Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
SIFCO is engaged in the production of forgings and machined and sub-assembled components primarily for the A&E markets. The processes and services include forging, heat-treating, chemical processing and machining. The Company operates under one business segment.
When planning and evaluating its business operations, the Company takes 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
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aircraft; (ii) the projected build rate for industrial steam and gas turbine engines; and (iii) the projected maintenance, repair and overhaul schedules for commercial, business and military aircraft, as well as the engines that power such aircraft.
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.
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 armored military vehicles; (ii) airframe applications for a variety of aircraft; (iii) industrial gas and steam turbine engines for power generation units; and (iv) other commercial applications.
Impact of COVID-19 & Other Factors
As previously noted, the lingering impact and residual effects of the COVID-19 pandemic, along with other factors such as ongoing geopolitical tensions, continue to impact the United States and other countries in which the Company operates, including strains on supply chains and inflationary impacts. During fiscal 2022, the ongoing impact of the COVID-19 pandemic continued to effect the Company’s results of operations. Given the long lead times for certain of the Company's products, the Company has continued to see an impact related to the effects of COVID-19 on orders and deliveries in fiscal 2022. While the exact timing and pace of recovery in our markets continues to be indeterminable, there are indications that commercial air travel is steadily recovering. While the long-term outlook remains positive given the nature of the industry, there continues to be uncertainty with the respect to when commercial air traffic will return to pre-COVID-19 levels. Given the fluidity of the situation, it is still unclear how lasting and deep the ongoing economic impacts of COVID-19 will last.
In response to the uncertain environment created by the COVID-19 pandemic and its effects, the Company has, at various points in fiscal 2022 and prior periods, taken measures to reduce costs by furloughing and laying off certain of its employees from one of its plant locations that has experienced reduced sales of commercial aerospace products. Such employees have since returned to work.
Additionally, our operations are subject to global economic and geopolitical risks. For example, while the Company does not have a presence in these regions, the ongoing conflict between Russia and Ukraine has impacted economic activity as well as the availability and price of raw materials and energy. The Company continues to actively monitor these factors and find ways to mitigate the impact on its operations.
Fiscal Year 2022 Compared with Fiscal Year 2021
Net Sales
Net sales comparative information for fiscal 2022 and 2021, respectively, is as follows:
(Dollars in millions) Years Ended
September 30, Increase
(Decrease)
Net Sales 2022 2021
Aerospace components for:
Fixed wing aircraft $ 39.5 $ 38.5 $ 1.0
Rotorcraft 15.6 27.2 (11.6)
Energy components for power generation units 17.4 20.4 (3.0)
Commercial product and other revenue 11.4 13.5 (2.1)
Total $ 83.9 $ 99.6 $ (15.7)
Net sales in fiscal 2022 decreased 15.8%, or $15.7 million to $83.9 million, compar ed with $99.6 million in fiscal 2021. Given the long lead times for certain of the Company's products, the Company has seen a greater impact related to the effects of COVID-19 on orders and deliveries in fiscal 2022 than in fiscal 2021. Fixed wing aircraft sales increased $1.0 million compared with the same period last year due to timing of customer orders, an increase in build rates in certain commercial programs and sales for military programs. Rotorcraft sales decreased $11.6 million in fiscal 2022 compared to the same period in fiscal 2021 primarily due to a timing change in requirements after advance ordering from customers in fiscal 2021 to help the
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overall supply chain through the effects of the COVID-19 pandemic. The energy components for power generation un its decreased $3.0 million compared with the same period last year due to customer order reductions.
Commercial net sales wer e 47.4% of total net sales and military net sales wer e 52.6% of to tal net sales in fiscal 2022, compared with 36.7% and 63.3%, respectively, in the comparable period in fiscal 2021. Commercial net sales (which includes energy components) increased $3.2 million to $39.8 million in fiscal 2022, compared to $36.6 million in fiscal 2021 primarily due to the increase in build rates in the commercial aerospace industry. Military net sales decreased $18.9 million to $44.1 million in fiscal 2022, compared to $63.0 million in fiscal 2021 primarily due to timing of orders related to certain military programs as a result of advance ordering in fiscal 2021 and lower munition progra m volumes, such as H60 and Hellfire missile due to timing.
