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 continued long term impact of the COVID-19 pandemic and related residual negative impact on the global economy, which may exacerbate the above factors and/or impact our results of operations and financial condition; (20) in connection with its entry into the Forbearance Agreement, the Company is evaluating available financial alternatives, including obtaining acceptable alternative financing as well as seeking additional waivers, forbearances or amendments to the covenants or other provisions of the Credit Agreement to address any existing or future defaults and has engaged financial advisors to assist the Company. If the Company is unable to reach an agreement with its lender to waive the defaults, extend the forbearance period or find alternative financing prior to the expiration of the forbearance period, the lender of the Credit Agreement may choose to accelerate repayment. The Company cannot provide assurances that it will be successful in negotiating such a waiver or extension of the forbearance period, restructuring of existing debt obligations, obtaining capital or entering into a strategic alternative transaction which provides sufficient funding for the refinancing of its outstanding indebtedness prior to the expiration of the forbearance period or prior to the maturity date of its obligations under the Credit Agreements. 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 continue 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. 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) commercial space, semiconductor and other commercial applications. 16 Impact of COVID-19 & Other Factors 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, 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. 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 seeks to find ways to mitigate the impact on its operations. Backlog of Orders SIFCO’s total backlog at December 31, 2022 was $84.2 million, compared with $75.7 million as of December 31, 2021. Orders may be subject to modification or cancellation by the customer with limited charges. Recovery in the A&E markets coupled with extended raw material lead times has resulted in increased bookings. Backlog information may not be indicative of future sales. Three Months Ended December 31, 2022 compared with Three Months Ended December 31, 2021 Net Sales Net sales comparative information for the first three months of fiscal 2023 and 2022 is as follows: (Dollars in millions) Three Months Ended December 31, Increase/ (Decrease) Net Sales 2022 2021 Aerospace components for: Fixed wing aircraft $ 10.7 $ 9.9 $ 0.8 Rotorcraft 4.4 3.5 0.9 Energy components for power generation units 4.6 3.6 1.0 Commercial product and other revenue 1.6 2.2 (0.6) Total $ 21.3 $ 19.2 $ 2.1 Net sales for the first three months of fiscal 2023 increased $2.1 million to $21.3 million, compared with $19.2 million in the comparable period of fiscal 2022. In general, the production of the Company's products have lead times of varying lengths. The timing of shipments, coupled with increased demand in the steam turbine power generation market, have contributed to the increase of sales year over year. Fixed wing sales increased $0.8 million compared with the same period last year primarily due to F35 and F18 programs. Rotorcraft sales increased $0.9 million compared with the same period last year primarily due to commercial and Blackhawk programs. The energy components for power generation units increased by $1.0 million due to growth in the steam turbine markets that we serve. Commercial products and other revenue decreased $0.6 million in the first three months of fiscal 2023 compared to the same period in fiscal 2022, primarily due to the timing of orders related to a munitions program. Commercial net sales were 47.8% of total net sales and military net sales were 52.2% of total net sales in the first three months of fiscal 2023, compared with 43.4% and 56.6%, respectively, in the comparable period in fiscal 2022. Military net sales increased by $0.2 million to $11.1 million in the first three months of fiscal 2023, compared with $10.9 million in the comparable period of fiscal 2022, primarily due to timing in order placement. Co mmercial net sales increased $1.8 million to $10.2 million in the first three months of fiscal 2023, compared with $8.3 million in the comparable period of fiscal 2022 primarily due to an increase in the power generation steam turbine market. Cost of Goods Sold Cost of goods sold increased by $0.8 million, or 4.2%, to $20.0 million, or 94.1% of net sales, during the first three months of fiscal 2023, compared with $19.2 million or 99.9% of net sales, in the comparable period of fiscal 2022. The increase is 17 primarily due to higher volume and $0.4 million idle expense partially offset by $0.5 million in lower payroll costs and NRV release of $0.8 million. Gross Profit Gross