Item 7. Management’s Discussion and Analysis
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
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 2026. 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
This report contains statements (including but not limited to certain statements in Items 1, 3, and 7) that are forward-looking as defined by the Securities and Exchange Commission in its rules, regulations and releases. 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. These statements are based on management’s current expectations that are based on assumptions that are subject to risks and uncertainties. Actual results may vary because of variations between these assumptions and actual performance. 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.
The Company intends that such forward-looking statements qualify for the safe harbors from liability established by the Private Securities Litigation Reform Act of 1995. 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. Accordingly, the making of such statements should not be regarded as a representation by the Company or any other person that the results expressed therein will be achieved. The Company assumes no obligation, and disclaims any obligation, to publicly update or revise any forward-looking statements to reflect subsequent events, new information, or otherwise.
Fiscal 2026 Compared to Fiscal 2025
Net Sales
Net sales for fiscal 2026 increased 11.9%, or $40.5 million, to $381.3 million from $340.7 million in fiscal 2025. The Company’s acquisition of Kobelt in the third fiscal quarter of fiscal 2025 contributed approximately $7.6 million of incremental revenue. Excluding the impact of this acquisition, the Company’s revenue grew by 9.7% in fiscal 2026, as strong growth in the Veth product combined with growing global military demand for both marine and industrial products, along with generally strong market conditions. Currency translation had a favorable impact on fiscal 2026 sales compared to the prior year totaling $17.2 million, primarily due to the strengthening of the euro against the U.S. dollar.
Sales for our manufacturing segment increased 15.2%, or $44.9 million, versus the same period last year. The Company’s Veth propulsion operation in the Netherlands experienced an 16.4% increase in sales compared to fiscal 2025. The primary driver for this increase remains growing demand through market and geographic penetration for the Company’s innovative propulsion solutions around the globe, along with improving supply chain and operational performance. The Company’s Katsa operation in Finland experienced an increase of 30.8%, with acceleration in demand from European military applications. The Company’s domestic manufacturing operation experienced a 3.8% increase in sales in fiscal 2026, driven in part by some improvement in oil and gas demand. The Company’s Italian manufacturing operations reported a 29.9% increase in sales from fiscal 2025, with a positive currency impact combining with an improved European industrial demand. The Company’s Belgian manufacturing operation saw a 7.7% decrease in sales from fiscal 2025 with softer demand from domestic customers due to the impact of tariffs. The Company’s Swiss manufacturing operation, which supplies customized propellers for the global mega yacht and patrol boat markets, experienced a 45.9% increase in sales compared to fiscal 2025, primarily due to the collaboration with Veth driving improved pleasure craft demand.
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Sales for our distribution segment were down 11.6%, or $15.2 million, compared to fiscal 2025. The Company’s Asian distribution operations in Singapore, China and Japan experienced a 7.8% decrease in sales on somewhat softer demand for energy related products in China. The Company’s North American distribution operation saw a 32.0% decrease on weaker domestic demand for marine products from the European operations due primarily to the impact of tariffs. The Company’s European distribution operation was down 19.0% from the prior year, driven by weaker European demand. The Company’s distribution operation in Australia and New Zealand, which provides boat accessories, propulsion and marine transmission systems for the pleasure craft market, saw a slight increase in revenue (2.3%) on consistent demand for pleasure craft products in the region.
Net sales for the Company’s marine transmission and propulsion systems were up 13.2% in fiscal 2026 compared to the prior fiscal year. This increase reflects generally strong market conditions, continued global growth of the Veth product, the addition of the Kobelt product line for the full fiscal year and improved military demand for marine transmissions. In the off-highway transmission market, the year-over-year increase of 11.9% can be attributed primarily to an increase in global demand for energy related products. The increase experienced in the Company’s industrial products of 11.0% was a function of stronger demand in the North American construction and recycling markets, along with the addition of the Kobelt product line for the full fiscal year.
