16 EXHIBIT 13 FINANCIAL HIGHLIGHTS 1996 1995 1994 Net Sales $176,657 $164,232 $141,193 Earnings Before Accounting Changes 6,559 5,672 4,389 Earnings Per Share Before Accounting Changes 2.36 2.03 1.57 Dividends Per Share .70 .70 .70 Average Shares Outstanding For The Year 2,776,805 2,790,111 2,799,390 Sales and Earnings by Quarter 1996 1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr. Year Net Sales $36,775 $41,763 $47,209 $50,910 $176,657 Gross Profit 7,093 9,295 11,340 13,149 40,877 Net Earnings 221 1,263 1,808 3,267 6,559 Net Earnings Per Share .08 .45 .65 1.18 2.36 Dividends Per Share .175 .175 .175 .175 .70 Stock Price Range: High 25 1/4 23 3/4 23 1/4 25 1/2 25 1/2 Low 22 1/2 22 21 3/8 22 1/4 21 3/8 Sales and Earnings by Quarter 1995 1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr. Year Net Sales $31,600 $41,102 $42,946 $48,584 $164,232 Gross Profit 6,444 9,246 9,502 11,154 36,346 Net Earnings 183 1,384 1,405 2,700 5,672 Net Earnings Per Share .07 .49 .50 .97 2.03 Dividends Per Share .175 .175 .175 .175 .70 Stock Price Range: High 24 1/4 23 5/8 21 1/4 25 25 Low 19 3/8 17 18 3/8 21 3/8 17 Based on average shares outstanding for the period. In thousands of dollars except per share and stock price range statistics. (1) 17 Management's Discussion and Analysis of Financial Condition and Results of Operations RESULTS OF OPERATIONS NET SALES, NEW ORDERS AND BACKLOG Sales for 1996 continued the upward trend of the past three years but at a rate below that of the previous year. The increased demand occurred in most markets, but was most evident in the marine pleasure craft and commercial markets. The multi-year trend of order rate and backlog improvement ended in fiscal year 1996 with order rates stabilizing early in the year and moderating during the last fiscal quarter. Net sales for 1996 were $176 million, an increase of 7 percent over the $164 million reported in 1995, and 25 percent above the $141 million in 1994. The recovery begun in 1994 strengthened worldwide in 1995 with the pleasure craft and commercial marine, light construction equipment, agricultural tractor, and specialty vehicle markets all providing support for increased domestic and European production volume. In 1996, the demand from marine and construction equipment markets continued, and there was new interest in modulating clutches for marine and environmental applications overseas. Shipments from our overseas marketing subsidiaries in 1995 were up approximately 8 percent from the previous year and increased by about 10 percent in the year just completed. In 1995, sales gains were realized in Arneson surface drives and higher-horsepower marine transmissions for the Australian fish boat market. There also was continuing improvement in the volume of transmissions sold through our South African subsidiary to the agricultural tractor market. The 1996 sales gains of about 10 percent from these subsidiaries continued to be driven by the marine market with some moderation in the agricultural tractor business. The six-month order backlog (orders to be shipped within the following six months) showed a modestly improving trend through fiscal year 1994, but during 1995 order rates improved considerably. The 53 percent improvement in six- month backlog from $47 million to $72 million during the year was continuous and strong. Order rates were steady through most of fiscal 1996 and closely matched our shipping rates. However, due to higher shipments and lower order rates during the fourth quarter, the six-month backlog declined to $66 million at year-end, down 9 percent for the year. For several years prior to fiscal 1995, the fluctuation in foreign currency exchange rates had little impact on the dollar sales. However, in fiscal 1995 the dollar weakened significantly against the currencies of most of the countries in which the Company operates, most notably about 15 percent against European currencies. That decline in the dollar's value helped boost reported sales and accounted for about one-half of the offshore sales increase in 1995. In 1996, exchange rate fluctuations again were relatively small and did not have a significant impact on dollar sales. Price increases, which were implemented selectively in each year, had the overall effect of increasing revenues by a rate about equal to the rate of inflation. MARGINS, COSTS AND EXPENSES There have been continuing efforts during the past three years to adjust manpower requirements and to restructure manufacturing facilities to establish a foundation for more efficient operations. Most of the recent activity has been at our domestic operations. A voluntary separation program for hourly (19) employees in early 1994 and rearrangement of machine tools into cells during much of the past three years have been the principal activities. While those efforts caused some inefficiencies during the period, we recently have begun to realize the benefits of the changes. The gross margin increased by more than 2 percentage points in 1995, caused 18 primarily by the increased domestic sales volume. The European margin also improved in 1995 as a result of higher volume and greater productivity, but those gains were partially offset by the effects of the decline in the value of the U.S. dollar. The weaker dollar put pressure on profit margins since much of the incremental demand was in dollar denominated sales. Fortunately, our Belgian employees were able to achieve greater productivity to offset some of the margin loss. The consolidated gross margin increased an additional 1 percentage point in 1996 primarily as a result of good productivity and a favorable product mix at our Belgian operation. Domestic margins improved during the last quarter of the fiscal year, but were slightly lower for the full year. A charge was made in the first quarter to cover the costs associated with a salaried employee voluntary separation program, but savings later in the year offset much of that expense. The factory rearrangement was completed in the second fiscal quarter, but there was a mid-year production and shipping disruption caused by the installation of new computer hardware and business systems software in