Cost of Goods Sold
Cost of goods sol d ("COGS") decreased by $2.6 million, or 3.0%, to $85.8 million, or 102.2% of net sales, during fiscal 2022, compared with $88.4 million or 88.7% of net sales in the comparable period of fisc al 2021. The decrease was primarily due to lower volume from the military and munitions programs, increased raw material pricing and outside processing costs, inventory write down to net realizable value ("NRV") of $1.5 million and idle expense of $3.1 million partially offset by cost controlling measures including lower payroll costs of $1.8 million . Net sales decreased at a greater rate than COGS, leading COGS as a percent of net sales to be greater in fiscal 2022 than in fiscal 2021. This was primarily a result of the Company recording idle expense of $3.1 million, an inventory write down to NRV of $1.5 million, and experiencing increased outside processing and raw material costs. Prior year results include d $2.1 million of idle expense and $0.3 million of inventory write down to NRV.
Gross Profit (Loss)
Gross profit (loss) decreased by $13.1 million, or 116.6%, to a loss of $1.9 million during fiscal 2022, compared with $11.2 million profit in fiscal 2021. Gross margin percent of sales was (2.2%) during fiscal 2022, compared with 11.3% in fiscal 2021, primarily due to lower volume, inventory write down to NRV o f $1.5 m illion and incremental idle costs of $1.0 million, higher raw material prices, and outside processing costs in fiscal 2022 compared with the prior year, partially offset by lower payroll.
Selling, General and Administrative Expenses
Selling, general and administrative expenses were $11.9 million, or 14.2% of net sales, during fiscal 2022, compared with $13.5 million, or 13.5% of net sales, in fiscal 2021. The decrease in selling, general and administrative expenses is due to the continued cost reduction efforts by management, including lower wages, commissions and travel expenses, partially offset by higher legal and professional costs.
Amortization of Intangibles
Amortization of in tangibles decreased $0.7 million to $0.3 million during fiscal 2022, compared with $1.0 million in the comparable period of fiscal 2021. Such decrease was primarily due to certain intangible assets that were fully amortized during fiscal 2022.
Other/General
The Company recorded an operat ing loss of $14.1 million during fiscal 2022, compared with an operating loss of $1.1 million in fiscal 2021.
Included in the current year results, the Company recognized a gain on extinguishment of debt related to the PPP loan, that was forgiven by the SBA, for $5.1 million. See Note 5, Debt for further discussion. Prior year results included a gain on insurance recoveries of $2.4 million a gain on debt extinguishment of $0.3 million due to partial loan forgiveness at the Company's Maniago location.
Interest expe nse was $0.6 million in fisca l 2022 and fiscal 2021. See Note 5, Debt, of the consolidated financial statements for further information.
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The following table sets forth the weighted average interest rates and weighted average outstanding balances under the Company’s debt agreements in fiscal 2022 and 2021:
Weighted Average
Interest Rate
Years Ended September 30, Weighted Average
Outstanding Balance
Years Ended September 30,
2022 2021 2022 2021
Revolving credit agreement 2.6% 1.5% $ 10.4 million $ 9.1 million
Foreign term debt 2.8% 3.5% $ 6.2 million $ 7.0 million
Other debt 0.7% 0.9% $ 1.9 million $ 5.7 million
The Company believes that inflation did not materially impact its results of operations in either fiscal 2022 or 2021. However, the Company does expect inflationary pressures to have some impact in fiscal 2023.
Income Taxes
The Company’s effective tax rate in fiscal 2022 was 0.4% compared with 62.2% in fiscal 2021. The decrease in the effective tax rate in fiscal 2022 is primarily attributable to tax benefits from adjusting deferred taxes recorded in Italy applied against a year-to-date loss in fiscal 2021 which was non-recurring in fiscal 2022 and changes in jurisdictional mix of income in fiscal 2022 compared with the same period in fiscal 2021. 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 Income (Loss)
Net loss wa s $9.6 million during fiscal 2022, compared with net loss of $0.7 million in fisca l 2021. The decrease in income in the current period was primarily due to lower volume, increased inventory write down to NRV, higher idle expense, raw material prices as a result of supply chain constraints, excess and obsolete costs, and outside processing expenses, partially offset by the gain on debt extinguishment of debt related to the PPP loan and lower payroll and selling, general and administrative expenses.
