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 Aerospace and Defense, Energy and Commercial Space 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 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.
Cybersecurity Incident
As reported on Forms 8-K filed January 6, 2023 and February 10, 2023, the Company became aware of unauthorized access to the Company's systems on December 30, 2022. The Company’s domestic operations were impacted by this Cybersecurity Incident which resulted in production delays and delayed shipments due to information access limitations. The Company initiated response protocols and an investigation, engaging cyber security experts to assist with the assessment of the incident and to help determine what data was impacted. The Company has since completed data recovery and restoration from the cyber incident. See Note 11 , Commitments and Contingencies.
Fiscal Year 2023 Compared with Fiscal Year 2022
Net Sales
Net sales comparative information for fiscal 2023 and 2022, respectively, is as follows:
(Dollars in millions) Years Ended
September 30, Year Over Year Increase
(Decrease)
Net Sales 2023 2022
Aerospace components for:
Fixed wing aircraft $ 40.1 $ 39.5 $ 0.6
Rotorcraft 16.4 15.6 0.8
Energy components for power generation units 23.0 17.4 5.6
Commercial product and other revenue 7.5 11.4 (3.9)
Total $ 87.0 $ 83.9 $ 3.1
Net sales in fiscal 2023 increased 3.7%, or $3.1 million to $87.0 million, compar ed with $83.9 million in fiscal 2022. The timing of shipments, coupled with increased demand in the steam turbine power generation market, have contributed to the increase in deliveries in fiscal 2023 than in fiscal 2022. Fixed wing aircraft sales increased $0.6 million compared with the same period last year primarily due to F35, 737 and 787 programs. Rotorcraft sales increased $0.8 million in fiscal 2023 compared to the same period in fiscal 2022 primarily due to commercial and Blackhawk programs. The energy components for power generation un its increased $5.6 million compared with the same period last year due to growth in the steam turbine markets. Commercial products and other revenue decreased $3.9 million in fiscal 2023 compared to the same period in fiscal 2022, primarily due to timing of orders related to a munitions program partially offset by an increase in commercial space.
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Commercial net sales wer e 55.6% of total net sales and military net sales wer e 44.4% of to tal net sales in fiscal 2023, compared with 47.4% and 52.6%, respectively, in the comparable period in fiscal 2022. Commercial net sales increased $8.6 million to $48.4 million in fiscal 2023, compared to $39.8 million in fiscal 2022 primarily due to growth in the energy components for power generation units (steam turbine markets) and the increase in build rates in the commercial aerospace industry. Military net sales decreased $5.4 million to $38.7 million in fiscal 2023, compared to $44.1 million in fiscal 2022 primarily due to V22 demand reduction and timing of orders related to a munition progra m.
Cost of Goods Sold
Cost of goods sol d ("COGS") decreased by $6.3 million, or 7.3%, to $79.5 million, or 91.3% of net sales, during fiscal 2023, compared with $85.8 million or 102.2% of net sales in the comparable period of fisc al 2022. The decrease was primarily due to increased volume, ERC benefit of $1.5 million and reduction of net realizable value ("NRV") reserve of $0.9 million and lower idle expense of $0.9 million . Current year results include $2.1 million of idle expense and $0.9 million benefit associated with NRV compared with prior year costs of $3.1 million and $1.5 million, respectively.
Gross Profit (Loss)
Gross profit increased by $9.4 million, to $7.5 million during fiscal 2023, compared with a loss of $1.9 million in fiscal 2022. Gross margin percent of sales was 8.7% during fiscal 2023, compared with (2.2%) in fiscal 2022, primarily due to increased volume, ERC benefit of $1.5 million, reduction of NRV reserve and idle expense, and lower outside processing costs compared with the prior year.
Selling, General and Administrative Expenses
Selling, general and administrative expenses were $14.0 million, or 16.1% of net sales, during fiscal 2023, compared with $11.9 million, or 14.2% of net sales, in fiscal 2022. The increase in selling, general and administrative expenses is primarily due to incremental IT costs related to the cybersecurity incident of $1.3 million and professional fees primarily related to the ERC credit of $0.4 million partially offset by ERC benefit of $0.2 million. See Note 11 , Commitments and Contingencies for further discussion on cyber incident.