November. Marketing, engineering, and administrative (MEA)expenses for fiscal year 1995 increased by almost 16 percent over 1994 but declined as a percent of sales. Principal components of the increase were computer leasing and training costs associated with the planned new business systems, weakness of the dollar exchange rates, and expenses associated with domestic operational changes. In 1996, the MEA expenses increased by 8 percent, about the same as the sales growth. Increases were due primarily to the addition of marketing and engineering personnel, higher computer related expense, and additional product promotion and other marketing expense. INTEREST, TAXES AND NET EARNINGS Interest expense increased significantly in 1995 as a result of both higher bank rates and greater domestic borrowing. The incremental debt was related to a business acquisition made early in the fiscal year. In 1996, there was another large increase in interest expense which was attributed about equally to higher domestic debt and payment of interest related to the audit of prior years' tax returns. As discussed in more detail below, additional debt was required to finance the working capital increase. The effective income tax rate of 12 percent in 1994 was well below normal and resulted from the utilization of foreign tax credits to offset the domestic tax liability. The effective income tax rate returned to a more normal range in 1995 but was still somewhat below historical figures as we again were able to utilize a small amount of foreign tax credit. There was a further increase of five percentage points in the effective tax rate in 1996 due primarily to the proportionately greater foreign earnings on which a higher tax rate is applied. The Financial Accounting Standards Board recently issued Statement of Accounting Standard 123, "Accounting for Stock Based Compensation", which is addressed in Footnote J to the consolidated financial statements. ACQUISITIONS Twin Disc purchased the stock of Marine Diffusion, SRL, an Italian company active in the distribution of the Arneson surface drive in May 1995. The company, renamed Twin Disc Italia, SRL, provides sales and service for the full range of Twin Disc products and improves product visibility and service capability for our European customers. (20) In February 1996, the Company entered into an agreement with Doen Marine Pty., Melbourne, giving Twin Disc the right to manufacture and market the Doen line of axial-flow water jet propulsion systems for boats. The water jets will be manufactured in Racine and will complement our line of marine transmissions, surface drives, and electronic control systems. 19 LIQUIDITY AND CAPITAL RESOURCES Operating cash flows for 1995 increased to $7.6 million with some working capital increases, primarily inventory, partially offsetting the cash flow generated by improved net earnings. The operating cash flows and $1.4 million of net additional borrowing provided funds to invest in business acquisitions, purchase capital equipment and pay dividends. In 1996, the net cash from operating activities was a deficit of $4.8 million. Despite the higher earnings, working capital increases more than offset the positive cash flows. Receivables as a percent of net sales rose two percentage points from last year, but most of that increase was due to the high domestic shipments in June. Inventory, at higher levels throughout the year, declined during the fourth quarter and, as a percent of sales, ended the year at about the same rate as in 1995. Also, current liabilities were down from the prior year due to lower trade payables and a decline in the amount of current pension liabilities. During the year we took advantage of relatively low interest rates to convert $20 million of our revolving bank credit into fixed rate 10- year private placement debt. This will provide a stable financial base for future development and growth. Overall debt rose by $11 million in 1996 to cover increased working capital and purchase of the water jet license. Fixed asset purchases in 1995 and 1996 were less than depreciation. We will continue to make the changes necessary to enhance our manufacturing capability and expect future spending will exceed depreciation somewhat in order to support more efficient manufacture of current and newly developed product. With the increase in current assets and decline in liabilities, the current ratio at June 30, 1996 rose to 3.0, up from 2.5 at the previous two year- ends. Working capital increased by $6 million in 1995, generally reflecting the funds required to support the higher sales volume. Further increases of $9 million in 1996 related to the higher sales volume and the reduction of current liabilities discussed above. The Company is involved in various stages of investigation relative to hazardous waste sites on the United States EPA National Priorities List. It is not possible at this time to determine the ultimate outcome of those matters; but, as discussed further in footnote O to the audited financial statements, they are not expected to affect materially the Company's operations, financial position, or cash flows. The Company believes the capital resources available in the form of existing cash, lines of credit and funds provided by operations will be adequate to meet anticipated requirements for capital expenditures and other foreseeable business requirements in the future. (21) 20 TWIN DISC, INCORPORATED AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS JUNE 30, 1996 and 1995 (In thousands) 1996 1995 ---- ---- ASSETS Current assets: Cash and cash equivalents $ 2,043 $ 3,741 Trade accounts receivable, net 34,917 29,247 Inventories 51,083 47,157 Deferred income taxes 2,710 3,865 Other 5,887 6,480 ------- ------- Total current assets 96,640 90,490 Property, plant and equipment, net 35,715 37,348 Investment in affiliates 12,079 14,249 Deferred income taxes 3,758 4,119 Intangible pension asset 8,079 8,293 Other assets 6,428 3,802 ------- ------- $162,699 $158,301 ------- ------- ------- ------- LIABILITIES and SHAREHOLDERS' EQUITY Current liabilities: Notes payable $ 7,360 $ 2,415 Accounts payable 8,806 12,395 Accrued liabilities 17,836 