Non-GAAP Financial Measures
Presented below is certain financial information based on our EBITDA and Adjusted EBITDA. References to “EBITDA” mean earnings (losses) from 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 (loss) 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 it 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 profit (loss), to measure operating performance. The Company’s calculation of EBITDA and Adjusted EBITDA may not be comparable to the calculation of similarly titled measures reported by other companies.
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The following table sets forth a reconciliation of net loss to EBITDA and Adjusted EBITDA:
(Dollars in thousands) Years Ended
September 30,
2022 2021
Net loss $ (9,640) $ (743)
Adjustments:
Depreciation and amortization expense 6,348 7,662
Interest expense, net 646 638
Income tax benefit (43) (1,222)
EBITDA (2,689) 6,335
Adjustments:
Foreign currency exchange loss, net (1) 15 23
Other (income) loss, net (2) (149) 215
(Gain) loss on disposal of assets (3) (7) 209
Gain on insurance recoveries (4) — (2,397)
Gain on debt extinguishment (5) (5,106) (287)
Equity compensation expense (6) 428 469
Pension settlement/curtailment benefit (7) 208 274
LIFO impact (8) 729 924
Adjusted EBITDA $ (6,571) $ 5,765
(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.
(3) Represents the difference between the proceeds from the sale of operating equipment and the carrying value shown on the Company's books or asset impairment of long-lived assets.
(4) 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.
(5) Represents the gain on extinguishment of debt and interest for the amount forgiven by the SBA as it relates to the PPP loan in fiscal 2022 and term debt forgiveness as is relates to foreign borrowings in fiscal 2021.
(6) 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.
(7) Represents expense incurred by its defined benefit pension plans related to settlement of pension obligations.
(8) Represents the change in the reserve for inventories for which cost is determined using the last-in, first-out (“LIFO”) method.
Reference to the above activities can be found in the consolidated financial statements included in Item 8 of this Annual Report on Form 10-K.
B. Liquidity and Capital Resources
Historically, the main sources of liquidity of the Company have been cash flows from operations and borrowings under our Credit Agreement (as defined below under "Financing Activities"). The ongoing impact and magnitude of the COVID-19 pandemic remain uncertain (including the pandemic's continued effects on the global economy and potential for market disruptions) with the commercial aerospace industry. Along with the global disruption in travel and, further, the pandemic and responses to the various resurgences and continued spread of the pandemic continue to cause interruptions to the business of our customers and suppliers, which in turn is likely to 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 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 management will
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continue to assess and actively manage liquidity. See "Results of Operation - COVID-19" for further discussion on the impact of the pandemic.
Cash and cash equivale nts increased to $1.2 million at Septemb er 30, 2022 compared with $0.3 million at September 30, 2021. At September 30, 2022 and 2021, cash included financing proceeds for capital investment and a nominal amount, respectively, 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 activi ties provided $0.3 million of cash in f iscal 2022, compared with $3.9 million in fiscal 2021. The cash provided by operating activities in fiscal 2022 was primarily due to non-cash items, such as depreciation and amortization of $6.3 million, inventory write down to NRV $1.5 million, LIFO effect of $0.7 million, equity based compensation of $0.3 million and source of working capital of $6.0 million, partially offset by the forgiveness of the PPP loan of $5.1 million and net loss of $9.6 million. The source of cash from working capital of $6.0 million was primarily due to reductions in receivables due to lower sales and improved collections as well as decreases in inventories, partially offset by payments to suppliers.
The Company’s operating activities provided $3.9 million of cash in fiscal 2021. The cash provided by operating activities in fiscal 2021 was primarily due to non-cash items, such as depreciation and amortization of $7.7 million, LIFO effect of $0.9 million, inventory write down to NRV $0.3 million, equity based compensation, and source of working capital of $1.4 million, partially offset by a net gain on insurance recovery combined with loss on disposal of assets of $2.2 million and deferred income taxes of $1.3 million and net loss of $0.7 million. The source of cash from working capital of $1.4 million was primarily due to reductions in receivables due to lower sales and improved collections as well as decreases in inventories, partially offset by payments to suppliers and disbursements related to the fire recovery.
