margins for Revolving
Loans, Term Loans, and the Unused Revolving Credit Commitment were 3.25%,
3.875%, and .20%, respectively. Under the Ninth Amendment, the Applicable
Margins are between 1.25% and 2.75% for Revolving Loans and Letters of Credit;
1.375% and 2.875% for Term Loans; and .10% and .15% for the Unused Revolving
Credit Commitment (each depending on the Company’s Total Funded Debt to EBITDA
ratio).

The Ninth Amendment also revised the Company’s financial covenants under the
Credit Agreement. The Company’s Total Funded Debt to EBITDA ratio (for which the
Bank provided relief during period covered by the Forbearance Agreement) may not
exceed 3.50 to 1.00, and the Company’s Fixed Charge Coverage Ratio may not be
less than 1.10 to 1.00. The Company’s Tangible Net Worth may not be less than
$100,000,000 plus 50% of positive Net Income for each fiscal year ending on or
after June 30, 2023.

Borrowings under the Credit Agreement are secured by substantially all of the
Company’s personal property, including accounts receivable, inventory, machinery
and equipment, and intellectual property. The Company has also pledged 100% of
its equity interests in certain domestic subsidiaries and 65% of its equity
interests in certain foreign subsidiaries. The Company also entered into a
Collateral Assignment of Rights under Purchase Agreement for its acquisition of
Veth Propulsion. To effect these security interests, the Company entered into
various amendment and assignment agreements that consent to the assignment of
certain agreements previously entered into between the Company and the Bank of
Montreal in connection with the 2016 Credit Agreement. The Company also amended
and assigned to BMO a Negative Pledge Agreement that it has previously entered
into with Bank of Montreal, pursuant to which it agreed not to sell, lease or
otherwise encumber real estate that it owns except as permitted by the Credit
Agreement and the Negative Pledge Agreement.

Upon the occurrence of an Event of Default, BMO may take the following actions
upon written notice to the Company: (1) terminate its remaining obligations
under the Credit Agreement; (2) declare all amounts outstanding under the Credit
Agreement to be immediately due and payable; and (3) demand the Company to
immediately Cash Collateralize L/C Obligations in an amount equal to 105% of the
aggregate L/C Obligations or a greater amount if BMO determines a greater amount
is necessary. If such Event of Default is due to the Company’s bankruptcy, the
Bank may take the three actions listed above without notice to the Company.

On March 3, 2021 the Company submitted its application for forgiveness of the
PPP Loan. The application was supported by documentation of qualified expenses
and compliance of eligibility with the program. On June 16, 2021 the Company was
notified by the SBA that the PPP loan was fully forgiven. The Company recorded
the forgiveness as income from extinguishment of loan. This is described further
in Note G, Debt, of the notes to the consolidated financial statements.

The Company’s balance sheet remains strong, there are no material
off-balance-sheet arrangements, and it continues to have sufficient liquidity
for its near-term needs. The Company had approximately $17.0 million of
available borrowings under the Credit Agreement as of June 30, 2022. The Company
expects to continue to generate enough cash from operations, as well as its
credit facilities, to meet its operating and investing needs. As of June 30,
2022
, the Company also had cash of $12.5 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 2023,
the Company expects to contribute $0.6 million to its defined benefit pension
plans, the minimum contribution required.




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Net working capital increased $10.0 million, or 8.8%, during fiscal 2022 and the
current ratio (calculated as total current assets divided by total current
liabilities) increased from 2.4 at June 30, 2021 to 2.5 at June 30, 2022. The
increase in net working capital was primarily the result of an increase to
inventory ($9.1 million) resulting from growing demand and supply chain
imbalances. Other increases included trade receivables ($6.0 million – due to
increased sales volume in the fourth quarter), lower trade payables ($2.5
million
) and slightly higher other current assets ($0.8 million). These
increases were partially offset by a reduction in the current portion of assets
held for sale ($6.6 million – due primarily to the sale of a Swiss property) and
increased accrued expenses ($5.0 million).

The Company expects capital expenditures to be approximately $12 million$15
million
in fiscal 2022. These anticipated expenditures reflect the Company’s
plans to invest in modern equipment to drive efficiencies, quality improvements
and cost reductions.

Management believes that available cash, the credit facility, cash generated
from future operations, and potential access to debt markets will be adequate to
fund the Company’s capital requirements for the foreseeable future.



Contractual Obligations


The Company’s significant contractual obligations as of June 30, 2022 are
discussed in Note H “Lease Obligations” in the Notes to Consolidated Financial
Statements in Part II, Item 8 of this 2022 Annual Report on Form 10-K. There are
no material undisclosed guarantees. As of June 30, 2022, the Company had no
additional material purchase obligations other than those created in the
ordinary course of business related to inventory and property, plant and
equipment, which generally have terms of less than 90 days. The Company also has
long-term obligations related to its postretirement plans which are discussed in
detail in Note M “Pension and Other Postretirement Benefit Plans” in the Notes
to Consolidated Financial Statements in Part II, Item 8 of this 2022 Annual
Report on Form 10-K. Postretirement medical claims are paid by the Company as
they are submitted, and they are anticipated to be $0.3 million in 2022 based on
actuarial estimates; however, these amounts can vary significantly from year to
year because the Company is self-insured. In fiscal 2023, the Company expects to
contribute $0.6 million to its defined benefit pension plans, the minimum
contribution required.