22,042 ------- ------- Total current liabilities 34,002 36,852 Long-term debt 19,938 14,000 Accrued retirement benefits 33,578 32,827 ------- ------- 87,518 83,679 Shareholders' equity: Common shares authorized: 15,000,000; issued: 3,643,630; no par value 11,653 11,653 Preferred shares authorized: 200,000 - - Retained earnings 71,658 67,054 Cumulative adjustments 9,706 13,797 ------- ------- 93,017 92,504 Less treasury stock, at cost 17,836 17,882 ------- ------- Total shareholders' equity 75,181 74,622 ------- ------- $162,699 $158,301 ------- ------- ------- ------- The notes to consolidated financial statements are an integral part of these statements. (22) 21 TWIN DISC, INCORPORATED and SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS for the years ended June 30, 1996, 1995 and 1994 (In thousands, except per share data) 1996 1995 1994 ---- ---- ---- Net sales $176,657 $164,232 $141,193 Cost of goods sold 135,780 127,886 113,404 ------- ------- ------- Gross profit 40,877 36,346 27,789 Marketing, engineering and administrative expenses 28,706 26,461 22,840 ------- ------- ------- Earnings from operations 12,171 9,885 4,949 Other income (expense): Interest income 121 186 173 Interest expense (1,942) (1,281) (733) Equity in earnings of affiliates 45 186 522 Other, net 512 (392) 56 ------- ------- ------- (1,264) (1,301) 18 ------- ------- ------- Earnings before income taxes 10,907 8,584 4,967 Income taxes 4,348 2,912 578 ------- ------- ------- Net earnings $ 6,559 $ 5,672 $ 4,389 ------- ------- ------- ------- ------- ------- Earnings per common share, based on weighted average shares outstanding $ 2.36 $ 2.03 $ 1.57 ------- ------- ------- ------- ------- ------- Weighted average shares outstanding 2,777 2,790 2,799 ------- ------- ------- ------- ------- ------- The notes to consolidated financial statements are an integral part of these statements. (23) 22 TWIN DISC, INCORPORATED and SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS for the years ended June 30, 1996, 1995 and 1994 (In thousands) 1996 1995 1994 ---- ---- ---- Cash flows from operating activities: Net earnings $ 6,559 $ 5,672 $ 4,389 Adjustments to reconcile to net cash provided by operating activities: Depreciation and amortization 5,233 4,847 4,726 Gain (loss)on sale of fixed assets (26) 65 (185) Equity in earnings of affiliates (45) (186) (522) Provision for deferred income taxes 1,646 1,038 (161) Changes in operating assets and liabilities: Trade accounts receivable, net (6,055) (2,266) (66) Inventories (3,926) (3,259) 1,969 Other assets (987) (3,608) (1,842) Accounts payable (3,513) 3,765 501 Accrued liabilities (3,231) 1,170 (570) Deferred retirement plan (336) 337 (1,099) ------- ------- ------- Net cash provided (used) by operating activities (4,681) 7,575 7,140 ------- ------- ------- Cash flows from investing activities: Proceeds from sale of plant assets 18 39 1,126 Dividends received from affiliate 548 371 342 Acquisitions of plant assets (4,140) (4,290) (4,216) Payments for business acquisitions and investment in affiliates - (3,172) - Payment for license agreement (2,402) - - ------- ------- ------- Net cash used by investing activities (5,976) (7,052) (2,748) ------- ------- ------- Cash flows from financing activities: Increases (decreases) in notes payable, net 5,076 (1,113) 262 Proceeds from long-term debt 19,914 2,500 - Principal payments on long-term debt (14,000) - (1,500) Acquisition of treasury stock - (586) - Proceeds from exercise of stock options 35 71 - Dividends paid (1,943) (1,951) (1,960) ------- ------- ------- Net cash provided (used) by financing activities 9,082 (1,079) (3,198) ------- ------- ------- Effect of exchange rate changes on cash (123) 131 69 ------- ------- ------- Net change in cash and cash equivalents (1,698) (425) 1,263 Cash and cash equivalents: Beginning of year 3,741 4,166 2,903 ------- ------- ------- End of year $ 2,043 $ 3,741 $ 4,166 ------- ------- ------- ------- ------- ------- The notes to consolidated financial statements are an integral part of these statements. (24) 23 TWIN DISC, INCORPORATED and SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY for the years ended June 30, 1996, 1995 and 1994 (In thousands) 1996 1995 1994 ---- ---- ---- Common stock Balance, June 30 $ 11,653 $ 11,653 $ 11,653 ------- ------- ------- Retained earnings Balance, July 1 67,054 63,353 60,924 Net earnings 6,559 5,672 4,389 Cash dividends (1,943) (1,951) (1,960) Stock options exercised (12) (20) - ------- ------- ------- Balance, June 30 71,658 67,054 63,353 ------- ------- ------- Treasury stock, at cost Balance, July 1 (17,882) (17,387) (17,387) Shares acquired - (586) - Stock options exercised 46 91 - ------- ------- ------- Balance, June 30 (17,836) (17,882) (17,387) ------- ------- ------- Cumulative adjustments Balance, July 1 13,797 7,778 6,219 Foreign currency translation adjustment (3,755) 5,352 2,510 Minimum pension liability adjustment, net (336) 667 (951) ------- ------- ------- Balance, June 30 9,706 13,797 7,778 ------- ------- ------- Shareholders' equity balance, June 30 $ 75,181 $ 74,622 $ 65,397 ------- ------- ------- ------- ------- ------- The notes to consolidated financial statements are an integral part of these statements. (25) 24 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS A. SIGNIFICANT ACCOUNTING POLICIES The following is a summary of the significant accounting policies followed in the preparation of these financial statements: Consolidation Principles--The consolidated financial statements include the accounts of Twin Disc, Incorporated and its subsidiaries, all of which are wholly owned. Certain foreign subsidiaries are included based on fiscal years ending May 31, to facilitate prompt reporting of consolidated accounts. All significant intercompany transactions have been eliminated. Revenue Recognition--Revenues are recognized when products are shipped. Investment In Affiliates--The Company's 25% investments in affiliates are stated at cost, adjusted for equity in undistributed earnings since acquisition. Translation Of Foreign Currencies--Substantially all foreign currency balance sheet accounts are translated into United States