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. 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 products in the Aerospace and Energy ("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 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; (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 turbine 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) extraordinary or force majeure events affecting the business or operations of our business; and (12) the impact of the novel coronavirus ("COVID-19") pandemic and related impact on the global economy, which may exacerbate the above factors and/or impact our results of operations and financial condition.
The Company is engaged in the production of forgings and machined components primarily for the A&E markets. The processes and services provided by the Company include forging, heat-treating, machining, subassembly, and test. The Company operates under one business segment.
The Company endeavors to plan and evaluate its business operations while taking into consideration certain factors including the following: (i) the projected build rate for commercial, business and military aircraft, as well as the engines that power such aircraft; (ii) the projected maintenance, repair and overhaul schedules for commercial, business and military aircraft, as well as the engines that power such aircraft; and (iii) the projected build rate and repair for industrial turbines.
The Company operates within a cost structure that includes a significant fixed component. Therefore, higher net sales volumes are expected to result in greater operating income because such higher volumes allow the business operations to better leverage the fixed component of their respective cost structures. Conversely, the opposite effect is expected to occur at lower net sales and related production volumes.
A. Results of Operations
Overview
The Company produces forged components for (i) turbine engines that power commercial, business and regional aircraft as well as military aircraft and other military applications; (ii) airframe applications for a variety of aircraft; (iii) industrial gas and steam turbine engines for power generation units; and (iv) other commercial applications.
Fire Restoration
Recovery on the insurance claim related to the fire on December 26, 2018 at the Orange location continues in fiscal 2020. The Company continues to work diligently to restore the site back to full service as safely and quickly as possible. The 2500 ton press from storage that was placed in service in fiscal 2019 continues to run and the press located in Michigan was taken off-line at the end of November 2019 relocated to Orange and placed in service in March 2020. Restoration is nearly complete for the structure of the manufacturing building and presses damaged in the fire. The Company began running one restored press at the end of December 2019, while another finished being restored at the end of July 2020. During the first nine months of fiscal 2020, the Company received cash proceeds from insurance of $8.8 million, of which $3.5 million was recognized in fiscal 2019, $2.6 million was used to offset expense incurred as a result of the fire and business interruption and $2.7 million used for capital; and, separately, $0.7 million in proceeds from the insurance carrier went directly to the landlord for the continued restoration of the damaged building as prescribed under the lease arrangement. The table below reflects the receipt of proceeds and how they were expended as of June 30, 2020. Any additional recoveries in excess of recognized losses are treated as gain contingencies and will be recognized when the gain is realized or realizable. The Company also maintains business interruption insurance coverage and continues to work with the insurance company to reach an agreement on the recoverable amounts of business interruption expenses, which $0.9 million was realized in the first nine months of fiscal 2020.
|
|
|
|
|
|
Balance sheet (Other receivables - dollars in millions):
|
|
|
|
September 30, 2019
|
$
|
3.5
|
|
|
Cash proceeds
|
(8.8
|
)
|
|
Capital expenditures
|
2.7
|
|
|
Other expenses
|
1.7
|
|
|
Business interruption
|
0.9
|
|
June 30, 2020
|
$
|
—
|
|
For further detail of how the consolidated condensed statements of operations were impacted for the nine and three months ended, refer to Note 10, Commitments and Contingencies.
COVID-19
In March 2020, the outbreak of COVID-19 caused by a novel strain of the coronavirus was recognized as a pandemic by the World Health Organization, and the outbreak became widespread in the United States and other countries in which we operate. The Company has continued to take proactive steps to ensure the safety of its employees and customers and to preserve the Company’s financial flexibility. We have enacted operating protocols to ensure the safety of our employees and adopted precautions in compliance with various regulatory orders and recommendations imposed in the jurisdictions in which we operate. We may decide to take further actions that we determine to be in the best interest of our employees and customers, or are required by federal, state or local authorities.
The A&E industry in which we operate has been impacted by the COVID-19 pandemic and the impact of this pandemic on this industry as well as the global economy continues to evolve. The extent of the pandemic’s effect on Company’s financial condition, liquidity and future results of operations, as well as the A&E industry generally, depends on future developments, which cannot be predicted at this time. These future developments include, without limitation, the scope and severity of the pandemic, mitigation actions taken in response to the pandemic, the length of time involved in resuming economic activity, and the impact on government programs and budgets. Reduced demand for products or impaired ability to meet customer demand as a result of the pandemic or future developments could have a material adverse effect on our business, operations and financial performance. Given the evolution of the COVID-19 pandemic and the varied global responses to curb its spread, the Company is not presently able to estimate the effects of the COVID-19 outbreak on its future results of operations, financial condition or liquidity.
