BASIS OF PRESENTATION AND

SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The consolidated financial statements and information included in this Annual Report on Form

-K (“Form

-K”) include the financial results of Veth Propulsion Holding B.V. (“Veth Propulsion”) for the period beginning

July 2, 2018

through

June 30, 2019.

The financial results included in this Form

-K related to the acquisition method accounting for the Veth Propulsion acquisition have been finalized. See Note B, Acquisition of Veth Propulsion Holding B.V., for further information about the acquisition and related transactions and the acquisition accounting.

Significant Accounting Policies

The following is a summary of the significant accounting policies followed in the preparation of these financial statements:

Consolidation Principles

--The consolidated financial statements include the accounts of Twin Disc, Incorporated and its wholly and majority-owned domestic and foreign subsidiaries (the “Company”). Certain foreign subsidiaries are included based on fiscal years ending

May 31,

to facilitate prompt reporting of consolidated accounts. The Company also has a controlling interest in a Japanese joint venture, which is consolidated based upon a fiscal year ending

March 31.

All significant intercompany transactions have been eliminated.

Management Estimates--

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual amounts could differ from those estimates.

Translation of Foreign Currencies

--The financial statements of the Company’s non-U.S. subsidiaries are translated using the current exchange rate for assets and liabilities and the weighted-average exchange rate for the year for revenues and expenses. The resulting translation adjustments are recorded as a component of accumulated other comprehensive loss, which is included in equity. Gains and losses from foreign currency transactions are included in earnings. Included in other income (expense) are foreign currency transaction losses of (

$681

) and (

$198

) in fiscal

2019

and

2018,

respectively.

Cash

--The Company considers all highly liquid investments with original maturities of

three

months or less to be cash equivalent. Under the Company’s cash management system, cash balances at certain banks are funded when checks are presented for payment. To the extent that checks issued, but

not

yet presented for payment, exceed the balance on hand at the specific bank against which they were written, the amount of those un-presented checks is included in accounts payable.

Accounts

Receivable

--These represent trade accounts receivable and are stated net of an allowance for doubtful accounts of

$1,582

and

$1,478

June 30, 2019

and

2018,

respectively. The Company records an allowance for doubtful accounts for certain customers where a risk of default has been specifically identified as well as provisions determined on a general basis when it is believed that some default is probable and estimable. The assessment of likelihood of customer default is based on a variety of factors, including the length of time the receivables are past due, the historical collection experience and existing economic conditions. Various factors

may

adversely impact its customer’s ability to access sufficient liquidity and capital to fund their operations and render the Company’s estimation of customer defaults inherently uncertain. While the Company believes current allowances for doubtful accounts are adequate, it is possible that these factors

may

cause higher levels of customer defaults and bad debt expense in future periods.

Fair Value of Financial Instruments

--The carrying amount reported in the consolidated balance sheets for cash, trade accounts receivable and accounts payable approximate fair value because of the immediate short-term maturity of these financial instruments

If measured at fair value, cash would be classified as Level

and all other items listed above would be classified as Level

in the fair value hierarchy, as defined in Note O, Pension and Other Postretirement Benefit Plans. The Company’s borrowings under the revolving loan agreement, which is classified as long-term debt and consists of loans that are routinely borrowed and repaid throughout the year, approximate fair value at

June 30, 2019.

The Company’s term loan borrowing, which is LIBOR-based, approximates fair value at

June 30, 2019.

If measured at fair value in the financial statements, long-term debt (including any current portion) would be classified as Level

in the fair value hierarchy.

Derivative Financial Instruments

The Company has written policies and procedures that place all financial instruments under the direction of the Company’s corporate treasury department and restrict all derivative transactions to those intended for hedging purposes. The use of financial instruments for trading purposes is prohibited. The Company uses derivative financial instruments to manage certain financial risks. The Company enters into forward contracts to reduce the earnings and cash flow impact of non-functional currency denominated receivables and payables. The Company uses interest rate swap contracts to reduce the exposure to variability in interest rates on floating debt borrowings. The Company designates certain financial instruments as cash flow hedges for accounting purposes. See Note T, Derivative Financial Instruments, for additional information.

Inventories

--Inventories are valued at the lower of cost or net realizable value. Cost has been determined by the last-in,

first

-out (LIFO) method for the majority of inventories located in the United States, and by the

first

-in,

first

-out (FIFO) method for all other inventories. Management specifically identifies obsolete products and analyzes historical usage, forecasted production based on future orders, demand forecasts, and economic trends, among others, when evaluating the adequacy of the reserve for excess and obsolete inventory.