dollars at the rates of exchange prevailing at year-end. Revenues and expenses are translated at average rates of exchange in effect during the year. Foreign currency translation adjustments are recorded as a component of shareholders' equity. Gains and losses from foreign currency transactions are included in earnings. Cash Equivalents--The Company considers all highly liquid marketable securities purchased with a maturity date of three months or less to be cash equivalents. Receivables--Trade accounts receivable are stated net of an allowance for doubtful accounts of $372,000 and $409,000 at June 30, 1996 and 1995, respectively. Inventories--Inventories are valued at the lower of cost or market. Cost has been determined by the last-in, first-out (LIFO) method for parent company inventories, and by the first-in, first-out (FIFO) method for other inventories. Property, Plant and Equipment and Depreciation--Assets are stated at cost. Expenditures for maintenance, repairs and minor renewals are charged against earnings as incurred. Expenditures for major renewals and betterments are capitalized and amortized by depreciation charges. 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 equipment, the cost of the asset and the related accumulated depreciation are removed from the accounts and the resulting gain or loss is reflected in earnings. Fully depreciated assets are not removed from the accounts until physical disposition. Management Estimates--The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual amounts could differ from those estimates. Fair Value of Financial Instruments--The carrying amount reported in the consolidated balance sheets for cash and cash equivalents, accounts receivable, accounts payable and short-term debt approximates fair value because of the immediate short-term maturity of these financial instruments. The carrying amount reported for long-term debt approximates fair value because the underlying instrument bears interest at a current market rate. 25 Income Taxes--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 the temporary differences are expected to reverse. (26) The Company does not provide for taxes which would be payable if undistributed earnings of its foreign subsidiaries or its foreign affiliate were remitted because the Company either considers these earnings to be invested for an indefinite period or anticipates that if such earnings were distributed, the U. S. income taxes payable would be substantially offset by foreign tax credits. Reclassification--Certain amounts in the consolidated financial statements for prior years have been reclassified to conform to the 1996 presentation. B. INVENTORIES The major classes of inventories at June 30 were as follows: (In thousands) 1996 1995 ---- ---- Finished parts $41,535 $32,887 Work-in-process 5,429 7,849 Raw materials 4,119 6,421 ------- ------- $51,083 $47,157 ------- ------- ------- ------- Inventories stated on a LIFO basis represent approximately 36% of total inventories at June 30, 1996 and 1995. The approximate current cost of the LIFO inventories exceeded the LIFO cost by $17,171,000 and $16,782,000 at June 30, 1996 and 1995, respectively. C. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment at June 30 were as follows: (In thousands) 1996 1995 ---- ---- Land $ 1,399 $ 1,406 Buildings 19,082 19,366 Machinery and equipment 88,182 88,675 ------- ------- 108,663 109,447 Less accumulated depreciation 72,948 72,099 ------- ------- $35,715 $37,348 ------- ------- ------- ------- D. BUSINESS SEGMENTS AND FOREIGN OPERATIONS The Company and its subsidiaries are engaged in one line of business, the manufacture and sale of power transmission equipment. Transfers among geographic areas are made at established intercompany selling prices. Principal products include industrial clutches, hydraulic torque converters, fluid couplings, power-shift transmissions, marine transmissions, universal joints, power take-offs, and reduction gears. The Company sells to both domestic and foreign customers in a variety of market areas, principally 26 construction, industrial, marine, energy and natural resources and agricultural. One customer accounted for approximately 10%, 12% and 13% of consolidated net sales in 1996, 1995 and 1994, respectively. (27) Information about the Company's operations in different geographic areas for the years ended June 30, 1996, 1995 and 1994 is summarized as follows: (In thousands) 1996 1995 1994 ---- ---- ---- Sales to unaffiliated customers: United States $120,137 $108,607 $ 95,331 Foreign: Europe 34,206 35,572 27,222 Other 22,314 20,053 18,640 ------- ------- ------- Total $176,657 $164,232 $141,193 ------- ------- ------- ------- ------- ------- Transfers between geographic areas: United States $ 30,230 $ 26,167 $ 24,003 Foreign: Europe 23,130 15,024 10,508 Other 322 361 132 ------- ------- ------- Total $ 53,682 $ 41,552 $ 34,643 ------- ------- ------- ------- ------- ------- Net sales: United States $150,367 $134,774 $119,334 Foreign: Europe 57,336 50,596 37,730 Other 22,636 20,414 18,772 Eliminations (53,682) (41,552) (34,643) ------- ------- ------- Total $176,657 $164,232 $141,193 ------- ------- ------- ------- ------- ------- Earnings before income taxes: United States $ 2,821 $ 4,332 $ 1,500 Foreign: Europe 6,126 2,635 1,513 Other 1,960 1,617 1,954 ------- ------- ------- Total $ 10,907 $ 8,584 $ 4,967 ------- ------- ------- ------- ------- ------- Identifiable assets at June 30: United States $117,552 $106,971 $ 98,945 Foreign: Europe 36,356 39,537 30,778 Other 12,794 10,269 9,814 Eliminations (4,003) 1,524 4,379 ------- ------- ------- Total $162,699 $158,301 $143,916 ------- ------- ------- ------- ------- ------- Net earnings of the foreign subsidiaries were $4,758,000,$2,480,000 and $2,365,000 in 1996, 1995 and 1994, respectively. The net assets of the foreign subsidiaries were $32,085,000 and $32,368,000 at June 30, 1996 and 1995, respectively. Undistributed earnings of foreign subsidiaries, on which no provisions for United States income taxes have been made, aggregated approximately $22,949,000 (including $5,170,000 translation component) at June (28) 27 30, 1996. Included