Backlog of Orders
SIFCO’s total backlog at June 30, 2020 was $100.9 million, compared with $104.4 million as of June 30, 2019 and $117.6 million as of September 30, 2019. Orders may be subject to modification or cancellation by the customer with limited charges. Sales in the A&E markets continue to be impacted by the general economy, newly acquired part numbers won and continued sales recovery from the fire at Orange and may be affected by the COVID-19 pandemic, which has created increased pressure in these markets. If the COVID-19 pandemic continues to have a material impact on the A&E markets, including with regards to our more significant customers, it could materially affect our business and results of operations. Backlog may decline as customers adjust orders in response to the ongoing COVID-19 pandemic and its impact on their operations. Backlog information may not be indicative of future sales.
Nine Months Ended June 30, 2020 compared with Nine Months Ended June 30, 2019
Net Sales
Net sales for the first nine months of fiscal 2020 increased to $84.5 million, compared with $81.3 million in the comparable period of fiscal 2019. Net sales comparative information for the first nine months of fiscal 2020 and 2019 is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
(Dollars in millions)
|
Nine Months Ended June 30,
|
|
Increase/ (Decrease)
|
Net Sales
|
2020
|
|
2019
|
|
Aerospace components for:
|
|
|
|
|
|
Fixed wing aircraft
|
$
|
39.1
|
|
|
$
|
39.0
|
|
|
$
|
0.1
|
|
Rotorcraft
|
22.3
|
|
|
17.2
|
|
|
5.1
|
|
Energy components for power generation units
|
9.9
|
|
|
13.3
|
|
|
(3.4
|
)
|
Commercial product and other revenue
|
13.2
|
|
|
11.8
|
|
|
1.4
|
|
Total
|
$
|
84.5
|
|
|
$
|
81.3
|
|
|
$
|
3.2
|
|
The increase of $5.1 million in rotorcraft sales in the first nine months of fiscal 2020 compared to the same period in fiscal 2019 is primarily due to increased shipments relating to certain military programs, such as the Black Hawk and CH53. Commercial products and other revenue increased $1.4 million in the first nine months of fiscal 2020 compared to the same period in fiscal 2019, primarily due to timing of shipments for the Hellfire II missile program and other ordnance work along with new product sales. Net sales in energy components for power generation units decreased by $3.4 million compared with the same period last year due to the continued softening of the energy market and some impact due to the global outbreak of COVID-19. In response to the outbreak of COVID-19, the Italian government restricted the operations of businesses within Italy, including the Company’s operations in Maniago, Italy ("Maniago"). The Company received an exemption from these government restrictions based on the nature of its operations, and temporarily reduced its operations in Maniago and undertook a temporary shutdown from March 17 through March 22 to perform a deep cleaning of the facility for employee safety due to the COVID-19 outbreak. Since the temporary cessation of operations in Maniago that occurred in March, Maniago has resumed operations and has experienced other disruptions, such as border closures to other countries, resulting in a delay in product shipments as of the end of June, which impacted the quarter by approximately $1.3 million. With countries subsequently beginning to reopen, Maniago expects to complete such shipments within the upcoming quarter.
Commercial net sales were 41.4% of total net sales and military net sales were 58.6% of total net sales in the first nine months of fiscal 2020, compared with 50.7% and 49.3%, respectively, in the comparable period in fiscal 2019. A shift in mix between commercial versus military sales in comparable periods is due to an increase in military programs, such as the Black Hawk program, partially offset by the decline in energy sales and continued delays in production due to the ongoing recovery efforts at the Orange location and the impact to the commercial aerospace industries due to COVID-19. Military net sales increased by $9.5 million to $49.6 million in the first nine months of fiscal 2020, compared with $40.1 million in the comparable period of fiscal 2019, primarily due to the timing of shipments for the Hellfire II missile program and other programs such as the Black Hawk and CH53. Commercial
net sales decreased $6.3 million to $34.9 million in the first nine months of fiscal 2020, compared with $41.2 million in the comparable period of fiscal 2019 primarily due to the continued business interruption created by the fire at the Orange location and timing related to certain programs as they were impacted by COVID-19 and the soft energy market.