profit increased $1.3 million to $1.3 million in the first three months of fiscal 2023, compared with nearly breakeven gross profit in the comparable period of fiscal 2022. Gross margin percent of sales was 5.9% during the first three months of fiscal 2023, compared with nominal in the comparable period in fiscal 2022. The increase in gross profit compared to prior fiscal year was primarily due to increased volume, lower payroll costs, release of NRV reserve $0.8 million and lower idle expense $0.9 million. Selling, General and Administrative Expenses Selling, general and administrative expenses were $3.3 million, or 15.4%, of net sales during the first three months of fiscal 2023, compared with $3.5 million, or 18.4%, of net sales in the comparable period of fiscal 2022. The decrease in selling, general and administrative expenses is primarily due lower payroll costs $0.1 million and incentive compensation $0.2 million and $0.2 million lower commission. Amortization of Intangibles Amortization of intangibles was $0.1 million in the first three months of fiscal 2023 and fiscal 2022. Other/General 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 2023 and 2022: Weighted Average Interest Rate Three Months Ended December 31, Weighted Average Outstanding Balance Three Months Ended December 31, 2022 2021 2022 2021 Revolving credit agreement 5.9 % 1.6 % $ 11.2 million $ 8.7 million Foreign term debt 3.5 % 1.2 % $ 7.3 million $ 6.0 million Other debt 1.7 % 1.1 % $ 0.6 million $ 5.6 million Income Taxes The Company’s effective tax rate through the first three months of fiscal 2023 was (2.6%), compared with 1.3% for the same period of fiscal 2022. The decrease in the effective rate was primarily attributable to changes in jurisdictional mix of income in fiscal 2023 compared with the same period of 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 Net loss was $2.6 million during the first three months of fiscal 2023, compared with net loss of $3.7 million in the comparable period of fiscal 2022. The improvement compared with prior year is primarily due to higher volume and lower selling, general and administrative expenses. 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 18 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, 2022 2021 Net loss $ (2,589) $ (3,691) Adjustments: Depreciation and amortization expense 1,571 1,614 Interest expense, net 275 115 Income tax benefit 66 (49) EBITDA (677) (2,011) Adjustments: Foreign currency exchange (gain) loss, net (1) (3) 5 Other (income) loss, net (2) 182 (32) Gain on disposal of assets (3) (11) — Equity compensation (4) 122 161 LIFO impact (5) 262 176 Adjusted EBITDA $ (125) $ (1,701) (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, grant income and loss on insurance recovery. (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 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 19 operating expenses, including salaries, working capital requirements and certain capital expenditures (see "Investing Activities," below). The Company's liquidity could be negatively affected if the Company is unable to reach an agreement with its lender to waive the defaults, extend the forbearance period or find alternative financing prior to the expiration of the forbearance period, if customers extending payment terms to the Company, or if there is a general decrease in demand for our products. The Company and management will continue to assess and actively manage liquidity needs. See "Results of Operation" for further discussion of the lingering impacts of COVID-19. See Note 7, Debt and Subsequent Event . Cash and cash equivalents was $1.2 million at December 31, 2022 and $1.2 million at September 30, 2022. At December 31, 2022, 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 for the first three months of fiscal 2023 provided $0.3 million of cash, generated primarily by decreases in accounts receivable of $1.6 million and inventory reserves $0.8 million, partially offset by an increase in inventory $1.5 million compared with September 30, 2022. The Company’s operating activities for the first three months of fiscal 2022 provided $1.2 million of cash, 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 compared with September 30, 2021. 