Amortization of Intangibles
Amortization of in tangibles decreased $0.1 million to $0.2 million during fiscal 2023, compared with $0.3 million in the comparable period of fiscal 2022. The decrease was primarily due to certain intangible assets that were fully amortized during fiscal 2023.
Other/General
The Company recorded an operat ing loss of $6.7 million during fiscal 2023, compared with an operating loss of $14.1 million in fiscal 2022.
Prior year results included 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 and Subsequent Event for further discussion.
Net interest expe nse was $1.3 million in fisca l 2023 compared with $0.6 million in fisca l 2022. The increase was due to higher interest rates and higher average borrowings compared with the prior year. See Note 5, Debt and Subsequent Event for further discussion.
The following table sets forth the weighted average interest rates and weighted average outstanding balances under the Company’s debt agreements in fiscal 2023 and 2022:
Weighted Average
Interest Rate
Years Ended September 30, Weighted Average
Outstanding Balance
Years Ended September 30,
2023 2022 2023 2022
Revolving credit agreement 6.9% 2.6% $ 13.1 million $ 10.4 million
Foreign term debt 4.6% 2.8% $ 7.1 million $ 6.2 million
Other debt 1.5% 0.7% $ 0.5 million $ 1.9 million
The Company believes that inflation did not materially impact its results of operations in either fiscal 2023 or 2022.
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Income Taxes
The Company’s effective tax rate in fiscal 2023 was (1.9%) compared with 0.4% in fiscal 2022. The decrease in the effective tax rate in fiscal 2023 is primarily attributable to changes in jurisdictional mix of income in fiscal 2023 compared with the same period 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
Net loss wa s $8.7 million during fiscal 2023, compared with $9.6 million in fisca l 2022. The decrease in net loss in the current period was primarily due to increased volume, ERC refund benefit, reduction of NRV reserve and idle expense, lower outside processing costs and stabilized raw material pricing partially offset by cybersecurity incident costs. Prior year results included a $5.1 million gain on debt extinguishment previously noted.
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 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.
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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,
2023 2022
Net loss $ (8,692) $ (9,640)
Adjustments:
Depreciation and amortization expense 6,404 6,348
Interest expense, net 1,348 646
Income tax expense (benefit) 159 (43)
EBITDA (781) (2,689)
Adjustments:
Foreign currency exchange loss, net (1) 9 15
Other loss (income), net (2) 275 (149)
Loss (gain) on disposal of assets (3) 1 (7)
Gain on debt extinguishment (4) — (5,106)
Equity compensation expense (5) 375 428
Pension settlement/curtailment benefit (6) 108 208
LIFO impact (7) (305) 729
IT incident costs, net (8) 1,275 —
Strategic alternative expense (9) 86 —
Adjusted EBITDA $ 1,043 $ (6,571)
(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.
(4) 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.
(5) 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.
(6) Represents expense incurred by its defined benefit pension plans related to settlement of pension obligations.
(7) Represents the change in the reserve for inventories for which cost is determined using the last-in, first-out (“LIFO”) method.
(8) Represents incremental information technology costs as it relates to the cybersecurity incident and loss on insurance recovery.
(9) Represents expense related to evaluation of strategic alternatives.
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 Company's liquidity could be negatively affected if the Company is unable to restructure existing debt obligations, obtain capital or enter into a strategic alternative transaction which provides sufficient funding for the refinancing of its outstanding indebtedness prior to the maturity date of its obligations under the Credit Agreements, by customers extending payment terms to the Company and/or the decrease in demand for our products. The Company and management will continue to assess and actively manage liquidity needs. See Note 5 , Debt and Subsequent Event .