Property, Plant and Equipment and Depreciation

--Assets are stated at cost. Expenditures for maintenance, repairs and minor renewals are charged against earnings as incurred. Expenditures for major renewals and betterments are capitalized and depreciated. Depreciation is provided on the straight-line method over the estimated useful lives of the assets. The lives assigned to buildings and related improvements range from

years, and the lives assigned to machinery and equipment range from

years. Upon disposal of property, plant and equipment, the cost of the asset and the related accumulated depreciation are removed from the accounts and the resulting gain or loss is reflected in earnings. Fully depreciated assets are

not

removed from the accounts until physically disposed.

Impairment of Long-lived Assets

--The Company reviews long-lived assets for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets

may

not

be fully recoverable. For property, plant and equipment and other long-lived assets, excluding indefinite-lived intangible assets, the Company performs undiscounted operating cash flow analyses to determine if an impairment exists. If an impairment is determined to exist, any related impairment loss is calculated based on fair value. Fair value is primarily determined using discounted cash flow analyses; however, other methods

may

be used to determine the fair value, including

third

party valuations when necessary.

Goodwill and Other Intangibles

--Goodwill and other indefinite-lived intangible assets, primarily tradenames, are tested for impairment at least annually during the Company’s

fourth

fiscal quarter and more frequently if an event occurs which indicates the asset

may

be impaired. If applicable, goodwill and other indefinite-lived intangible assets

not

subject to amortization have been assigned to reporting units for purposes of impairment testing based upon the relative fair value of the asset to each reporting unit.

A significant amount of judgment is involved in determining if an indicator of impairment has occurred. Such indicators

may

include, among others: a significant decline in expected future cash flows; a sustained, significant decline in the Company’s stock price and market capitalization; a significant adverse change in legal factors or in the business climate; unanticipated competition; the testing for recoverability of a significant asset group within a reporting unit; and slower growth rates. Any adverse change in these factors could have a significant impact on the recoverability of these assets and could have a material impact on the Company’s consolidated financial statements.

Goodwill impairment charges are recorded using a simplified

one

-step approach. The fair value of a reporting unit, as defined, is compared to the carrying value of the reporting unit, including goodwill. The fair value is primarily determined using discounted cash flow analyses which is driven by projected growth rates, and which applies an appropriate market-participant discount rate; the fair value determined is also compared to the value obtained using a market approach from guideline public company multiples. If the carrying amount exceeds the fair value, that difference is recognized as an impairment loss.

In fiscal

2018

and prior years, the annual testing date was the last day of the fiscal year. In fiscal

2019,

the Company changed its annual testing date to the

first

day of the Company’s

fourth

fiscal quarter in order to provide the Company more time and better information to perform the analyses. The Company does

not

believe that this change constitutes a material change to the method in applying an accounting principle.

The Company conducted interim qualitative assessments throughout the year, and its annual assessment for goodwill impairment as of

March 30, 2019

and

June 30, 2018

using updated inputs, including appropriate risk-based, country and company specific weighted average discount rates for the Company’s reporting units.

The fair value of the Company’s other intangible assets with indefinite lives, primarily tradenames, is estimated using the relief-from-royalty method, which requires assumptions related to projected revenues; assumed royalty rates that could be payable if the Company did

not

own the asset; and a discount rate. The Company completed the impairment testing of indefinite-lived intangibles as of

June 30, 2019

and concluded there were

impairments.

Changes in circumstances, existing at the measurement date or at other times in the future, or in the numerous estimates associated with management’s judgments, assumptions and estimates made in assessing the fair value of goodwill and other indefinite-lived intangibles, could result in an impairment charge in the future. The Company will continue to monitor all significant estimates and impairment indicators, and will perform interim impairment reviews as necessary.

Any cost incurred to extend or renew the term of an indefinite lived intangible asset are expensed as incurred.

Income

Taxes

--The Company recognizes deferred tax assets and liabilities for the expected future income tax consequences of events that have been recognized in the Company’s financial statements. Under this method, deferred tax assets and liabilities are determined based on the temporary differences between the financial statement carrying amounts and the tax bases of assets and liabilities using enacted tax rates in effect in the years in which temporary differences are expected to reverse. Valuation allowances are provided for deferred tax assets where it is considered more likely than

not

that the Company will

not

realize the benefit of such assets. The Company evaluates its uncertain tax positions as new information becomes available. Tax benefits are recognized to the extent a position is more likely than

not

to be sustained upon examination by the taxing authority.

