SIFCO INDUSTRIES INC 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations Management’s Discussion and Analysis of Financial Condition and Results of Operations may contain various forward-looking statements and includes assumptions concerning the Company’s operations, future results and prospects. The words "will," "may," "designed to," "outlook," "believes," "should," "anticipates," "plans," "expects," "intends," "estimates," "forecasts" and similar expressions identify certain of these forward-looking statements. These forward-looking statements are based on current expectations and are subject to risk and uncertainties. In connection with the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, the Company provides this cautionary statement identifying important economic, political and technological factors, among others, the absence or effect of which could cause the actual results or events to differ materially from those set forth in or implied by the forward-looking statements and related assumptions. Such factors include the following: (1) the impact on business conditions in general, and on the demand for product in the aerospace and energy (or "A&E") industries in particular, of the global economic outlook, including the continuation of military spending at or near current levels and the availability of capital and liquidity from banks, the financial markets and other providers of credit; (2) the future business environment, including capital and consumer spending; (3) competitive factors, including the ability to replace business that may be lost at comparable margins; (4) metals and commodities price increases and the Company’s ability to recover such price increases; (5) successful development and market introduction of new products and services; (6) continued reliance on consumer acceptance of regional and business aircraft powered by more fuel efficient turboprop engines; (7) continued reliance on military spending, in general, and/or several major customers, in particular, for revenues; (8) the impact on future contributions to the Company’s defined benefit pension plans due to changes in actuarial assumptions, government regulations and the market value of plan assets; (9) stable governments, business conditions, laws, regulations and taxes in economies where business is conducted; (10) the ability to successfully integrate businesses that may be acquired into the Company’s operations; (11) cyber and other security threats or disruptions faced by us, our customers or our suppliers and other partners; (12) our exposure to additional risks as a result of our international business, including risks related to geopolitical and economic factors, suppliers, laws and regulations; (13) the ability to maintain a qualified workforce; (14) the adequacy and availability of our insurance coverage; (15) our ability to develop new products and technologies and maintain technologies, facilities, and equipment to win new competitions and meet the needs of our customers; (16) our ability to realize amounts in our backlog; (17) investigations, claims, disputes, enforcement actions, litigation and/or other legal proceedings; (18) extraordinary or force majeure events affecting the business or operations of our business; and (19) the impact of the novel COVID-19 pandemic and related impact on the global economy, which may exacerbate the above factors and/or impact our results of operations and financial condition. The Company is engaged in the production of forgings and machined components primarily for the A&E markets. The processes and services provided by the Company include forging, heat-treating, machining, subassembly, and test. The Company operates under one business segment. The Company endeavors to plan and evaluate its business operations while taking into consideration certain factors including the following: (i) the projected build rate for commercial, business and military aircraft, as well as the engines that power such aircraft; (ii) the projected maintenance, repair and overhaul schedules for commercial, business and military aircraft, as well as the engines that power such aircraft; and (iii) the projected build rate and repair for industrial turbines. The Company operates within a cost structure that includes a significant fixed component. Therefore, higher net sales volumes are expected to result in greater operating income because such higher volumes allow the business operations to better leverage the fixed component of their respective cost structures. Conversely, the opposite effect is expected to occur at lower net sales and related production volumes. 13 A. Results of Operations Overview The Company produces forged components for (i) turbine engines that power commercial, business and regional aircraft as well as military aircraft and other military applications; (ii) airframe applications for a variety of aircraft; (iii) industrial gas and steam turbine engines for power generation units; and (iv) other commercial applications. The novel coronavirus ("COVID-19") continues to impact the United States and other countries in which we operate, as well as the markets we service. The effects continue to evolve, including scope, severity and duration, as well as the potential of new outbreaks of the virus, the impact of new variants, actions to contain the continued spread or treat its impact, the effectiveness of the vaccine and vaccine rates, and governmental, business and other actions taken in response to the pandemic. The exact timing and pace of the recovery continues to be indeterminable as certain markets have reopened, some of which have since experienced a resurgence of COVID-19 cases, and, throughout the course of time, new variants of COVID-19 have been identified and spread significantly, resulting in additional restrictions put in place by certain governments around the world. Capital markets and economies worldwide continue to be negatively