Cost of Goods Sold
Cost of goods sold decreased by $4.3 million, or 5.8%, to $70.8 million, or 83.7% of net sales, during the first nine months of fiscal 2020, compared with $75.1 million or 92.4% of net sales, in the comparable period of fiscal 2019. The decrease was due primarily to improved productivity and the receipt of $2.7 million in insurance proceeds related to business interruption and expense incurred related to the fire, partially offset by $1.7 million of unabsorbed costs related to the Orange location due to the fire and the one-time pension withdrawal liability charge of $0.8 million incurred for exiting its multi-employer plan as further explained in Note 7, Retirement Benefit Plans.
Gross Profit
Gross profit increased $7.5 million to $13.8 million during the first nine months of fiscal 2020, compared with $6.2 million in the comparable period of fiscal 2019. Gross margin percent of sales was 16.3% during the first nine months of fiscal 2020, compared with 7.6% in the comparable period in fiscal 2019. The increase in gross profit was primarily due to the reduced cost of goods sold as a percentage of sales, as outlined above.
Selling, General and Administrative Expenses
Selling, general and administrative expenses were $10.4 million, or 12.3% of net sales during the first nine months of fiscal 2020, compared with $11.4 million, or 14.0% of net sales in the comparable period of fiscal 2019. The decrease in selling, general and administrative expenses is due to the continued cost reduction efforts by management in response to COVID-19 and other effects of the COVID-19 pandemic and its impact on operations such as reduced bank fees, less travel expense, lower legal and professional costs (prior year included arbitration costs), lower equity compensation and commissions, partially offset by higher incentive compensation accrual of $0.5 million.
Amortization of Intangibles
Amortization of intangibles was $1.2 million in the first nine months of fiscal 2020 and fiscal 2019, respectively.
Other/General
The Company recorded operating income of $4.7 million in the first nine months of fiscal 2020, compared with an operating loss of $9.9 million in the first nine months of fiscal 2019.
The prior year's operating loss includes an $8.3 million non-cash charge related to the Maniago reporting unit as its goodwill was impaired.
In the first nine months ended June 30, 2020, results included $2.7 million gain on insurance proceeds, compared to a gain of $4.5 million in the comparable period, both periods related to the net gain on insurance proceeds related to the fire at the Orange location.
Interest expense was $0.7 million in the first nine months of fiscal 2020, compared to $0.8 million in the first nine months of fiscal 2019.
The following table sets forth the weighted average interest rates and weighted average outstanding balances under the Company’s debt agreement in the first nine months of both fiscal 2020 and 2019:
|
|
|
|
|
|
|
|
|
|
|
|
Weighted Average
Interest Rate
Nine Months Ended
June 30,
|
|
Weighted Average
Outstanding Balance
Nine Months Ended
June 30,
|
|
2020
|
|
2019
|
|
2020
|
|
2019
|
Revolving credit agreement
|
3.2
|
%
|
|
4.1
|
%
|
|
$ 14.8 million
|
|
$ 17.9 million
|
Foreign term debt
|
3.9
|
%
|
|
2.7
|
%
|
|
$ 5.5 million
|
|
$ 7.2 million
|
Other debt
|
0.4
|
%
|
|
—
|
%
|
|
$ 6.1 million
|
|
$ 0.0 million
|
Income Taxes
The Company’s effective tax rate through the first nine months of fiscal 2020 was (2%), compared with 8% for the same period of fiscal 2019. The decrease in the effective rate was primarily attributable to changes in jurisdictional mix of income in fiscal 2020 compared with the same period of fiscal 2019. 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 income was $4.2 million during the first nine months of fiscal 2020, compared with a net loss of $9.9 million in fiscal 2019, respectively. The increase in income is primarily due to higher gross profit, attributed to continued improved productivity and insurance proceeds received in the first nine months of fiscal 2020 and lower selling, general and administrative expenses. Additionally, the Company did not experience a non-cash charge to goodwill as it did in the prior year.