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Cash and cash equivale nts decreased to $0.4 million at Septemb er 30, 2023 compared with $1.2 million at September 30, 2022. At September 30, 2023 and 2022, cash included financing proceeds for capital investment and a nominal amount 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 used $1.4 million of cash in f iscal 2023, compared with $0.3 million provided in fiscal 2022. The cash used by operating activities in fiscal 2023 was primarily due to net operating loss of $8.7 million, adjusted for non-cash items such as change in NRV reserve $1.1 million, and LIFO benefit of $0.3 million, partially offset by depreciation and amortization of $6.4 million, equity based compensation of $0.3 million and sources of working capital of $1.7 million. The source of cash from working capital of $1.7 million was primarily due to increase in accounts payable due to timing of payments and lower inventories due to extended lead times, partially offset by higher accounts receivable due to increased sales at the end of the fiscal year.
The Company’s operating activi ties provided $0.3 million of cash in f iscal 2022. 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 of $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.
Investing Activities
Cash used for investing activities was $2.4 million in fiscal 2023, compared with $3.2 million in fiscal 2022. Fiscal 2023 and fiscal 2022 expenditures were used primarily for manufacturing enhancement and maintenance capital. Capital commitments at September 30, 2023 were $1.1 million. The Company anticipates the total fiscal 2024 capital expenditures will be within the range of $3.5 million to $4.5 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 $2.9 million in fiscal 2023 compared to cash provided by financing activities of $3.7 million in fiscal 2022.
As discussed in Note 5, Debt and Subsequent Event , the Company amended the Credit Agreement and the Export Agreement on August 9, 2023. The combined maximum borrowings decreased to $30.0 million from $35.0 million. The Seventh Amendment (the "Seventh Amendment") to the Credit Agreement (as amended, the "Credit Agreement") consists of a senior secured revolving credit facility with a maximum borrowing of $23.0 million, previously $28.0 million. The revolving commitment through the Third Amendment (the "Third Amendment") of the Export Credit Agreement, which lends amounts to the Company on foreign receivables remained unchanged at $7.0 million. The Seventh Amendment, among other things, (i) advanced the loan maturity date to December 31, 2023; (ii) provided a waiver of Existing Defaults and concludes the forbearance period as described under the Forbearance Agreement dated April 28, 2023; (iv) 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 Revolving Commitment, less the Availability Block, if applicable, the Borrowing Base, and in combination with the Export Revolving Loan under the Export Credit Agreement to $18.0 million through September 30, 2023 and $19.0 million thereafter; (v) the Reserves under the Borrowing Base in the ABL Credit Agreement were reduced to $1.5 million through September 30, 2023 and $2.0 million thereafter. The Third Amendment amends the Export Credit Agreement to (i) modified the loan maturity date to December 31, 2023 and (ii) provided waiver of Existing Defaults and concludes the forbearance period as described under the Forbearance Agreement dated April 28, 2023. The Seventh Amendment was subject to satisfaction of certain post closing deliverables, including: (i) one or more proposed term sheets which provide for the refinancing of all of the Obligations under the current Credit Agreement, in each case in an amount sufficient to repay the Obligations in full, by no later than September 19, 2023; (ii) a Confidential Information Memorandum ("CIM"), by no later than September 20, 2023; and (iii) a duly executed term sheet providing for the refinancing of all of the Obligations in an amount sufficient to repay the Obligations in full, by no later than October 8, 2023. All post closing deliverables were satisfied as required under the Seventh Amendment.
As discussed in Note 5, Debt and Subsequent Event , on November 8, 2023, the Company entered into the Eighth Amendment to the Credit Agreement (the "Eighth Amendment") with its Lender. The Eighth Amendment, among other things, reduced the Reserves under the Borrowing Base in the Credit Agreement to $1.5 million, or such lesser amount, if any, as may be agreed upon in writing by the Lender in its sole discretion.