in earnings are foreign currency transaction gains (losses) of $409,000, $(248,000) and $21,000 in 1996, 1995 and 1994, respectively. E. INVESTMENTS IN AFFILIATES The Company's investments in affiliates consists of 25% interests in Niigata Converter Company, Ltd., Japan and Palmer Johnson Distributors, LLC, a domestic distributor of Twin Disc products. The Company acquired the interest in Palmer Johnson Distributors, LLC, in July 1994. Undistributed earnings of the affiliates included in consolidated retained earnings approximated $3,120,000 and $3,623,000 at June 30, 1996 and 1995, respectively. Combined condensed financial data of the above-listed affiliates are summarized in U.S. dollars as follows: (In thousands) 1996 1995 ---- ---- Current assets $104,949 $111,393 Other assets 51,263 63,898 ------- ------- $156,212 $175,291 ------- ------- ------- ------- Current liabilities $100,153 $100,836 Other liabilities 14,622 24,693 Shareholders' equity 41,437 49,762 ------- ------- $156,212 $175,291 ------- ------- ------- ------- 1996 1995 1994 ---- ---- ---- Net sales $183,487 $169,256 $152,728 Gross profit 23,436 26,173 21,864 Net earnings 181 742 2,087 F. ACCRUED LIABILITIES Accrued liabilities at June 30 were as follows: (In thousands) 1996 1995 ---- ---- Salaries and wages $ 5,756 $ 6,476 Retirement plans 4,122 7,818 Other 7,958 7,748 ------- ------- $ 17,836 $ 22,042 ------- ------- ------- ------- (29) G. DEBT Short-term notes payable consists of amounts borrowed under line of credit agreements. Unused lines of credit total $11,632,000 at June 30, 1996. These lines of credit are available predominately at the LIBOR rate and may be 28 withdrawn at the option of the banks. The weighted average interest rate of short-term lines outstanding at June 30, 1996 and 1995 was 8.4% and 9.4%, respectively. Prior to June 1996, the Company maintained a three-year revolving credit agreement (the "Agreement") for borrowings of up to $16 million. The Agreement provided that the Company could select among various loan arrangements with interest based on the LIBOR or prime rates. The Company paid a commitment fee of 3/8 of 1% annually on the unused portion of the Agreement. In June 1996, the Company issued $20 million of 7.37% ten-year notes in a private placement offering, net of $86,000 unamortized debt issuance costs. Principal payments of $2,857,000 are due in the years 2000 through 2005, with the remaining balance due on June 1, 2006. Cash paid for interest was $1,802,000, $1,288,000 and $771,000 in 1996, 1995 and 1994, respectively. H. LEASE COMMITMENTS Approximate future minimum rental commitments under noncancellable operating leases are as follows: Fiscal Year (In thousands) ----------- ------------ 1997 $ 2,000 1998 1,693 1999 1,245 2000 738 2001 469 Thereafter 229 ----- $ 6,374 ----- ----- Total rent expense for operating leases approximated $2,109,000, $1,939,000 and $1,633,000 in 1996, 1995 and 1994, respectively. I. SHAREHOLDERS' EQUITY At June 30, 1996 and 1995, treasury stock consisted of 866,356 and 868,606 shares of common stock, respectively. The Company issued 2,250 shares of treasury stock in 1996 to fulfill its obligations under the stock option plans. The difference between the cost of treasury shares issued and the option price is charged to retained earnings. Cash dividends per share were $.70 in 1996, 1995 and 1994. (30) In 1988, the Company's Board of Directors established a Shareholder Rights Plan and distributed to shareholders of record on July 1, 1988, one preferred stock purchase right for each outstanding share of common stock. Under certain circumstances, a right may be exercised to purchase one one-hundredth of a share of Series A Junior Preferred Stock at an exercise price of $80, subject to certain anti-dilution adjustments. The rights become exercisable ten (10) days after a public announcement that a party or group has either acquired at least 20%, (or at least 30% in the case of existing holders who currently own 20% or more of the common stock), or commenced a tender offer for at least 30%, of the Company's common stock. Generally, after the rights become exercisable, if the Company is a party to certain merger or business combination transactions, or transfers 50% or more of its assets or earnings power, or certain other events occur, each right will entitle its holders, other than the acquiring person, to buy a number of shares of common stock of the Company, or of the other party to the transaction, having a value of twice 29 the exercise price of the right. The rights expire June 30, 1998 and may be redeemed by the Company for $.05 per right at any time until ten (10) days following the stock acquisition date. The Company has designated 50,000 shares of the preferred stock for the purpose of a Shareholder Rights Plan. J. STOCK OPTION PLANS The Company has a non-qualified stock option plan for officers, key employees and directors to purchase up to 125,000 shares of common stock, and an incentive stock option plan for officers and key employees to purchase up to 225,000 shares of common stock. The plans are administered by the Executive Selection and Compensation Committee of the Board of Directors which has the authority to determine which officers and key employees of the Company will be granted options. The grant of options to non-employee directors is fixed and based on such directors' seniority. All options allow for the purchase of common stock at prices not less than the fair market value at the date of grant, except for options under the incentive stock option plan if the optionee owns more than 10% of the total combined voting power of all classes of the Company's stock, in which case the option price will be not less than 110% of the fair market value of such stock. Options granted under the plans become exercisable immediately and expire ten years after the date of grant, unless the employee owns more than 10% of the total combined voting power of all classes of the Company's stock, in which case they must be exercised within five years of the date of grant. Shares available for future options as of June 30 were as follows: 1996 1995 ---- ---- Non-qualified stock