Three Months Ended June 30, 2020 compared with Three Months Ended June 30, 2019
Net Sales
Net sales for the third quarter of fiscal 2020 increased 11.7% to $27.8 million, compared with $24.9 million in the comparable period of fiscal 2019. Net sales comparative information for the third quarter of fiscal 2020 and 2019 is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
(Dollars in millions)
|
Three Months Ended
June 30,
|
|
Increase (Decrease)
|
Net Sales
|
2020
|
|
2019
|
|
Aerospace components for:
|
|
|
|
|
|
Fixed wing aircraft
|
$
|
13.7
|
|
|
$
|
12.6
|
|
|
$
|
1.1
|
|
Rotorcraft
|
8.7
|
|
|
5.1
|
|
|
3.6
|
|
Energy components for power generation units
|
3.8
|
|
|
4.9
|
|
|
(1.1
|
)
|
Commercial product and other revenue
|
1.6
|
|
|
2.3
|
|
|
(0.7
|
)
|
Total
|
$
|
27.8
|
|
|
$
|
24.9
|
|
|
$
|
2.9
|
|
The majority of the increase was attributed to a $3.6 million increase in rotorcraft sales in the third quarter of fiscal 2020 compared to the same period in fiscal 2019 and is primarily due to increased shipments relating to certain military programs, such as the Black Hawk and Apache. The $1.1 million increase in fixed wing aircraft sales is due to increased shipments coming from the Orange location as it increases its production and its capabilities are restored when compared to the same period in fiscal 2019. Net sales in energy components for power generation units decreased by $1.1 million compared with the same period last year due to the continued softening of the energy market and as previously discussed within the nine months management and analysis section and due to the global outbreak of COVID-19. Sales were impacted in the quarter by approximately $1.3 million attributable to the inability to ship to its customers due to border closures, which have subsequently reopened.
Commercial net sales were 44.2% of total net sales and military net sales were 55.8% of total net sales in the third quarter of fiscal 2020, compared with 59.2% and 40.8%, respectively, in the comparable period of fiscal 2019. Military net sales increased by $5.4 million to $15.5 million in the third quarter of fiscal 2020, compared with $10.1 million in the comparable period of fiscal 2019. Commercial net sales decreased $2.4 million to $12.3 million in the third quarter of fiscal 2020, compared with $14.7 million in the comparable period of fiscal 2019 primarily due to lower sales in the energy market.
Cost of Goods Sold
Cost of goods sold was $23.6 million, or 85.1% of net sales, during the third quarter of fiscal 2020, compared with $23.5 million or 94.4% of net sales, in the comparable period of fiscal 2019, primarily driven by improved productivity as the Orange location completes restoration on certain presses and receipt of insurance proceeds of $0.3 million related to extra expense coverage.
Gross Profit
Gross profit increased $2.8 million to $4.1 million during the third quarter of fiscal 2020, compared with $1.4 million in the comparable period of fiscal 2019. Gross margin was 14.9% during the third quarter of fiscal 2020, compared with 5.6% in the comparable period in fiscal 2019. The increase in gross margin was primarily due to higher sales volume, improved productivity and receipt of insurance proceeds related to extra expense from the Orange fire.
Selling, General and Administrative Expenses
Selling, general and administrative expenses were $2.9 million, or 10.3% of net sales, during the third quarter of fiscal 2020, compared with $3.5 million, or 14.0% of net sales, in the comparable period of fiscal 2019. The decrease is primarily due to a decrease in legal and professional costs of $0.3 million.
Amortization of Intangibles
Amortization of intangibles was $0.4 million for both the third quarter of fiscal 2020 and fiscal 2019, respectively.
Other/General
The Company recorded an operating income of $2.5 million in the third quarter of fiscal 2020, compared to an operating loss of $7.5 million in the third quarter of fiscal 2019.
Current period results include a $1.7 million gain in insurance proceeds compared to $3.3 million in the third quarter of fiscal 2019 related to insurance recovery from the damage that occurred related to the fire at the Orange location.
The results from the third quarter of the prior year include an $8.3 million non-cash charge related to the Maniago reporting unit as its goodwill was impaired.
Interest expense was $0.2 million in the third quarter of fiscal 2020 and fiscal 2019.
The following table sets forth the weighted average interest rates and weighted average outstanding balances under the Company’s Credit Agreement in the third quarter of both fiscal 2020 and 2019:
|
|
|
|
|
|
|
|
|
|
|
|
Weighted Average
Interest Rate
Three Months Ended
June 30,
|
|
Weighted Average
Outstanding Balance
Three Months Ended
June 30,
|
|
2020
|
|
2019
|
|
2020
|
|
2019
|
Revolving credit agreement
|
2.0
|
%
|
|
4.1
|
%
|
|
$ 12.5 million
|
|
$ 12.5 million
|
Foreign term debt
|
3.9
|
%
|
|
2.9
|
%
|
|
$ 5.3 million
|
|
$ 6.7 million
|
Other debt
|
0.9
|
%
|
|
—
|
%
|
|
$ 6.1 million
|
|
$ 0.0 million
|
Income Taxes
The Company's effective tax rate in the third quarter of fiscal 2020 was 2%, compared with 4% for the same period of fiscal 2019. The decrease in the effective rate was primarily attributable to changes in jurisdictional mix of income during the three months ended June 30, 2020 compared to the same period of fiscal 2019, partially offset by an increase in discrete tax. 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 income was $2.3 million during the third quarter of fiscal 2020, compared with net loss of $7.4 million in the comparable period of fiscal 2019. Net income increased primarily due to higher sales and increased gross profit, lower selling, general and administrative expenses along with the gain on property recovered by insurance of $1.7 million as the Company continues to work through the restoration of the Orange location, while results from the third quarter of the prior year includes $8.3 million non-cash charge due to goodwill impairment at one of its reporting units.