impacted by COVID-19 and, given the fluidity of the situation, it is still unclear how lasting and deep the economic impacts will be, specifically in relation to the commercial aerospace industry and energy industries. During the first quarter of fiscal 2022, COVID-19 continues to have an impact on the Company’s results of operations. The Company has been impacted by delays in receiving orders and delays in getting materials required to produce certain products. Due to the uncertain environment created by COVID-19, the Company has taken measures to reduce costs from time to time since the commencement of the COVID-19 pandemic (including during the first quarter of fiscal 2022) by furloughing certain of its employees from one of its plant locations that continues to experience reduced sales of commercial aerospace products. The employees furloughed in the first quarter of 2022 have since returned to work. The Company continues to actively monitor and find ways to mitigate the impact on its operations. Backlog of Orders SIFCO’s total backlog at December 31, 2021 was $75.7 million, compared with $81.1 million as of December 31, 2020. Orders may be subject to modification or cancellation by the customer with limited charges. Sales in the A&E markets continue to be impacted by COVID-19, which has created increased pressure in these markets and accordingly restrained sales in such markets. Backlog information may not be indicative of future sales. Net Sales Net sales comparative information for the first three months of fiscal 2022 and 2021 is as follows: (Dollars in millions) Three Months Ended December 31, Increase/ (Decrease) Net Sales 2021 2020 Aerospace components for: Fixed wing aircraft $ 9.9 $ 9.8 $ 0.1 Rotorcraft 3.5 7.7 (4.2) Energy components for power generation units 3.6 6.5 (2.9) Commercial product and other revenue 2.2 1.1 1.1 Total $ 19.2 $ 25.1 $ (5.9) Net sales for the first three months of fiscal 2022 decreased $5.9 million to $19.2 million, compared with $25.1 million in the comparable period of fiscal 2021. In general, the production of the Company's products have lead times of varying lengths. The varying lead times, coupled with constraints caused by pressures in timely obtaining raw materials, have contributed to the decline of sales year over year, along with the current state of the commercial aerospace market, in particular, the wide body market. Rotorcraft sales decreased $4.2 million compared with the same period last year due to delays in receiving customer orders and a decrease in build rates. The energy components for power generation units decreased by $2.9 million due to variability in the steam turbine market that we serve. Commercial products and other revenue increased $1.1 million in the first three months of fiscal 2022 compared to the same period in fiscal 2021, primarily due to the timing of orders. Commercial net sales were 43.4% of total net sales and military net sales were 56.6% of total net sales in the first three months of fiscal 2022, compared with 42.9% and 57.1%, respectively, in the comparable period in fiscal 2021. Military net sales decreased by $3.4 million to $10.9 million in the first three months of fiscal 2022, compared with $14.3 million in the comparable period of fiscal 2021, primarily due to delays in receiving customer orders and ability to timely get material to 14 produce parts. Commercial net sales decreased $2.4 million to $8.3 million in the first three months of fiscal 2022, compared with $10.7 million in the comparable period of fiscal 2021 primarily due to a decrease in energy components sales for power generation due to decreased demand in the market. Cost of Goods Sold Cost of goods sold decreased by $1.9 million, or 9.1%, to $19.2 million, or 99.9% of net sales, during the first three months of fiscal 2022, compared with $21.1 million or 84.4% of net sales, in the comparable period of fiscal 2021. The decrease is primarily due to lower volume and lower labor costs, partially offset by $1.2 million of idle expense and $0.3 million in higher natural gas costs. Prior year included approximately $0.5 million in insurance recoveries related to business interruption from the fire claim that occurred in December 2018 at the Orange, California ("Orange") location . Gross Profit Gross profit decreased $3.9 million to a breakeven amount in the first three months of fiscal 2022, compared with $3.9 million of gross profit in the comparable period of fiscal 2021. Gross margin percent of sales was nominal during the first three months of fiscal 2022, compared with 15.6% in the comparable period in fiscal 2021. The decrease in gross profit was primarily due to decreased volume and higher costs as described above. Selling, General and Administrative Expenses Selling, general and administrative expenses were $3.5 million, or 18.4% of net sales during the first three months of fiscal 2022, compared with $3.8 million, or 15.3% of net sales in the comparable period of fiscal 2021. The decrease in selling, general and administrative expenses is due to $0.2 million in lower commissions. Amortization of Intangibles Amortization of intangibles was $0.1 million in the first three months of fiscal 2022, compared with $0.3 million in the comparable period of fiscal 2021. Such decrease was primarily due to certain intangible assets which became fully amortized. Other/General Prior year results included a $2.5 million gain in insurance recoveries related to the assets that were damaged in the fire at the Orange location that occurred in December 2018. The following table sets forth the weighted average interest rates and weighted average outstanding balances under the Company’s debt agreement in the first three months of both fiscal 2022 and 2021: Weighted Average Interest Rate Three Months Ended December 31, Weighted Average Outstanding Balance Thee Months Ended December 31, 2021 2020 2021 2020 Revolving credit agreement 1.6 % 1.5 % $ 8.7 million $ 10.8 million Foreign term debt 1.2 % 3.0 % $ 6.0 million $ 7.1 million Other debt 1.1 % 0.9 % $ 5.6 million $ 5.8 million Income Taxes The Company’s effective tax rate through the first three months of fiscal 2022 was 1.3%, compared with (43)% for the same period of fiscal 2021. The increase in the effective rate was primarily attributable to tax benefits from adjusting deferred taxes recorded in Italy recognized on a discrete basis in fiscal 2021, which were non-recurring in fiscal 2022. The effective tax rate differs from the U.S. federal statutory rate due primarily to the valuation allowance against the Company’s U.S. deferred tax assets and income in foreign jurisdictions that are taxed at different rates than the U.S. statutory tax rate. Net (Loss) Income Net loss was $3.7 million during the first three months of fiscal 2022, compared with net income of $3.0 million in the comparable period of fiscal 2021. The net loss is attributed to lower sales and decreased gross profit due to idle costs recorded. Prior year results included $2.5 million in insurance recoveries and a favorable tax benefit. 15 Non-GAAP Financial Measures Presented below is certain financial information based on the Company's EBITDA and Adjusted EBITDA. References to “EBITDA” mean earnings (losses) from continuing operations before interest, taxes, depreciation and amortization, and references to “Adjusted EBITDA” mean EBITDA plus, as applicable for each relevant period, certain adjustments as set forth in the reconciliations of net income to EBITDA and Adjusted EBITDA. Neither EBITDA nor Adjusted EBITDA is a measurement of financial performance under generally accepted accounting principles in the United States of America (“GAAP”). The Company presents EBITDA and Adjusted EBITDA because management believes that they are useful indicators for evaluating operating performance and liquidity, including the Company’s ability to incur and service debt and it uses EBITDA to evaluate prospective acquisitions. Although the Company uses EBITDA and Adjusted EBITDA for the reasons noted above, the use of these non-GAAP financial measures as analytical tools has limitations. Therefore, reviewers of the Company’s financial information should not consider them in isolation, or as a substitute for analysis of the Company's results of operations as reported in accordance with GAAP. Some of these limitations include: • Neither EBITDA nor Adjusted EBITDA reflects the interest expense, or the cash requirements necessary to service interest payments on indebtedness; • Although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future, and neither EBITDA nor Adjusted EBITDA reflects any cash requirements for such replacements; • The omission of the substantial amortization expense associated with the Company’s intangible assets further limits the usefulness of EBITDA and Adjusted EBITDA; and • Neither EBITDA nor Adjusted EBITDA includes the payment of taxes, which is a necessary element of operations. Because of these limitations, EBITDA and Adjusted EBITDA should not be considered as measures of discretionary cash available to the Company to invest in the growth of its businesses. Management compensates for these limitations by not viewing EBITDA or Adjusted EBITDA in isolation and specifically by using other GAAP measures, such as net income (loss), net sales, and operating income (loss), to measure operating performance. Neither EBITDA nor Adjusted EBITDA is a measurement of financial performance under GAAP, and neither should be considered as an alternative to net loss or cash flow from operations determined in accordance with GAAP. The Company’s calculation of EBITDA and Adjusted EBITDA may not be comparable to the calculation of similarly titled measures reported by other companies. The following table sets forth a reconciliation of net income to EBITDA and Adjusted EBITDA: Dollars in thousands Three Months Ended December 31, 2021 2020 Net (loss) income $ (3,691) $ 2,993 Adjustments: Depreciation and amortization expense 1,614 1,825 Interest expense, net 115 165 Income tax benefit (49) (905) EBITDA (2,011) 4,078 Adjustments: Foreign currency exchange loss, net (1) 5 7 Other loss (income), net (2) (32) 62 Gain on insurance recoveries (3) — (2,495) Equity compensation (4) 161 143 LIFO impact (5) 176 128 Adjusted EBITDA $ (1,701) $ 1,923 (1) Represents the gain or loss from changes in the exchange rates between the functional currency and the foreign currency in which the transaction is denominated. (2) Represents miscellaneous non-operating income or expense, such as pension costs or grant income. 16 (3) Represents the difference between the insurance proceeds received for the damaged property and the carrying values shown on the Company's books for the assets that were damaged in the fire at the Orange location that occurred in December 2018. (4) Represents the equity-based compensation expense recognized by the Company under the 2016 Plan due to granting of awards, awards not vesting and/or forfeitures. (5) Represents the change in the reserve for inventories for which cost is determined using the last-in, first-out (“LIFO”) method. B. Liquidity and Capital Resources The main sources of liquidity for the Company have been cash flows from operations and borrowings under our Credit Agreement. We anticipate that cash provided by the cash flows from operations and borrowing capacity under our Credit Agreement will be sufficient to meet our anticipated cash requirements for the next twelve months, which primarily include operating expenses, including salaries and working capital requirements. The ongoing impact and magnitude of COVID-19 continues to remain uncertain (including the pandemic's continued effects on the global economy and potential for market disruptions) due to the continued interruptions to the business of our customers and suppliers, which in turn can impact our business operations and