option plan 28,650 42,550 Incentive stock option plan 67,500 89,150 (31) Stock option transactions under the plans during 1996 and 1995 were as follows: 1996 1995 ---- ---- Non-qualified stock option plan: Options outstanding at beginning of year 81,450 71,550 Granted 13,900 12,600 Cancelled - (1,700) Exercised ($17.88-$19.50 per share) - (1,000) ------- ------- Options outstanding at June 30 95,350 81,450 ------- ------- ------- ------- Options price range at June 30 $ 14.00 - $ 14.00 - 29.63 29.63 Incentive stock option plan: Options outstanding at beginning of year 132,050 118,550 Granted 25,050 24,450 Cancelled (3,400) (7,550) Exercised ($14.00-$19.50 per share) (2,250) (3,400) 30 ------- ------- Options outstanding at June 30 151,450 132,050 ------- ------- ------- ------- Options price range at June 30 $ 14.00 - $ 14.00 - 29.63 29.63 The Company is required to adopt the pro forma disclosure requirements of SFAS No. 123, "Accounting for Stock Based Compensation," in fiscal year 1997. In the current fiscal year, the Company accounted for its stock option plan under the provisions of Accounting Principles Board Opinion No. 25. K. 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 charges for ongoing efforts to refine existing products. Research and development costs charged to operations totalled $2,564,000, $2,718,000 and $2,649,000 in 1996, 1995 and 1994, respectively. Total engineering and development costs were $6,998,000, $7,411,000 and $6,843,000 in 1996, 1995 and 1994, respectively. L. INCOME TAXES United States and foreign earnings before income taxes were as follows: (In thousands) 1996 1995 1994 ---- ---- ---- United States $ 2,821 $ 4,332 $ 1,500 Foreign 8,086 4,252 3,467 ------ ------ ------ $10,907 $ 8,584 $ 4,967 ------ ------ ------ ------ ------ ------ (32) The provision (credit) for income taxes is comprised of the following: (In thousands) 1996 1995 1994 ---- ---- ---- Currently payable: Federal $ 829 $ 782 $ (112) State 78 12 39 Foreign 1,925 1,007 812 ------ ------ ------ 2,832 1,801 739 ------ ------ ------ Deferred: Federal 388 452 (150) State (54) 12 - Foreign 1,182 647 (11) ------ ------ ------ 1,516 1,111 (161) ------ ------ ------ $ 4,348 $ 2,912 $ 578 ------ ------ ------ ------ ------ ------ The components of the net deferred tax asset as of June 30, were as follows: 31 (In thousands) 1996 1995 ---- ---- Deferred tax assets: Retirement plans and employer benefits $ 9,971 $10,878 Research and development expenses 926 205 Other 1,550 1,205 Foreign net operating loss carryforwards 380 1,823 Foreign tax credit carryforwards 292 2,150 R&E tax credit carryforwards 335 250 Alternative minimum tax credit carryforwards 1,223 979 Valuation allowance - (1,430) ------ ------ 14,677 16,060 ------ ------ Deferred tax liabilities: Fixed assets 6,368 6,771 Other 1,841 1,305 ------ ------ 8,209 8,076 ------ ------ Total net deferred tax assets $ 6,468 $ 7,984 ------ ------ ------ ------ [CAPTION] (33) The Company previously recorded a valuation allowance to reflect the estimated amount of deferred tax assets which may not be realized due to the expiration of net operating loss and tax credit carryforwards. The change in the valuation allowance is as follows: (In thousands) 1996 1995 ---- ---- Balance at July 1 $(1,430) $(2,453) Utilization of foreign net operating loss carryforwards - 139 Utilization of foreign tax credit carryforwards 1,430 884 ------ ------ Balance at June 30 $ - $(1,430) ------ ------ ------ ------ Following is a reconciliation of the applicable U.S. federal income tax rate to the effective tax rates reflected in the statements of operations: 1996 1995 1994 ---- ---- ---- U.S. federal income tax rate 34.0% 34.0% 34.0% Increases (reductions) in tax rate resulting from: Utilization of net operating loss carryforwards - (1.6) (12.2) Foreign tax items 4.2 (1.8) (13.8) Employee benefits - foreign - 1.8 3.2 Other, net 1.7 1.5 0.4 ---- ---- ---- 39.9% 33.9% 11.6% ---- ---- ---- ---- ---- ---- At June 30, 1996, net operating loss carryforwards of approximately $900,000 were available for reduction of future foreign income taxes payable at Twin Disc International, S. A. Cash paid for income taxes was $4,946,000, $2,698,000 and $1,636,000 in 1996, 32 1995 and 1994, respectively. M. RETIREMENT PLANS The Company has noncontributory, qualified defined benefit pension plans covering substantially all domestic employees and contributory plans covering certain foreign employees. Domestic plan benefits are based on years of service, and for salaried employees on final average compensation. 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 contributed for federal income tax purposes. Domestic plan assets consist principally of listed equity and fixed income securities. In addition, the Company has unfunded, non-qualified retirement plans for certain management employees and directors. Benefits are based on final average compensation and do not vest until such management employee reaches normal retirement with the Company. (34) Net pension expense for the Company's domestic defined benefit plans consists of the following components: (In thousands) 1996 1995 1994 ---- ---- ---- Service cost-benefits earned during the year $ 1,529 $ 1,585 $ 1,382 Interest cost on projected benefit obligation 6,823 6,643 6,518 Actual return on plan assets (9,956) (3,835) (1,882) Net amortization and deferral 5,304 (588) (2,432) ------ ------ ------ Net pension cost $ 3,700 $ 3,805 $ 3,586 ------ ------ ------ ------ ------ ------ The following table sets forth the Company's domestic defined benefit plans' funded status and the amounts recognized in the Company's balance sheet as of June 30: (In thousands) 1996 1995 ---- ---- Actuarial present value of benefit obligations: Vested benefit obligation $ 70,042 $ 63,804 Non-vested benefit obligation 15,683 14,622 ------- ------- Accumulated benefit obligation 85,725 78,426 Effect of projected future compensation levels 4,622 4,475 ------- ------- Projected benefit obligation 90,347 82,901 Plan assets at fair value (73,422) (64,110) ------ ------ Deficiency of plan assets compared to projected benefit obligation 16,925 18,791 Unrecognized net loss (4,042) (2,139) Unrecognized prior service cost (8,656) (9,651) Unrecognized transitional net liability (667) (799) Adjustment required to recognize additional minimum liability 9,095 8,758 ------- ------- Accrued retirement cost at June 30 $ 12,655 $ 14,960 ------- ------- ------- ------- 33 Assumptions used in accounting for the retirement plans are as follows: 1996 1995 ---- ---- Discount rate 7.8% 8.5% Rate of increase in compensation levels 4.5% 4.5% Expected long-term rate of return on plan assets 9.0% 9.0% (35) Total accrued retirement costs at June 30 are summarized as follows: (In thousands) 1996 1995 ---- ---- Current: Domestic defined benefit plans $ 1,156 $ 3,907 Foreign contributory benefit plans 673 1,092 ------ ------ 1,829 4,999 Long-term: Domestic defined benefit plans 11,499 11,053 ------ ------ $13,328 $16,052 ------ ------ ------ ------ Retirement plan expense for the Company's foreign plans was $597,000, $307,000 and $246,000 in 1996, 1995 and 1994, respectively. The Company sponsors defined contribution plans covering substantially all domestic employees. These plans provide for employer contributions based primarily on employee participation. The total expense under the plans was $1,056,000, $906,000 and $933,000 in 1996, 1995 and 1994, respectively. In addition to providing pension benefits, the Company provides health care and life insurance benefits for certain domestic retirees. In 1993, the Company executed amendments to the health care insurance plan to require all employees retiring after December 31, 1992, and electing to continue coverage through the Company's group plan, to pay 100% of the premium cost. The Company recognized $2,680,000, $2,841,000 and $2,193,000 in non-pension postretirement benefit expense in 1996, 1995 and 1994, respectively, which consists primarily of interest cost. The following table sets forth the status of the postretirement benefit programs (other than pensions) and amounts recognized in the Company's consolidated balance sheet at June 30: (In thousands) 1996 1995 ---- ---- Accumulated postretirement benefit obligation: Retirees $28,077 $29,993 Fully eligible active plan participants 433 387 Other active participants 471 393 ------ ------ 28,981 30,773 Unamortized net amount resulting from changes in plan experience and actuarial assumptions (4,279) (6,222) ------ ------ Accrued postretirement benefit obligation $24,702 $24,551 ------ ------ ------ ------ 34 The current portion of the accumulated postretirement benefit obligation of $2,293,000 and $2,680,000 is included in accrued liabilities at June 30, 1996 and 1995, respectively. The assumed weighted average discount rate used in determining the actuarial present value of the accumulated postretirement benefit obligation was 7.75% and 8% at June 30, 1996 and 1995, respectively. The assumed weighted average health care cost trend rate was 10% in fiscal year 1996, decreasing by 1% each year thereafter until it reaches 7% in fiscal year 1999, and remains constant thereafter. A 1% increase in the assumed health care trend would increase the accumulated postretirement benefit obligation by approximately $1.9 million and the interest cost by approximately $154,000. (36) N. ACQUISITION Effective January 1, 1995, the Company purchased all outstanding stock of Marine Diffusion SRL, an Italian distributor of Twin Disc products and other marine components and assemblies. The purchase price ($172,000) approximated the fair value of assets acquired. The purchase method of accounting was applied to the above transaction. The results of operations of the acquisition are included in the accompanying consolidated financial statements since the date of acquisition. Pro forma results of operations are not presented as the amounts do not significantly differ from historical results. O. CONTINGENCIES The Company is involved in various stages of investigation relative to hazardous waste sites, two of which are on the United States EPA National Priorities List (Superfund sites). The Company's assigned responsibility at each of the Superfund sites is less than 2%. The Company has also been requested to provide administrative information related to two other potential Superfund sites but has not yet been identified as a potentially responsible party. Additionally, the Company is subject to certain product liability matters. At June 30, 1996, the Company has accrued approximately $1,200,000, which represents the best estimate available for the possible losses. This amount has been accrued over the past several years. Based on the information available, the Company does not expect that any unrecorded liability related to these matters would materially affect the consolidated financial position, results of operations or cash flows. (37) 35 REPORT OF INDEPENDENT ACCOUNTANTS To the Shareholders Twin Disc, Incorporated Racine, Wisconsin We have audited the accompanying consolidated balance sheets of Twin Disc, Incorporated and Subsidiaries as of June 30, 1996 and 1995, and the related consolidated statements of operations, changes in shareholders' equity, and cash flows for each of the three years in the period ended June 30, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Twin Disc, Incorporated and Subsidiaries as of June 30, 1996 and 1995, and the consolidated results of their operations and their cash flows for each of the three years in the period ended June 30, 1996 in conformity with generally accepted accounting principles. COOPERS & LYBRAND L.L.P. Milwaukee, Wisconsin July 26, 1996 (39) 36 FINANCIAL SUMMARY 1996 1995 1994 1993 1992 (In thousands of dollars, except where noted) Statement of Operations Net sales $176,657 $164,232 $141,193 $139,403 $136,255 Costs and expenses, including marketing, engineering and administrative 164,486 154,347 136,244 135,284 134,242 Earnings from operations 12,171 9,885 4,949 4,119 2,013 Other income (expense) (1,264) (1,301) 18 (95) (162) Earnings before income taxes 10,907 8,584 4,967 4,024 1,851 Income taxes 4,348 2,912 578 1,362 810 Net earnings 6,559 5,672 4,389 2,662 1,041 Overseas operations Sales 55,520 55,625 45,862 44,766 45,668 Earnings (loss) 4,758 2,480 2,365 1,673 (478) Balance