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As discussed in Note 5, Debt and Subsequent Event , on December 21, 2023 the Company entered into the Ninth Amendment (the "Ninth Amendment") to the Credit Agreement and the Fourth Amendment (the "Fourth Amendment") to the Export Credit Agreement with its lender JPMorgan Chase Bank, N.A. (the "Lender") The Ninth Amendment amends the Credit Agreement to, among other things, to: (i) reflect the incurrence by borrowers of the Subordinated Loan and the execution and delivery by borrowers, the Lender and GHI of the Subordinated Loan Documents, and the receipt by borrowers of $3.0 million immediately available funds on the Ninth Amendment Effective Date; (ii) delay the maturity date from December 31, 2023 to October 4, 2024, or any earlier date on which the Revolving Commitment is reduced to zero or otherwise terminated pursuant to the terms of the Credit Agreement; (iii) reduce the Revolving Commitment from $23.0 million to $19.0 million; (iv) modify the Reserves of $1.5 million, increasing on the first day of each month by $0.3 million, commencing on May 1, 2024 and continuing until (and including) August 1, 2024, or such lesser amount, if any, as may be agreed upon in writing by the Lender in its sole discretion (which may be by email from the Lender), plus (d) the PP&E Component; (v) modify the Applicable Margin schedule to reflect the following applicable rates 2.75% (SOFR Spread), and 0.50% (Commitment Fee Rate). The Fourth Amendment of the Export Credit Agreement, to, among other things, to: (i) reflect the incurrence by borrowers of the Subordinated Loan and the execution and delivery by borrowers, the Lender and GHI of the Subordinated Loan Documents, and the receipt by borrowers of $3.0 million in immediately available funds on the Ninth Amendment Effective Date; and (ii) delay the maturity date to October 4, 2024, or any earlier date on which the Revolving Commitment is reduced to zero or otherwise terminated pursuant to the terms thereof.
The Company incurred a secured subordinated loan from Garnet Holdings, Inc., a California corporation owned and controlled by Mark J. Silk (“GHI”) (Mr. Silk is a member of the Board of Directors of the Company and considered a related party), in the original principal amount of $3.0 million (the “Subordinated Loan”) as a condition to the consummation of the transactions contemplated by the Ninth Amendment to the Credit Agreement. See Note 13 , Related Party Transactions and Note 14 , Subsequent Event for further discussion.
As discussed in Note 5, Debt and Subsequent Event , the Company's Maniago, Italy location did not obtain any new borrowings in fiscal 2023. The Company repaid $2.0 million of its Company's foreign term loans in 2023.
In fiscal 2022, the Company's Maniago, Italy location obtained borrowings from two separate lenders. 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.
The Company had net borrowings under its revolving credit facility of $5.1 million in fiscal 2023 and $2.2 million in fiscal 2022. 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 7.68% at September 30, 2023 and the Export Credit Agreement, as discussed in Note 5, Debt and Subsequent Event, has a rate based on SOFR plus a 1.75% spread, which was 7.18% at September 30, 2023. 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 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 and Subsequent Event . The availability at September 30, 2023 was $2.8 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 $1.5 million Reserve minimum as of September 30, 2023, 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.
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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. 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
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Estimates are revised as additional information becomes available. The Company believes that the accounting estimates employed and the resulting balances are reasonable; however, actual results in these areas could differ from the management's estimates under different assumptions or conditions.
Significant accounting policies used in the preparation of the consolidated financial statements are discussed in Note 1, Summary of Significant Accounting Policies . The Company believes that the assumptions and estimates associated with allowance for doubtful accounts, inventory valuation, goodwill, contract balances, and income taxes have the greatest potential impact on our financial statements because they are inherently uncertain, involve significant judgements, and include areas where different estimates reasonably could materially impact the financial statements. The Company believes that the critical accounting estimates employed and the resulting balances are reasonable; however, actual results in these areas could differ from management's estimates under different assumptions or conditions.
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 19% 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. Management’s judgment is necessary in determining the proper write down for obsolete and excess inventory. For the portion of the Company's inventory not valued at LIFO, inventory is valued at FIFO and stated at the lower of cost or net realizable value. The Company evaluates net realizable value on a quarterly basis. See Note 2, Inventories for further discussion.
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.
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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 whenever events or changes in circumstances indicate that the carrying amount of the long-lived asset (group) might not be recoverable. 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.
2023 Long-Lived Asset Recoverability Tests
In the first, second, third and fourth quarters, the Company evaluated triggering events and did not identify any indicators that the asset groups might be impaired.
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.
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.
If a reporting unit fails the quantitative impairment test, impairment expense is immediately recorded as the difference between the reporting unit's fair value and carrying value not to exceed the amount of goodwill recorded.