Revenue Recognition

--Revenue from contracts with customers is recognized using a

five

-step model consisting of the following: (

) identify the contract with a customer; (

) identify the performance obligations in the contract; (

) determine the transaction price; (

) allocate the transaction price to the performance obligations in the contract; and (

) recognize revenue when (or as) the Company satisfies a performance obligation. Performance obligations are satisfied when the Company transfers control of a good or service to a customer, which can occur over time or at a point in time. The amount of revenue recognized is based on the consideration to which the Company expects to be entitled in exchange for those goods or services, including the expected value of variable consideration. The customer’s ability and intent to pay the transaction price is assessed in determining whether a contract exists with the customer. If collectibility of substantially all of the consideration in a contract is

not

probable, consideration received is

not

recognized as revenue unless the consideration is nonrefundable and the Company

longer has an obligation to transfer additional goods or services to the customer or collectibility becomes probable.

Goods sold to

third

party distributors are subject to an annual return policy, for which a provision is made at the time of shipment based upon historical experience.

Shipping and Handling Fees and Costs

--The Company records revenue from shipping and handling costs in net sales. The cost associated with shipping and handling of products is reflected in cost of goods sold.

Recently Adopted Accounting Standards

May 2014,

the Financial Accounting Standards Board (“FASB”) issued updated guidance (ASU

2014

) on revenue from contracts with customers. This revenue recognition guidance supersedes existing guidance, including industry-specific guidance. The core principle is that an entity should recognize revenue to depict the transfer of control over promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance identifies steps to apply in achieving this principle. The Company adopted this guidance effective

July 1, 2018,

using the modified retrospective method. Prior periods presented were

not

retrospectively adjusted for this change. The Company has applied the new revenue recognition standard only to contracts that were

not

completed as of

July 1, 2018.

The Company determined that deferral of revenue is appropriate for certain agreements where the performance of services after product delivery is required. Such services primarily pertain to technical commissioning services by its entities in its marine and propulsion business, whereby the Company’s technicians calibrate the controls and transmission to ensure proper performance for the customer’s specific application. This service helps identify issues with the ship's design or performance that need to be remediated by the ship builder or other component suppliers prior to the ship being officially accepted into service by the ship buyer. The cumulative effect adjustment of adopting the new standard is

not

significant to the Company’s results of operations and financial condition.

February 2016,

the FASB issued guidance (ASU

2016

) which replaces the existing guidance for leases. The new standard establishes a right-of-use (“ROU”) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than

months. The Company elected to early adopt the standard effective

July 1, 2018

concurrent with the adoption of ASU

2014

09,

Revenue from Contracts with Customers, using the modified retrospective approach at the beginning of the earliest comparative period presented in the financial statements, which required the Company to restate each prior reporting period presented.

For operating leases in which the Company is a lessee, the Company concluded that all existing operating leases under the old guidance continue to be classified as operating leases under the new guidance, and all existing capital leases under the old guidance are classified as finance leases under the new guidance. The Company excluded any lease contracts with terms of

twelve

months or less as of the adoption date. The Company has lease agreements with lease and non-lease components, which are generally accounted for as separate lease components. The Company accounts for short-term leases on a straight-line basis over the lease term.

The following table presents the effect of the adoption of ASU

2016

on the Company’s condensed consolidated balance sheet as of

June 30, 2018:

	June 30, 2018		Adoption		June 30, 2018
	As Reported		Impact		Restated
Property, plant and equipment, net	$	48,940	$	6,527	$	55,467
Lease obligations		-		6,527		6,527

The adoption of ASU

2014

and ASU

2016

did

not

have an impact on the Company’s consolidated statement of operations and comprehensive income or consolidated statement of cash flows for the year ended

June 30, 2018.

March 2017,

the FASB issued guidance (ASU

2017

) intended to improve the presentation of net periodic pension cost and net periodic postretirement cost. This guidance requires that an employer report the service cost component in the same line item as other compensation costs arising from services rendered by the pertinent employees during the period. The other components of net benefit cost are required to be presented in the statement of operations separately from the service cost component and outside the subtotal of income from operations. The Company adopted this guidance effective

July 1, 2018

on a retrospective basis, which resulted in the reclassification of certain amounts from cost of goods sold and marketing, engineering and administrative expenses to other income (expense), net in the condensed consolidated statements of operations and comprehensive income. As a result, prior period amounts impacted have been revised accordingly. There was

impact to net income.