Non-GAAP Financial Measures
Presented below is certain financial information based on the Company's EBITDA and Adjusted EBITDA. References to “EBITDA” mean earnings (losses) from continuing operations before interest, taxes, depreciation and amortization, and references to “Adjusted EBITDA” mean EBITDA plus, as applicable for each relevant period, certain adjustments as set forth in the reconciliations of net income to EBITDA and Adjusted EBITDA.
Neither EBITDA nor Adjusted EBITDA is a measurement of financial performance under generally accepted accounting principles in the United States of America (“GAAP”). The Company presents EBITDA and Adjusted EBITDA because management believes that they are useful indicators for evaluating operating performance and liquidity, including the Company’s ability to incur and service debt and it uses EBITDA to evaluate prospective acquisitions. Although the Company uses EBITDA and Adjusted EBITDA for the reasons noted above, the use of these non-GAAP financial measures as analytical tools has limitations. Therefore, reviewers of the Company’s financial information should not consider them in isolation, or as a substitute for analysis of the Company's results of operations as reported in accordance with GAAP. Some of these limitations include:
|
|
•
|
Neither EBITDA nor Adjusted EBITDA reflects the interest expense, or the cash requirements necessary to service interest payments on indebtedness;
|
|
|
•
|
Although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future, and neither EBITDA nor Adjusted EBITDA reflects any cash requirements for such replacements;
|
|
|
•
|
The omission of the substantial amortization expense associated with the Company’s intangible assets further limits the usefulness of EBITDA and Adjusted EBITDA; and
|
|
|
•
|
Neither EBITDA nor Adjusted EBITDA includes the payment of taxes, which is a necessary element of operations.
|
Because of these limitations, EBITDA and Adjusted EBITDA should not be considered as measures of discretionary cash available to the Company to invest in the growth of its businesses. Management compensates for these limitations by not viewing EBITDA or Adjusted EBITDA in isolation and specifically by using other GAAP measures, such as net income (loss), net sales, and operating income (loss), to measure operating performance. Neither EBITDA nor Adjusted EBITDA is a measurement of financial performance under GAAP, and neither should be considered as an alternative to net loss or cash flow from operations determined in accordance with GAAP. The Company’s calculation of EBITDA and Adjusted EBITDA may not be comparable to the calculation of similarly titled measures reported by other companies.
The following table sets forth a reconciliation of net loss to EBITDA and Adjusted EBITDA:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dollars in thousands
|
Three Months Ended
|
|
Nine Months Ended
|
|
June 30,
|
|
June 30,
|
|
2020
|
|
2019
|
|
2020
|
|
2019
|
Net income (loss)
|
$
|
2,250
|
|
|
$
|
(7,370
|
)
|
|
$
|
4,168
|
|
|
$
|
(9,911
|
)
|
Adjustments:
|
|
|
|
|
|
|
|
Depreciation and amortization expense
|
1,845
|
|
|
1,896
|
|
|
5,576
|
|
|
5,735
|
|
Interest expense, net
|
183
|
|
|
229
|
|
|
697
|
|
|
835
|
|
Income tax (benefit)
|
33
|
|
|
(336
|
)
|
|
(101
|
)
|
|
(816
|
)
|
EBITDA
|
4,311
|
|
|
(5,581
|
)
|
|
10,340
|
|
|
(4,157
|
)
|
Adjustments:
|
|
|
|
|
|
|
|
Foreign currency exchange loss (gain), net (1)
|
12
|
|
|
(3
|
)
|
|
12
|
|
|
(4
|
)
|
Other income, net (2)
|
27
|
|
|
(15
|
)
|
|
(58
|
)
|
|
(50
|
)
|
Loss (gain) on disposal and impairment of assets (3)
|
55
|
|
|
—
|
|
|
98
|
|
|
(282
|
)
|
Gain on insurance proceeds received (4)
|
(1,683
|
)
|
|
(3,304
|
)
|
|
(2,683
|
)
|
|
(4,468
|
)
|
Equity compensation (5)
|
37
|
|
|
(59
|
)
|
|
262
|
|
|
367
|
|
LIFO impact (6)
|
(5
|
)
|
|
154
|
|
|
(16
|
)
|
|
98
|
|
Goodwill impairment (7)
|
—
|
|
|
8,294
|
|
|
—
|
|
|
8,294
|
|
Adjusted EBITDA
|
$
|
2,754
|
|
|
$
|
(514
|
)
|
|
$
|
7,955
|
|
|
$
|
(202
|
)
|
|
|
(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 values 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.