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. Investing Activities Cash used for investing activities was $0.5 million in the first three months of fiscal 2023 and the first three months of fiscal 2022 for capital expenditures. Capital commitments as of December 31, 2022 were $1.0 m illion. The Company anticipates that the remaining total fiscal 2023 capital expenditures will be within the range of $1.0 million to $1.5 million and will relate principally to the further enhancement of production and product offering capabilities and drive operating cost reductions. Financing Activities Cash provided by financing activities was $0.1 million in the first three months of fiscal 2023, compared with cash used for financing activities of $0.4 million in the first three months of fiscal 2022. As discussed in Note 7, Debt and Subsequent Event, the Company's Maniago location obtained new borrowings from a lender during the first three months 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. The Company had nominal net short-term debt repayments in the first three months of fiscal 2023 compared with net short-term debt repayments of $1.5 million in the first three months of fiscal 2022. The Company had net borrowings to the revolver under the Credit Agreement of $0.3 million in the first three months of fiscal 2023 compared with net borrowings of $0.3 million in the first three months of fiscal 2022. Under the Company's Credit Agreement, the Company is subject to certain customary loan covenants regarding availability as discussed in Note 7, Debt and Subsequent Event. The availability at December 31, 2023 was $8.1 million, which was greater than the 10.0% of the Revolving Commitment as of December 31, 2023. If availability falls below the 10% level or an event of default occurs, the Company is required to meet the fixed charge coverage ratio covenant, which must not be less than 1.1 to 1.0. As noted in Note 7, Debt and Subsequent Event on February 6, 2023, the Company received a Notice from its Lender, with respect to (i) that certain Credit Agreement dated as of August 8, 2018; and (ii) that certain Export Credit Agreement dated as of December 17, 2018. The Notice indicated that the Loan Parties to the Credit Agreements have informed Lender of the occurrence of Events of Defaults under the Credit Agreements as a result of the failure to deliver the required Borrowing Base Certificates thereunder and other Events of Default. The Notice indicated further that Lender is in the process of evaluating the Existing Defaults and reserves all of its rights and remedies under the Credit Agreements and any other Loan Documents with respect thereto. The failure by the Company to provide timely borrowing base certificates and monthly financial reports for the periods of December 2022, January 2023 and February 2023 in accordance with the terms of the Credit Agreements were a result of information access limitations experienced due to the cybersecurity incident that occurred on December 30, 2022. As a secondary default, the Company failed to maintain a FCCR not less than 1.1 to 1.0 for the periods of December 2022, January 2023, February 2023 and March 2023. The secondary default voided the availability spring minimum threshold and triggered the FCCR covenant compliance. See Note 12, Commitments & Contingencies . 20 As noted in Note 7, Debt and Subsequent Event on April 28, 2023, the Company and its subsidiary guarantors entered into a Forbearance Agreement with J.P. Morgan Chase Bank, N.A. in respect to the Event of Default under the Credit Agreement. Pursuant to the Forbearance Agreement, during the forbearance period defined therein: (i) the Reserves under the Borrowing Base in the ABL Credit Agreement are reduced to $2.0 million; (ii) the aggregate outstanding principal balance of the Revolving Exposure under the ABL Credit Agreement and Export Revolving Loan may not at any time exceed the lesser of $19.0 million and the Borrowing Base. As noted in Note 7, Debt and Subsequent Event, the Company entered its Sixth Amendment which amends the Credit Agreement to, among other things, (i) revise the fixed coverage ratio to exclude the first $1.5 million of unfunded capital expenditures through April 20, 2023, (ii) increase the letter of credit sub-limit from $2.0 million to $3.0 million, (iii) modify the reference rate from the London interbank offered rate ("LIBOR") to the secured overnight financing rate ("SOFR") under the Credit Agreement, and (iv) revise the property, plant and equipment component of the borrowing base under the Credit Agreement. Additionally, the Export Credit Agreement was amended by the Second Amendment, which replaces the reference rate from LIBOR to SOFR in the Export Credit Agreement. 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 saw significant volatility during the course of the pandemic. Tightening of the credit market and standards, as well as capital market volatility caused by various factors, including the continued long term effects of COVID-19 and/or ongoing geopolitical tensions, 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. 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. Recent Accounting Standards Not Yet Adopted For recent accounting standards not yet adopted refer to Note 1, Summary of Significant Accounting Policies - Recent Accounting Standards Not Yet Adopted for further detail. Additionally, the Company's significant accounting policies and procedures are explained in the Management's Discussion and Analysis section of the Company's Annual Report on Form 10-K for the year ended September 30, 2022.