Geographically, sales to the U.S. and Canada improved 23% in fiscal 2026 compared to fiscal 2025, representing 29.7% of consolidated sales for fiscal 2026 compared to 27.0% in fiscal 2025. The increase is primarily due to the addition of Kobelt, improving Veth demand in the region, improved industrial sales and strong oil and gas related shipments in the fourth quarter. Sales into the Asia Pacific market decreased 3.1% compared to fiscal 2025 and represented approximately 19.2% of sales in fiscal 2026, compared to 22.2% in fiscal 2025. The decrease in fiscal 2026 reflects softening demand for the Company’s oil and gas transmissions in the Chinese market. Sales into the European market improved approximately 16% from fiscal 2025 levels while accounting for 42% of consolidated net sales in fiscal 2026 compared to 41% of net sales in fiscal 2025. The growth is primarily the result of strong demand for the Company’s Veth and Katsa products. 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
Considering the impact of the inventory valuation accounting method change from LIFO to FIFO, which increased prior-year gross profit by approximately $1.2 million, fiscal 2026 gross profit increased $8.6 million, or 9.2%, to $102.6 million on a sales increase of $40.5 million. Gross profit as a percentage of sales decreased 70 basis points in fiscal 2026 to 26.9%, compared to 27.6% in fiscal 2025.
In addition to the impact of the accounting method change from LIFO to FIFO discussed above, several other factors affected the Company’s overall gross profit rate in fiscal 2026. Gross profit for the year was primarily impacted by improved volumes (approximately $11.0 million). This was offset by a less favorable product mix (approximately $1.2 million), primarily related to reduced aftermarket demand and growth in lower margin products. The Company’s margin percentage was diluted by approximately 50 basis points in the year due to the invoicing of tariffs with no margin ($1.9 million). The remaining increase ($1.9 million) is the result of price realization, cost reduction efforts, improved productivity and other adjustments at our operating facilities.
Marketing, Engineering and Administrative (ME&A) Expenses
Marketing, engineering, and administrative (ME&A) expenses of $84.5 million were up $2.1 million, or 2.5%, in fiscal 2026 compared to the prior fiscal year. As a percentage of sales, ME&A expenses decreased to 22.2% of sales versus 24.2% of sales in fiscal 2025. The increase in ME&A spending in fiscal 2026 compared to the prior year was primarily driven by the addition of the Kobelt operations for a full year ($1.4 million), an inflationary increase to salaries and benefits ($1.0 million) and a currency translation effect ($2.5 million). These increases were partially offset by reductions to the global bonus expense ($1.1 million), lower depreciation and amortization ($1.0 million) and other cost savings ($0.8 million).
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Restructuring of Operations
During the course of fiscal 2026 and fiscal 2025 the Company incurred $0.4 million and $0.4 million in restructuring charges, respectively. 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.
Interest Expense
Interest expense of $3.1 million for fiscal 2026 was $0.4 million higher than fiscal 2025 due to an increased average balance following the two recently completed acquisitions.
Other Income, Net
In fiscal 2026, other expense, net, of $1.3 million decreased by $4.0 million from the prior fiscal year other expense, net, of $5.5 million. This change is primarily due to a decrease in currency translation losses ($6.5 million), offset by an increase in defined benefit pension amortization ($2.0 million) and other miscellaneous items ($0.3 million).
Income Taxes
The effective tax rate for fiscal 2026 is (102.8%) compared to 113.6% for fiscal 2025.
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. During fiscal 2026, the Company reassessed the realizability of its deferred tax assets and concluded that substantially all of its U.S. valuation allowance was no longer required. As a result, the Company released the valuation allowance and recognized a corresponding income tax benefit. The Company's valuation allowance was $0.1 million and $16.5 million as of June 30, 2026 and 2025, respectively, with prior-year amounts adjusted to reflect the change in inventory valuation method.
Order Rates
As of June 30, 2026, the Company’s backlog of orders scheduled for shipment during the next six months (six-month backlog) was $178.3 million or approximately 18.5% higher than the six-month backlog of $150.5 million as of June 30, 2025. The increased backlog is primarily attributable to continued strength in order rates throughout the fiscal year, led by continued growth in demand for the Veth product, along with the addition of Kobelt backlog ($2.8 million).
Liquidity and Capital Resources
Fiscal Years 2026 and 2025
The net cash provided by operating activities in fiscal 2026 totaled $22.9 million, a decrease of $1.1 million from the prior fiscal year cash provided by operating activities of $24.0 million. The slight reduction in operating cash flow from the prior year was primarily due to an increase in trade receivables, offset by improved operating results and reduced inventory levels. The increase to trade receivables was volume driven, with the Company reporting a record revenue in the fourth quarter of fiscal 2026. The Company expects trade receivables to continue to move with revenue and will continue to focus on driving inventory reductions through fiscal 2027.