Investing Activities
Cash used for investing activities was $3.2 million in fiscal 2022, compared with $0.9 million in fiscal 2021. Fiscal 2022 expenditures were used primarily for manufacturing enhancement and maintenance capital. Fiscal 2021 included $4.1 million in proceeds received from insurance recovery on the damaged property related to the fire at the Orange location. Expenditures in fiscal 2021were used primarily for the restoration of the Orange location as a result of the fire, which were completed as of September 30, 2021. Capital commitments at September 30, 2022 were $1.6 million. The Company anticipates the total fiscal 2023 capital expenditures will be within the range of $3.5 million to $5.5 million and will relate principally to the further enhancement of production and product offering capabilities and operating cost reductions.
Financing Activities
Cash provided by financing activities was $3.7 million in fiscal 2022 compared to cash used by financing activities of $3.1 million in fiscal 2021.
As discussed in Note 5, Debt , the Company amended the Credit Agreement and the Export Agreement on March 23, 2022. The combined maximum borrowings remain unchanged at $35.0 million. The Sixth Amendment (the "Sixth Amendment") to the Credit Agreement (as amended, the "Credit Agreement") consists of a senior secured revolving credit facility with a maximum borrowing of $28.0 million, previously $30.0 million. The revolving commitment through the Second Amendment (the "Second Amendment") of the Export Credit Agreement, which lends amounts to the Company on foreign receivables increased its revolving commitment from $5.0 million to $7.0 million. The Sixth Amendment, among other things, (i) revises the fixed coverage ratio to exclude the first $1,500 of unfunded capital expenditures through April 20, 2023, (ii) increases the letter of credit sub-limit from $2,000 to $3,000, (iii) modifies the reference rate from the London interbank offered rate ("LIBOR") to the secured overnight financing rate ("SOFR") and (iv) revises the property, plant and equipment component of the borrowing base under the Credit Agreement.
As discussed in Note 5, Debt , the Company's Maniago, Italy location obtained borrowings from two separate lenders during fiscal 2022. The first loan was for $1.2 million with repayment terms of six years. A second loan with a five year term was obtained in the amount of $1.0 million. The proceeds of the first loan is to be used for working capital purposes, the proceeds of the second loan are earmarked for capital investment. The Company repaid $1.2 million of its Company's foreign term loans in 2022.
In addition to the two loans entered into in fiscal 2022, in the prior year, the Company received cash proceeds of $1.0 million from two new loans related to the Maniago location. A total of $0.4 million in cash was used to repay the Company's foreign term loans.
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The Company had net borrowings under its revolving credit facility of $2.2 million in fiscal 2022 and net repayments of $3.9 million in fiscal 2021. Amounts borrowed under the Credit Agreement are secured by substantially all the assets of the Company and its U.S. subsidiaries and a pledge of 66.67% of the stock of its first-tier non-U.S. subsidiaries. Borrowings will bear interest at the lender's established domestic rate or SOFR, plus the applicable margin as set forth in the Credit Agreement. The revolver has a rate based on SOFR plus a 2.25% spread, which was 4.86% at September 30, 2022 and the Export Credit Agreement, as discussed in Note 5, Debt, of the consolidated financial statements, has a rate based on SOFR plus a 1.75% spread, which was 4.36% at September 30, 2022. The Company also has a commitment fee of 0.25% under the Credit Agreement to be incurred on the unused balance of the revolver.
As the Company’s Credit Agreement is asset-based, a sustained significant decrease in revenue in the U.S. or excessive aging of the underlying receivables as a result of the impact of the COVID-19 pandemic could materially affect the collateral capacity limitation of the availability under the Credit Agreement and could impact our ability to comply with covenants in our Credit Agreement.
Under the Company's Credit Agreement, the Company is subject to certain customary loan covenants regarding availability as discussed in Note 5, Debt, of the consolidated financial statements. The availability at September 30, 2022 was $9.4 million. If the 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. Because the availability was greater than the 10.0% of the Revolving Commitment as of September 30, 2022, the FCCR calculation was not required.
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 defer payments for certain debt obligations at its Maniago location along with obtaining new financing in the current year to provide Maniago with sufficient liquidity.