results as well as our liquidity and capital resources. The Company's liquidity could be negatively affected by customers extending payment terms to the Company and/or the decrease in demand for our products as a result of the impact of COVID-19 on the commercial airline industry. As the impact of the COVID-19 pandemic on the economy and the Company's operations continues to evolve, the Company and management will continue to assess and actively manage liquidity needs. See "Results of Operation" for further discussion of the impact of COVID-19. Cash and cash equivalents was $0.7 million at December 31, 2021 and $0.3 million at September 30, 2021. At December 31 2021, the majority of the Company’s cash and cash equivalents were in the possession of its non-U.S. subsidiaries. Distributions from the Company's non-U.S. subsidiaries to the Company may be subject to adverse tax consequences. Operating Activities The Company’s operating activities provided $1.2 million of cash in the first three months of fiscal 2022, generated primarily by accounts receivable collections, an increase in accounts payable due to increased raw material purchases and other non-cash items, such as depreciation and amortization. Cash generation activities were partially offset by the net loss of $3.7 million and a $2.7 million increase in inventory to support sales in fiscal 2022. The Company’s operating activities provided $3.1 million of cash in the first three months of fiscal 2021. The cash provided by operating activities in the first three months of fiscal 2021 was primarily due to net income of $3.0 million and $1.4 million decrease in net working capital, partially offset by $1.2 million in non-cash items, such as gain on insurance recovery, and deferred income taxes, depreciation and amortization, equity based compensation, and LIFO effect. The cash provided by working capital was primarily due to decrease in receivables due to customer collections and decreased accrued liabilities. Investing Activities Cash used for investing activities was $0.5 million in the first three months of fiscal 2022, compared with $0.3 million in the first three months of fiscal 2021, which includes $3.5 million of insurance recovery on the damaged property related to the fire at the Orange location. Capital commitments as of December 31, 2021 were $1.0 million. The Company anticipates that the remaining total fiscal 2022 capital expenditures will be within the range of $3.0 million to $4.0 million and will relate principally to the further enhancement of production and product offering capabilities and drive operating cost reductions. Financing Activities Cash used for financing activities was $0.4 million in the first three months of fiscal 2022, compared with cash used for financing activities of $2.1 million in the first three months of fiscal 2021. As discussed in Note 5, Debt, the Company's Maniago location obtained new borrowings from a lender during the first quarter of fiscal 2022 for approximately $1.1 million with a six year term. The proceeds of this loan are to be used for working capital purposes. Short-term debt repayments were $1.5 million in the first three months of fiscal 2022 compared with net short-term debt borrowings of $1.8 million in the first three months of fiscal 2021. The Company had net borrowings to the revolver under the Credit Agreement of $0.3 million in the first three months of fiscal 2022 compared with net repayments of $3.7 million in the first three months of fiscal 2021. Under the Company's Credit Agreement, the Company is subject to certain customary loan covenants regarding availability as discussed in Note 5, Debt. The availability at December 31, 2021 was $12.2 million, which was greater than the 10.0% of the 17 Revolving Commitment as of December 31, 2021. As such, no covenant calculation was required. If availability had fallen short, the Company would be required to meet the fixed charge coverage ratio ("FCCR") covenant, which must not be less than 1.1 to 1.0. In the event of a default, we may not be able to access our revolver, which could impact the ability to fund working capital needs, capital expenditures and invest in new business opportunities. As noted in Note 10, Subsequent Events, the Company was notified that its application for forgiveness of the $5.0 million PPP Loan was approved by the SBA in January 2022. As such, the loan amount and all related interest accrued is to be forgiven. The Company will derecognize the liability in the second quarter of fiscal 2022 when the loan is forgiven and the Company is legally released from the loan. Future cash flows from the Company’s operations may be used to pay down amounts outstanding under the Credit Agreement and its foreign related debts. The Company believes it has adequate cash/liquidity available to finance its operations from the combination of (i) the Company’s expected cash flows from operations and (ii) funds available under the Credit Agreement for its domestic locations. The Company was able to obtain new financing at its Maniago location to provide Maniago with sufficient liquidity. Additionally, the credit and capital markets have seen significant volatility during the course of the pandemic. Tightening of the credit market and standards, as well as capital market volatility, could negatively impact our ability to obtain additional debt financing on terms equivalent to our existing Credit Agreement, in the event the Company seeks additional liquidity sources as a result of the continued impact of COVID-19. Capital market uncertainty and volatility, together with the Company’s market capitalization and status as a smaller reporting company could also negatively impact our ability to obtain equity financing. C. Recently Adopted Accounting Standards For recently adopted accounting standards refer to Note 1, Summary of Significant Accounting Policies - Recently Adopted Accounting Standards for further detail.