The net cash used by investing activities for fiscal 2026 primarily represents the acquisition of capital expenditures ($13.7 million). The capital spending amount reflects a decrease from the prior year, driven by some extended lead times on capital equipment.
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The net cash provided by financing activities relates primarily to additional borrowings to finance growth ($0.9 million). This was partially offset by payments for dividends ($2.7 million), payments on finance lease obligations ($1.2 million) and payments on stock compensation withholding taxes ($1.7 million). During fiscal 2026, 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
Current Credit Agreement
On June 30, 2026, Twin Disc, Incorporated (the “Company”) entered into a Credit Agreement (the “Credit Agreement”) among the Company, as Borrower; Kobelt Manufacturing Co. Ltd. ("Kobelt"), as Guarantor; Bank of Montreal, as a Lender, Administrative Agent, Swing Line Lender, and L/C Issuer; and JPMorgan Chase Bank, N.A. ("Chase"), as a Lender. The Credit Agreement refinanced and replaced the credit agreement dated February 14, 2025 among the Company, Kobelt, and Bank of Montreal. Capitalized terms in this Annual Report that are not otherwise defined herein are defined in the Credit Agreement.
Pursuant to the Credit Agreement, Bank of Montreal and Chase (the “Lenders”) made Term Loans to the Company in an aggregate principal amount of $30,000,000. The maturity date of the Term Loans is June 30, 2031, and the Company is required to make principal installments on the Term Loans of at least $375,000, per quarter (increasing to $562,500 per quarter for the quarter ending on or about September 30, 2028, and $750,000 per quarter for the quarter ending on or about September 30, 2030).
The Credit Agreement also allows the Company to enter into Revolving Loans with the Lenders from time to time prior to June 30, 2031 (the “Revolving Credit Termination Date”) in amounts not to exceed $60,000,000 (the “Revolving Credit Commitment”). The Revolving Credit Commitment includes a $5,000,000 sublimit for Swing Loans and a $4,000,000 sublimit for Letters of Credit that may be requested by the Company from time to time until the Revolving Credit Termination Date. Each Swing Loan or Letter of Credit provided pursuant to the terms of the Credit Agreement shall be a Revolving Loan provided under the Revolving Credit Commitment.
Interest rates under the Credit Agreement are based on the secured overnight financing rate (“SOFR”), the euro interbank offered rate (the “EURIBO Rate”), the Canadian Overnight Repo Rate Average (the “CORRA”), or a Base Rate based on the highest of the prime rate, federal funds rate, or Term SOFR. Loans under the Credit Agreement are designated as either as SOFR Loans, which accrue interest at a Term SOFR plus an Applicable Margin; Base Rate Loans, which accrue interest at the Base Rate plus an Applicable Margin; Eurodollar Loans, which accrue interest at the EURIBO Rate plus an Applicable Margin; Term CORRA Loans, which accrue interest at an Adjusted Term CORRA plus an Applicable Margin; Daily Compounded CORRA Loans, which accrue interest at a Daily Compounded CORRA plus an Applicable Margin; or Canadian Prime Rate Loans, which accrue interest at the Canadian Prime Rate plus an Applicable Margin. The Applicable Margin for Loans is between 1.50% and 3.00%, and the Applicable Margin for the Unused Revolving Credit Commitment is between 0.15% and 0.30% (each depending on the Company’s Total Funded Debt to EBITDA ratio). The Term Loan has been designated as a SOFR Loan.
Borrowings under the Credit Agreement are secured by substantially all of the Company’s and Kobelt’s personal property, including accounts receivable, inventory, machinery and equipment, and intellectual property. The Company has also pledged 65% of its equity interests in certain foreign subsidiaries. To effect these security interests, the Company entered into an Amended and Restated Security Agreement, Amended and Restated IP Security Agreement, Amended and Restated Pledge Agreement, and Amended and Restated Perfection Certificate with the Administrative Agent, and the Company has entered into an Amended Restated Agreement as to Liens and Encumbrances and an Amended and Restated Negative Pledge Agreement with the Administrative Agent with regard to the Company’s real property.
Upon the occurrence of an Event of Default, the Administrative Agent may take the following actions upon written notice to the Company: (1) terminate the remaining Commitments and all obligations of the Lenders under the Credit Agreement; (2) declare the principal and accrued interest of all Loans outstanding under the Credit Agreement to be immediately due and payable; and (3) demand the Company to immediately Cash Collateralize the outstanding L/C Obligations in an amount equal to 105% of the aggregate L/C Obligations. If such Event of Default is due to the Company’s bankruptcy, the actions and obligations listed above shall occur without notice to the Company.