Additionally, the credit and capital markets saw 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. Off-Balance Sheet Arrangements
In the normal course of business, the Company may be party to certain arrangements that are not reflected in the Consolidated Balance Sheets. The Company does not have obligations that meet the definition of an off-balance sheet arrangement that have had, or are reasonably likely to have, a material effect on the Company’s financial condition or results of operations.
D. Critical Accounting Policies and Estimates
Allowances for Doubtful Accounts
The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of certain customers to make required payments. The Company evaluates the adequacy of its allowances for doubtful accounts each quarter based on the customers’ credit-worthiness, current economic trends or market conditions, past collection history, aging of outstanding accounts receivable and specific identified risks. As these factors change, the Company’s allowances for doubtful accounts may change in subsequent periods. Historically, losses have been within management’s expectations and have not been significant.
Inventories
Approximately 42% of the Company's inventory is valued using the last-in, first-out (“LIFO”) method with the remaining valued using the first-in, first-out ("FIFO") method stated at the lower of cost or net realizable value. Net realizable value is the estimated selling price in the ordinary course of business less reasonably predictable costs of completion.
The Company evaluates obsolete and excess inventory on a quarterly basis. The Company maintains a formal policy, which requires at a minimum, that amounts are written down based on an analysis of the age of the inventory. In addition, if the Company learns of specific obsolescence, other than that identified by the aging criteria, an additional write down will be recognized. Specific obsolescence may arise due to a technological or market change or based on cancellation of an order.
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Management’s judgment is necessary in determining the net realizable value of these products to arrive at the proper write down for obsolete and excess inventory.
Revenue Recognition
The Company recognizes revenue using the five-step revenue recognition model in which it depicts the transfer of goods to customers in an amount that reflects the consideration to which a company expects to be entitled in exchange for those goods or services. The revenue standard also requires disclosure sufficient to enable users to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers, including qualitative and quantitative disclosures about contracts with customers, significant judgments and changes in judgments and assets recognized from the cost to obtain or fulfill a contract.
Contract Balances
Contract assets on the consolidated balance sheets are recognized when a good is transferred to the customer and the Company does not have the contractual right to bill for the related performance obligations. In these instances, revenue recognized exceeds the amount billed to the customer and the right to payment is not solely subject to the passage of time. Amounts do not exceed their net realizable value. Contract liabilities relate to payments received in advance of the satisfaction of performance under the contract. Payment from customers are received based on the terms established in the contract with the customer.
Impairment of Long-Lived Assets
The Company reviews the carrying value of its long-lived assets when events and circumstances warrant such a review. This review involves judgment and is performed using estimates of future undiscounted cash flows, which include proceeds from disposal of assets and which the Company considers a critical accounting estimate. The Company would assess the fair value of the asset group and compare it to its carrying value. Under the Accounting Standard Codification ("ASC") 360 ("Topic 360"), if the carrying value of a long-lived asset or asset group is greater than the estimated undiscounted future cash flows, then the long-lived asset or asset group is considered impaired and an impairment charge is recorded for the amount by which the carrying value of the long-lived asset or asset group exceeds its fair value.
In projecting future undiscounted cash flows, the Company relies on internal budgets and forecasts, and projected proceeds upon disposal of long-lived assets. The Company’s budgets and forecasts are based on historical results and anticipated future market conditions, such as the general business climate and the effectiveness of competition. The Company believes that its estimates of future undiscounted cash flows and fair value are reasonable; however, changes in estimates of such undiscounted cash flows and fair value could change the Company’s estimates, which could result in future impairment charges.
2022 Long-Lived Asset Recoverability Tests
In the third and fourth quarters, certain qualitative factors, including operating results, at the Orange, California ("Orange") location, triggered recoverability tests. The results of both indicated that the long-lived assets, right-of-use assets and definite lived intangible assets were recoverable and did not require further review for impairment.
2021 Long-Lived Asset Recoverability Tests
In the fourth quarter, certain qualitative factors, including operating results, at the Orange location, triggered a recoverability test. The results indicated that the long-lived assets, right-of-use assets and definite lived intangible assets were recoverable and did not require further review for impairment.