2023 Annual Goodwill Impairment Tests
SIFCO performed its annual test as of July 31, 2023. Goodwill existed at one of the Company's reporting units, Cleveland, Ohio as of July 31, 2023 and September 30, 2023. 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 .
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 July 31, 2022 and 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.
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Defined Benefit Pension Plan Expense
The Company maintains four 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 four 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-term rate of return on assets for the Company's pension plans as of September 30, 2023.
Impact on Fiscal 2023 Benefits Expense Impact on September 30, 2023 Projected Benefit Obligation for Pension Plans
Change in Assumptions
(In thousands)
25 basis point decrease in discount rate $ 17 $ 403
25 basis point increase in discount rate $ (17) $ (403)
100 basis point decrease in expected long-term rate of return on assets $ 181 $ —
100 basis point increase in expected long-term rate of return on assets $ (181) $ —
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.
As of September 30, 2023 and 2022, SIFCO used the following weighted-average assumptions:
Years Ended
September 30,
2023 2022
Discount rate for liabilities 5.6 % 5.2 %
Discount rate for expenses 5.1 % 2.9 %
Expected return on assets 6.2 % 6.4 %
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
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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 2023. Accordingly, the Company maintained its valuation allowance on its U.S. deferred tax assets as of the fourth quarter of fiscal year 2023.
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 for further discussion.
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, this ASU is effective for the Company beginning October 1, 2023. The effect of adopting this ASU is not expected to have a material impact to the Company's results within the consolidated statements of operations and financial condition.
In July 2023, the FASB issued ASU 2023-03, “ Presentation of Financial Statement (Topic 205), Income Statement - Reporting Comprehensive Income (Topic 220), Distinguishing Liabilities from Equity (Topic 480), Equity (Topic 505), and Compensation - Stock Compensation (Topic 718) ”, to amend various SEC paragraphs in the Accounting Standards Codification to reflect the issuance of SEC Staff Accounting Bulletin No. 120, among other things. The ASU does not provide any new guidance so there is no transition or effective date associated with it. The Company is currently assessing the impact of adopting ASU 2023-03 on the consolidated financial statements and related disclosures.
In November 2023, the FASB issued ASU 2023-07, " Segment Reporting (Topic 280): Improvements to Reportable Segment Disclosures" , that would enhance disclosures for significant segment expenses for all public entities required to report segment information in accordance with ASC 280. ASC 280 requires a public entity to report for each reportable segment a measure of segment profit or loss that its chief operating decision maker (“CODM”) uses to assess segment performance and to make decisions about resource allocations. The amendments in ASU 2023-07 improve financial reporting by requiring disclosure of incremental segment information on an annual and interim basis for all public entities to enable investors to develop more useful financial analyses. Currently, Topic 280 requires that a public entity disclose certain information about its reportable segments. For example, a public entity is required to report a measure of segment profit or loss that the CODM uses to assess segment performance and make decisions about allocating resources. ASC 280 also requires other specified segment items and amounts such as depreciation, amortization and depletion expense to be disclosed under certain circumstances. The amendments in ASU 2023-07 do not change or remove those disclosure requirements. The amendments in ASU 2023-07 also do not change how a public entity identifies its operating segments, aggregates those operating segments, or applies the quantitative thresholds to determine its reportable segments. The amendments in ASU 2023-07 are effective for fiscal years beginning after December 15, 2023, and interim periods within fiscal years beginning after December 15, 2024. Early adoption is permitted. A public entity should apply the amendments in ASU 2023-07 retrospectively to all prior periods presented in the financial statements. The Company is currently assessing the impact of adopting ASU 2023-07 on the consolidated financial statements and related disclosures.
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In December 2023, the FASB issued ASU 2023-09, " Income Taxes (Topic 740): Improvements to Income Tax Disclosures" . ASU 2023-09 is intended to enhance the transparency and decision usefulness of income tax disclosures. The amendments in ASU 2023-09 address investor requests for enhanced income tax information primarily through changes to the rate reconciliation and income taxes paid information. Early adoption is permitted. A public entity should apply the amendments in ASU 2023-09 prospectively to all annual periods beginning after December 15, 2024. The Company is currently evaluating the impact of this standard on our consolidated financial statements and related disclosures.
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