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The Company remains in compliance with its liquidity and other covenants under the Credit Agreement.
Management believes that available cash, the Credit Agreement, the unsecured lines of credit, cash generated from future operations, and potential access to debt markets will be adequate to fund the Company's cash and capital requirements for the foreseeable future.
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 $60.0 million of available borrowings under the Credit Agreement as of June 30, 2026. 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, 2026, the Company also had cash of $16.0 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 2027, the Company expects to contribute $2.0 million to its defined benefit pension plans, the minimum contribution required.
Considering the impact of the inventory valuation accounting method change from LIFO to FIFO on the prior year adjusted numbers (an increase in inventory of approximately $32 million), in fiscal 2026, net working capital increased $6.4 million, or 4.2%, during fiscal 2026 and the current ratio (calculated as total current assets divided by total current liabilities) increased to 2.3 at June 30, 2026 compared to 2.2 for June 30, 2025.
Increases in trade receivables ($7.8 million), decrease in other current assets ($2.5 million) and decreases in trade accounts payable ($7.9 million) increased net working capital. These increases were partially offset by decreases in inventories, net ($6.1 million).
The Company expects capital expenditures to be approximately $23 million - $27 million in fiscal 2027. These anticipated expenditures reflect the Company’s plans to invest in modern equipment to drive growth, 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, 2026 are discussed in Note H, Lease Obligations in the notes to the consolidated financial statements in Part II, Item 8 of this 2026 Annual Report on Form 10-K. There are no material undisclosed guarantees. As of June 30, 2026, 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 2026 Annual Report on Form 10-K. Postretirement medical claims are paid by the Company as they are submitted, and they are anticipated to be $0.6 million in fiscal 2027 based on actuarial estimates; however, these amounts can vary significantly from year to year because the Company is self-insured. In fiscal 2027, the Company expects to contribute $2.0 million to its defined benefit pension plans, the minimum contribution required.
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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, Description of Business and Summary of 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:
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 discount rates as the significant assumption in determining the obligation as of that date. The approach used to determine the discount rates is based on FTSE Above Median Pension Discount Curve model at June 30, 2026, as applied to the expected payouts from the pension plans. This yield curve is made up of Corporate Bonds rated AA or better.
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 discount rates on an annual basis and makes modifications 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 discount rates used are reasonable; however, changes in the discount rates 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 takes into account such factors as prior earnings history, expected future earnings, carry-back and carry-forward periods, and tax strategies that could potentially enhance the likelihood of realization of a deferred tax asset. In addition, all other available positive and negative evidence is taken into consideration, including impacts of tax reform.
During fiscal 2026, the Company reassessed the realizability of its deferred tax assets and concluded that substantially all of its U.S. and state valuation allowance was no longer required. As a result, the Company released the valuation allowance and recognized a corresponding income tax benefit. The release was supported by the Company's sustained profitability, including a three-year cumulative income position, as well as tax planning strategies available to support the realization of deferred tax assets. The Company released $23.9 million of valuation allowance during fiscal 2026, of which $16.4 million was recognized as an income tax benefit in the Consolidated Statement of Operations and Comprehensive Income (Loss), and $7.4 million was recorded directly to retained earnings in connection with the change in inventory valuation method from LIFO to FIFO. The Company's valuation allowance was $0.1 million and $16.5 million as of June 30, 2026 and 2025, respectively, with prior-year amounts adjusted to reflect the change in inventory valuation method.
As of June 30, 2026, the identified tax planning strategies had been fully implemented. The Company's determination that substantially all of the valuation allowance was no longer required as of December 26, 2025 involved significant judgment and consideration of all available positive and negative evidence, including the prudence, feasibility, and expected implementation of the tax planning strategies.
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Recently Issued Accounting Standards
See Note A, Description of Business and Summary of Significant Accounting Policies, of the notes to the consolidated financial statements for a discussion of recently issued accounting standards.
Item 7A. Quantitative and Qualitative Disclosure About Market Risk
The Company is electing not to provide this disclosure due to its status as a Smaller Reporting Company.
Item 8. Financial Statements and Supplementary Data
See Consolidated Financial Statements and Financial Statement Schedule.
Item 9. Change in and Disagreements with Accountants on Accounting and Financial Disclosure
None.