Impairment of Goodwill
Goodwill is tested for impairment annually as of July 31. If circumstances change during interim periods between annual tests that would more likely than not reduce the fair value of a reporting unit below its carrying value, the Company will test goodwill for impairment. Factors that would necessitate an interim goodwill impairment assessment include a sustained decline in the Company's stock price, prolonged negative industry or economic trends, or significant under-performance relative to expected, historical or projected future operating results. Management uses judgment to determine whether to use a qualitative analysis or a quantitative fair value measurement for its goodwill impairment testing. The Company's fair value measurement approach combines the income and market valuation techniques for each of the Company’s reporting units that carry goodwill. These valuation techniques use estimates and assumptions including, but not limited to, the determination of appropriate market comparables, projected future cash flows (including timing and profitability), discount rate reflecting the risk inherent in future cash flows, perpetual growth rate, and projected future economic and market conditions.
As permitted, if the reporting unit fails the impairment test, the Financial Accounting Standards Board ("FASB") issued an Accounting Standard Update ("ASU") removing step two from the goodwill impairment test. If a reporting unit fails the
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quantitative impairment test, impairment expense is immediately recorded as the difference between the reporting unit's fair value and carrying value. The Company adopted this standard effective March 31, 2017.
2022 Annual Goodwill Impairment Tests
SIFCO performed its annual test as of July 31, 2022. Goodwill existed at one of the Company's reporting units, Cleveland, Ohio as of September 30, 2022. No impairment charge was identified in connection with the annual goodwill impairment test with respect to the Cleveland reporting unit. Refer to Note 3, Goodwill and Intangible Assets, of the consolidated financial statements for further details.
2021 Annual Goodwill Impairment Tests
SIFCO performed its annual test as of July 31, 2021. Goodwill existed at one of the Company's reporting units, Cleveland, Ohio as of September 30, 2021. No impairment charge was identified in connection with the annual goodwill impairment test with respect to the Cleveland reporting unit. Refer to Note 3, Goodwill and Intangible Assets, of the consolidated financial statements for further details.
Defined Benefit Pension Plan Expense
The Company maintains three defined benefit pension plans in accordance with the requirements of the Employee Retirement Income Security Act of 1974 (“ERISA”). The amounts recognized in the consolidated financial statements for pension benefits under these three defined benefit pension plans are determined on an actuarial basis utilizing various assumptions. The following table illustrates the sensitivity to change in the assumed discount rate and expected long-rate of return on assets for the Company's pension plans as of September 30, 2022.
Impact on Fiscal 2022 Benefits Expense Impact on September 30, 2022 Projected Benefit Obligation for Pension Plans
Change in Assumptions
(In thousands)
25 basis point decrease in discount rate $ 22 $ 553
25 basis point increase in discount rate $ (22) $ (553)
100 basis point decrease in expected long-term rate of return on assets $ 211 $ —
100 basis point increase in expected long-term rate of return on assets $ (211) $ —
The discussion that follows provides information on the significant assumptions/elements associated with these defined benefit pension plans.
The Company determines the expected return on plan assets principally based on (i) the expected return for the various asset classes in the respective plans’ investment portfolios and (ii) the targeted allocation of the respective plans’ assets. The expected return on plan assets is developed using historical asset return performance as well as current and anticipated market conditions such as inflation, interest rates and market performance. Should the actual rate of return differ materially from the assumed/expected rate, the Company could experience a material adverse effect on the funded status of its plans and, accordingly, on its related future net pension expense.
The discount rate for each plan is determined, as of the fiscal year end measurement date, using prevailing market spot-rates (from an appropriate yield curve) with maturities corresponding to the expected timing/date of the future defined benefit payment amounts for each of the respective plans. Such corresponding spot-rates are used to discount future years’ projected defined benefit payment amounts back to the fiscal year end measurement date as a present value. A composite discount rate is then developed for each plan by determining the single rate of discount that will produce the same present value as that obtained by applying the annual spot-rates. The discount rate may be further revised if the market environment indicates that the above methodology generates a discount rate that does not accurately reflect the prevailing interest rates as of the fiscal year end measurement date. The Company computes a weighted-average discount rate taking into account anticipated plan payments and the associated interest rates from the USI Consulting Group Pension Discount Curve.