Other Matters


Critical Accounting Policies and Estimates

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

The Company’s significant accounting policies are described in Note A,
Significant Accounting Policies, of the notes to the consolidated financial
statements. Not all of these significant accounting policies require management
to make difficult, subjective, or complex judgments or estimates. However, the
policies management considers most critical to understanding and evaluating its
reported financial results are the following:



Accounts Receivable


The Company performs ongoing credit evaluations of its customers and adjusts
credit limits based on payment history and the customer’s credit-worthiness as
determined by review of current credit information. The Company continuously
monitors collections and payments from its customers and maintains a provision
for estimated credit losses based upon its 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 the Company’s accounts receivable are
dispersed among a large customer base, a significant change in the liquidity or
financial position of any one of its largest customers could have a material
adverse impact on the collectability of its accounts receivable and future
operating results.




                                       20

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Inventory


Inventories are valued at the lower of cost or net realizable value. Cost has
been determined by the last-in, first-out (LIFO) method for the majority of the
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 when evaluating the adequacy of
the reserve for excess and obsolete inventory. The adjustments 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.



Assets Held for Sale


Assets that will be recovered principally through sale rather than in its
continuing use in operations are reclassified out of property, plant and
equipment and into assets held for sale if all of the following criteria are
met: (a) management, having the authority to approve the action, commits to a
plan to sell the asset(s); (b) the asset is available for immediate sale in its
present condition subject only to terms that are usual and customary for sales
of such assets; (c) an active program to locate a buyer, and other actions
required to complete the plan to sell the asset have been initiated; (d) the
sale of the asset is probable and the transfer of the asset is expected to
qualify for recognition as a completed sale within a year; (e) the asset is
being actively marketed for sale at a price that is reasonable in relation to
its current fair value; and (f) actions required to complete the plan indicate
that it is unlikely that significant changes to the plan will be made or that
plan will be withdrawn.

Assets Held for Sale are carried at fair value less costs to sell, or net book
value, whichever is lower. The Company ceases to record depreciation expense at
the time of designation as held for sale.



Long-lived Assets


The Company reviews long-lived assets for impairment whenever events or changes
in business circumstances indicate that the carrying amount of the assets may
not be fully recoverable. For property, plant and equipment and other long-lived
assets, including intangible assets, the Company performs undiscounted operating
cash flow analyses to determine if an impairment exists. If an impairment is
determined to exist, any related impairment loss is calculated based on fair
value. Fair value is primarily determined using discounted cash flow analyses;
however, other methods may be used to substantiate the discounted cash flow
analyses, including third party valuations when necessary.



Warranty


The Company engages in extensive product quality programs and processes,
including actively monitoring and evaluating the quality of its suppliers.
However, its warranty obligation is affected by product failure rates, the
extent of the market affected by the failure and the expense involved in
satisfactorily addressing the situation. The warranty reserve is established
based on the Company’s best estimate of the amounts necessary to settle future
and existing claims on products sold as of the balance sheet date. When
evaluating the adequacy of the reserve for warranty costs, management takes into
consideration the term of the warranty coverage, historical claim rates and
costs of repair, knowledge of the type and volume of new products and economic
trends. While the Company believes that the warranty reserve is adequate and
that the judgment applied is appropriate, such amounts estimated to be due and
payable in the future could differ materially from what actually transpires.

Pension and Other Postretirement Benefit Plans

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 Willis Towers Watson BOND:Link model at June 30,

2022 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.




                                       21

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? Compensation Increase – reflect the long-term actual experience, the near-term

outlook and assumed inflation.

? Retirement and Mortality Rates – based upon the Society of Actuaries PRI-2012

base tables for annuitants and non-annuitants, adjusted for generational

mortality improvement based on the Society of Actuaries modified MP-2021

projection scale.

? 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. 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 of operations or cash flows.

Income Taxes and Valuation Allowances

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 carryforwards. 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 allowances 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 considers
such factors as prior earnings history, expected future earnings, carry-back and
carry-forward periods, and tax strategies that could potentially enhance the
likelihood of realization of a deferred tax asset. Based on the above criteria
the Company has determined that a full valuation allowance is appropriate as
relates to its domestic operations. A full domestic valuation allowance of $24.4
million
has been recognized in fiscal 2022. The recognition of a valuation
allowance does not affect the availability of the tax credits as the Company
realizes earnings.

Recently Issued Accounting Standards

See Note A, Significant Accounting Policies, of the notes to the consolidated
financial statements for a discussion of recently issued accounting standards.

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