The following table presents the effect of the adoption of ASU

2017

on the Company’s condensed consolidated statements of operations and comprehensive income for the year ended

June 30, 2018:

	For the Year Ended
	June 30, 2018			Adoption			June 30, 2018
	As Reported			Impact			Restated
Cost of goods sold	$	160,497		$	(405	)	$	160,092
Gross profit		80,236			405			80,641
Marketing, engineering and administrative expenses		61,909			(814	)		61,095
Income from operations		14,929			1,219			16,148
Other income (expense), net		(282	)		(1,219	)		(1,501	)

February 2018,

the FASB issued guidance (ASU

2018

) intended to eliminate the stranded tax effects resulting from the Tax Cuts and Jobs Act by allowing a reclassification from accumulated other comprehensive income to retained earnings. The Company elected to early adopt this guidance effective

July 1, 2018

by making a reclassification of

$6,903

from accumulated other comprehensive loss to retained earnings.

October 2016,

the FASB issued updated guidance (ASU

2016

) that changes the recognition of income tax consequences of an intra-entity transfer of an asset other than inventory. The Company adopted this guidance effective

July 1, 2018.

The adoption of this guidance did

not

have a material impact on the Company’s financial statements and disclosures.

August 2016,

the FASB issued updated guidance (ASU

2016

) that addresses

eight

specific cash flow issues with the objective of reducing the existing diversity in practice. The Company adopted this guidance effective

July 1, 2018.

The adoption of this guidance did

not

have a material impact on the Company’s financial statements and disclosures.

August 2017,

the FASB issued ASU

2017

12,

Derivatives and Hedging (ASC

815

) - Targeted Improvements to Accounting for Hedging Activities. The amendments in this guidance better align an entity’s risk management activities and financial reporting for hedging relationships through changes to both the designation and measurement guidance for qualifying hedging relationships and the presentation of hedge results. The Company elected to early adopt this standard during the

fourth

quarter of fiscal

2019.

The adoption of this guidance did

not

have a material impact on the Company’s financial statements and disclosures.

August 2018,

the SEC issued Release

No.

10532,

Disclosure Update and Simplification. In addition to eliminating certain disclosure requirements, this release also amends the interim financial statement requirements to require provision of the information required by Regulation S-

Rule

for the current and comparative year-to-date periods, with subtotals for each interim period. Rule

requires a reconciliation of stockholders’ equity beginning and ending balances for each period for which a statement of comprehensive income is required to be filed. The Company adopted this guidance during the Company’s

second

quarter of fiscal year

2019.

The adoption of this guidance did

not

have a material impact on the Company’s disclosures.

New Accounting Releases

June 2018,

the FASB issued guidance (ASU

2018

) intended to simplify the accounting for share based payments granted to nonemployees. Under the amendments in this guidance, payments to nonemployees would be aligned with the requirements for share based payments granted to employees. The amendments in this guidance are effective for fiscal years, and interim periods within those fiscal years, beginning after

December 15, 2018, (

the Company’s fiscal

2020

), including interim periods within that fiscal year. The Company is currently evaluating the potential impact of this guidance on the Company’s financial statements and disclosures.

August 2018,

the FASB issued updated guidance (ASU

2018

) as part of the disclosure framework project, which focuses on improving the effectiveness of disclosures in the notes to the financial statements. The amendments in this update modify the disclosure requirements on fair value measurements in Topic

820,

Fair Value Measurement. The amendments in this guidance are effective for fiscal years, and interim periods within those fiscal years, beginning after

December 15, 2019 (

the Company’s fiscal

2021

), with early adoption permitted. The Company is currently evaluating the potential impact of this guidance on the Company’s disclosures.

August 2018,

the FASB issued updated guidance (ASU

2018

) intended to modify the disclosure requirements for employers that sponsor defined pension or postretirement plans. The amendments in this guidance are effective for fiscal years ending after

December 15, 2020 (

the Company’s fiscal

2021

), with early adoption permitted. The Company is currently evaluating the potential impact of this guidance on the Company’s disclosures.

Special Note Regarding Smaller Reporting Company Status

June 2018,

the SEC issued Release

10513;

83550,

Amendments to Smaller Reporting Company Definition, which changed the definition of a smaller reporting company in Rule

12b

of the Securities Exchange Act of

1934,

as amended. Under this release, the new thresholds for qualifying are (

) public float of less than

$250

million or (

) annual revenue of less than

$100

million and public float of less than

$700

million (including

public float). The rule change was effective on

September 10, 2018,

the Company’s

first

fiscal quarter of fiscal year

2019.

The Company continues to qualify as a smaller reporting company based on its public float as of the last business day of its

second

fiscal quarter of fiscal year

2019.

A smaller reporting company

may

choose to comply with scaled or non-scaled financial and non-financial disclosure requirements on an item-by-item basis. The Company has scaled some of its disclosures of financial and non-financial information in this annual report. The Company

may

determine to provide 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.