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As of September 30, 2022 and 2021, SIFCO used the following assumptions:
Years Ended
September 30,
2022 2021
Discount rate for expenses 2.9 % 3.1 %
Expected return on assets 6.4 % 7.0 %
Deferred Tax Valuation Allowance
The Company accounts for deferred taxes in accordance with the provisions of the Accounting Standards Codification guidance related to accounting for income taxes, whereby the Company recognizes an income tax benefit related to income tax credits, loss carryforwards and deductible temporary differences between financial reporting basis and tax reporting basis.
A high degree of judgment is required to determine the extent a valuation allowance should be provided against deferred tax assets. On a quarterly basis, the Company assesses the likelihood of realization of its deferred tax assets considering all available evidence, both positive and negative. In determining whether a valuation allowance is warranted, the Company evaluates factors such as prior earnings history, expected future earnings, carry-back and carry-forward periods and tax strategies that could potentially enhance the likelihood of the realization of a deferred tax asset. The weight given to the positive and negative evidence is commensurate with the extent to which the evidence may be objectively verified. It is generally difficult to outweigh objectively verifiable negative evidence of recent financial reporting losses. Based on the weight of available evidence, the Company determines if it is more likely than not that its deferred tax assets will be realized in the future.
As a result of losses incurred in recent years, the Company entered into a three-year cumulative loss position in the U.S. jurisdiction during the fourth quarter of fiscal 2016 and remains in a cumulative loss position at the conclusion of fiscal 2022. Accordingly, the Company maintained its valuation allowance on its U.S. deferred tax assets as of the fourth quarter of fiscal year 2022.
Uncertain Tax Positions
The calculation of the Company's tax liabilities also involves considering uncertainties in the application of complex tax regulations. SIFCO recognizes liabilities for uncertain income tax positions based on its estimate of whether it is more likely than not that additional taxes will be required, and it reports related interest and penalties as income taxes. Refer to Note 7, Income Taxes , of the consolidated financial statements.
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E. Impact of Newly Issued Accounting Standards
In June 2016, the FASB issued ASU 2016-13, "Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments" and subsequent updates. ASU 2016-13 changes how entities will measure credit losses for most financial assets and certain other instruments that are not measured at fair value through net income. The new guidance will replace the current incurred loss approach with an expected loss model. The new expected credit loss impairment model will apply to most financial assets measured at amortized cost and certain other instruments, including trade and other receivables, loans, held-to-maturity debt instruments, net investments in leases, loan commitments and standby letters of credit. Upon initial recognition of the exposure, the expected credit loss model requires entities to estimate the credit losses expected over the life of an exposure (or pool of exposures). The estimate of expected credit losses should consider historical information, current information and reasonable and supportable forecasts, including estimates of prepayments. Financial instruments with similar risk characteristics should be grouped together when estimating expected credit losses. ASU 2016-13 does not prescribe a specific method to make the estimate, so its application will require significant judgment. ASU 2016-13 is effective for public companies in fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. However, in November 2019, the FASB issued ASU 2019-10, "Financial Instruments - Credit Loss (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842)," which defers the effective date for public filers that qualify as a smaller reporting company ("SRC"), as defined by the Securities and Exchange Commission, to fiscal years after December 15, 2022, including interim periods within those fiscal years. Because SIFCO is considered a SRC, the Company does not need to implement until October 1, 2023. The Company will continue to evaluate the effect of adopting ASU 2016-13 will have on the Company's results within the consolidated statements of operations and financial condition.
In March 2020, the FASB issued ASU 2020-04, "Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting," which is intended to provide temporary optional expedients and exceptions to the U.S. GAAP guidance on contract modifications and hedge accounting to ease the financial reporting burden related to the expected market transition from the London Interbank Offered Rate ("LIBOR") and other interbank offered rates to alternative reference rates. This ASU, along with recently issued ASU 2021-01, which further clarifies the scope of Topic 848, is available immediately and may be implemented in any period prior to the guidance expiration on December 31, 2022. ASU 2020-04 was effective beginning on March 12, 2020, and the Company may elect to apply the amendments prospectively through December 31, 2022. The Company has not applied any optional expedients and exceptions to date, and will continue to evaluate the impact of the guidance and whether it will apply the optional expedients and exceptions.
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