Sheet Assets Cash and equivalents 2,043 3,741 4,166 2,903 2,987 Receivables, net 34,917 29,247 25,682 25,106 26,026 Inventories 51,083 47,157 41,569 42,562 36,686 Other current assets 8,597 10,345 8,993 6,961 4,521 Total current assets 96,640 90,490 80,410 77,532 70,220 Investments and other assets 30,344 30,463 26,830 21,813 10,554 Fixed assets less accumulated depreciation 35,715 37,348 36,676 37,560 38,724 Total assets 162,699 158,301 143,916 136,905 119,498 Net assets overseas 32,085 32,368 29,580 28,059 30,477 Liabilities and Shareholders' Equity Current liabilities 34,002 36,852 32,710 31,252 35,694 Long-term debt 19,938 14,000 11,500 13,000 - Deferred liabilities 33,578 32,827 34,309 31,244 7,365 Shareholders' equity 75,181 74,622 65,397 61,409 76,439 Total liabilities and shareholders' equity 162,699 158,301 143,916 136,905 119,498 1993 Net Earnings data and Return percentages reflect operating earnings before the effect of adopting Financial Accounting Standards 106 and 109. The cumulative effect of their adoption was a net loss of $14.44 million or $5.16 per share. (40-41) 37 FINANCIAL SUMMARY (CONTINUED) 1996 1995 1994 1993 1992 (In thousands of dollars, except where noted) Comparative Financial Information Per share statistics Net earnings 2.36 2.03 1.57 .95 .37 Dividends .70 .70 .70 .70 .70 Shareholders' equity 27.07 26.75 23.36 21.93 27.10 Return on equity 8.7% 7.6% 6.7% 4.3% 1.4% Return on assets 4.0% 3.6% 3.0% 1.9% .9% Return on sales 3.7% 3.5% 3.1% 1.9% .8% Average shares outstanding 2,776,805 2,790,111 2,799,390 2,799,603 2,820 513 Number of shareholder accounts 913 996 1,058 1,139 1,214 Number of employees 1,080 1,097 1,099 1,114 1,221 Additions to plant and equipment 4,140 4,290 4,216 4,684 4,390 Depreciation 5,071 4,792 4,670 4,958 5,452 Net working capital 62,638 53,638 47,700 46,280 34,526 1993 Net Earnings data and Return percentages reflect operating earnings before the effect of adopting Financial Accounting Standards 106 and 109. The cumulative effect of their adoption was a net loss of $14.44 million or $5.16 per share. (40-41) 38 DIRECTORS MICHAEL E. BATTEN Chairman, Chief Executive Officer WILLIAM W. GOESSEL Retired Chairman and former Chief Executive Officer, Harnischfeger Industries, Incorporated, (Manufacturer of Cranes, Mining Equipment and Papermaking Machines), Milwaukee, Wisconsin JEROME K. GREEN Former Group Vice President, The Marmon Group, (A Diversified Manufacturer), Chicago, Illinois MICHAEL H. JOYCE President, Chief Operating Officer JOHN L. MURRAY Retired Chairman-Chief Executive Officer, Universal Foods Corporation, (Manufacturer and Marketer of Food Ingredients and Specialty Foods), Milwaukee, Wisconsin JAMES O. PARRISH Vice President-Finance & Treasurer PAUL J. POWERS Chairman, President-Chief Executive Officer, Commercial Intertech Corp., (Manufacturer of Hydraulic Components, Fluid Purification Products, Pre-Engineered Buildings and Stamped Metal Products), Youngstown, Ohio RICHARD T. SAVAGE President-Chief Executive Officer, Modine Manufacturing Company, (Manufacturer of Heat Exchange Equipment), Racine, Wisconsin DAVID L. SWIFT Retired Chairman, President-Chief Executive Officer, Acme-Cleveland Corporation, (Manufacturer of Diversified Industrial Products), Pepper Pike, Ohio STUART W. TISDALE Retired Chairman-Chief Executive Officer, WICOR, Inc. (Parent Company of Wisconsin Gas Company, Sta-Rite Industries, Incorporated and WEXCO of Delaware, Incorporated), Milwaukee, Wisconsin DAVID R. ZIMMER President-Chief Executive Officer, Core Industries, Inc., (Manufacturer of Specialized Products for Electronics, Fluid Controls, Construction and Farm Equipment Markets), Bloomfield Hills, Michigan (42) 39 OFFICERS MICHAEL E. BATTEN Chairman, Chief Executive Officer MICHAEL H. JOYCE President, Chief Operating Officer JAMES O. PARRISH Vice President-Finance & Treasurer PHILIPPE PECRIAUX Vice President-Europe JAMES MCINDOE Vice President-International Marketing LANCE J. MELIK Vice President-Corporate Development MICHAEL J. HABLEWITZ Vice President-Quality Assurance FRED H. TIMM Corporate Controller & Secretary PAUL A. PELLIGRINO Vice President-Engineering JOHN W. SPANO Vice President-Sales and Marketing DARRELL J. OLSON Vice President-Human Resources (43) 40 CORPORATE DATA ANNUAL MEETING Corporate Offices, 2:00 PM, October 18, 1996 SHARES TRADED New York Stock Exchange: Symbol TDI ANNUAL REPORT ON SECURITIES AND EXCHANGE COMMISSION FORM 10-K SINGLE COPIES OF THE COMPANY'S 1996 ANNUAL REPORT ON SECURITIES AND EXCHANGE COMMISSION FORM 10-K WILL BE PROVIDED WITHOUT CHARGE TO SHAREHOLDERS AFTER SEPTEMBER 30, 1996, UPON WRITTEN REQUEST DIRECTED TO THE SECRETARY, TWIN DISC, INCORPORATED, 1328 RACINE STREET, RACINE, WISCONSIN 53403. TRANSFER AGENT & REGISTRAR Firstar Trust Company, Milwaukee, Wisconsin INDEPENDENT ACCOUNTANTS Coopers & Lybrand L.L.P., Milwaukee, Wisconsin GENERAL COUNSEL von Briesen, Purtell, & Roper, S.C., Milwaukee, Wisconsin CORPORATE OFFICES Twin Disc, Incorporated, Racine, Wisconsin 53403, Telephone: (414) 638-4100 WHOLLY OWNED SUBSIDIARIES Twin Disc International S.A., Nivelles, Belgium Twin Disc Spain, S.A., Madrid, Spain Twin Disc Italia S.R.L., Viareggio, Italy Twin Disc (Pacific) Pty. ltd., Brisbane, Queensland, Australia Twin Disc (Far East) Ltd., Singapore Twin Disc (South Africa) Pty. Ltd., Johannesburg, South Africa Mill-Log Equipment Co., Inc., Coburg, Oregon Southern Diesel Systems Inc., Miami, Florida TD Electronics, Inc., Loves Park, Illinois PARTIALLY OWNED AFFILIATES Niigata Converter Company, Ltd., Kamo, Omiya and Tokyo, Japan Palmer Johnson Distributors, LLC, Sturgeon Bay, Wisconsin MANUFACTURING FACILITIES Racine, Wisconsin; Nivelles, Belgium; Kamo and Omiya Japan SALES OFFICES DOMESTIC Racine, Wisconsin; Coburg, Oregon; Seattle, Washington; Miami, Florida; Jacksonville, Florida OVERSEAS Nivelles, Belgium; Brisbane and Perth Australia; Singapore; Johannesburg, South Africa; Madrid, Spain; Viareggio, Italy AFFILIATES Tokyo, Japan; Sturgeon Bay, Wisconsin MANUFACTURING LICENSES Niigata Converter Company, Ltd., Tokyo, Japan; Transfluid S.R.L., Milan, Italy; Nakamura Jico Co. Ltd., Tokyo, Japan; Hindustan Motors, Ltd., Madras, India (44)