|
|
|
(5)
|
Represents the equity-based compensation expense recognized by the Company under its 2016 Long-Term Incentive Plan (as the amendment and restatement of, and successor to, the 2007 Long-Term Incentive Plan) due to granting of awards, awards not vesting and/or forfeitures.
|
|
|
(6)
|
Represents the change in the reserve for inventories for which cost is determined using the last-in, first-out (“LIFO”) method.
|
|
|
(7)
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Represents non-cash charge of goodwill impairment experienced at its reporting unit level.
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B. Liquidity and Capital Resources
Cash and cash equivalents were both $0.3 million at June 30, 2020 and September 30, 2019. At June 30, 2020, the majority of the $0.3 million 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.
Historically, the main sources of liquidity have been cash flows from operations and borrowings under our Credit Agreement. However, the continued impact of the COVID-19 pandemic (and the rapidly changing U.S. and global market and economic conditions due to the COVID-19 outbreak) is highly uncertain, with disruptions 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 a decrease in demand for our products as a result of the COVID-19 pandemic. Since the start of the pandemic, management has continued to evaluate the Company’s liquidity and capital resources and has taken a number of steps to help preserve financial flexibility in light of uncertainty resulting from the COVID-19 pandemic by deferring wage increases to non-union employees, increased oversight of all capital expenditure approval, working with vendors to reduce costs and obtained a Paycheck Protection Program Loan as referenced in Note 5, Debt and for the reasons described below. As the impact of the COVID-19 pandemic on the economy and the Company's operations continues to evolve, the Company and management will continue to assess liquidity needs.
Operating Activities
The Company’s operating activities provided $2.3 million of cash in the first nine months of fiscal 2020, compared with providing cash of $9.4 million in the first nine months of fiscal 2019. The cash provided by operating activities in the first nine months of fiscal 2020 was primarily due to net income of $4.2 million and $2.9 million in non-cash items, such as depreciation and amortization, equity based compensation, deferred income taxes and LIFO effect, partially offset by the use of working capital of $4.8 million (increase in inventory of $4.6 million, $2.8 million in contract assets, net accruals of $1.7 million offset by $4.3 million decrease in receivables). The use of cash from working capital was primarily due to increase in inventories to support orders and customer adjustments for the remaining fiscal 2020 and payments to suppliers and disbursements related to the fire recovery, partially offset by decreased receivables resulting from improved collections.
The Company’s operating activities provided $9.4 million of cash in the first nine months of fiscal 2019. The cash provided by operating activities in the first nine months of fiscal 2019 was primarily due to a reduction in working capital of $9.8 million, a result in non-cash items such as the goodwill impairment charge of $8.3 million, depreciation and amortization of $5.7 million, and other non-cash items, such as equity based compensation, deferred income taxes and LIFO effect, partially offset by a gain on insurance recovery combined with a disposal of asset of $4.8 million and a net loss of $9.9 million. The increase in cash from working capital was primarily due to decreased receivables due to collections, partially offset by timing of payments to suppliers.
Investing Activities
Cash used for investing activities was $1.3 million in the first nine months of fiscal 2020, which includes $6.2 million of insurance proceeds received due to the Orange location fire, compared with cash used for investing activities of $1.2 million in the first nine months of fiscal 2019. In addition to the $7.4 million expended for capital expenditures during the first nine months of fiscal 2020, $2.6 million was committed for future capital expenditures as of June 30, 2020. The Company anticipates that the total fiscal 2020 capital expenditures will be within the range of $4.0 million to $5.0 million (exclusive of fire related expenditures) and will relate principally to the further enhancement of production and product offering capabilities and operating cost reductions. Separate from the amounts given above, the Company anticipates incurring additional costs in fiscal 2020 of approximately $4.5 million to $6.5 million in capital expenditures at the Orange location as the result of the fire and resulting damage that took place. These costs are expected to be offset by insurance proceeds, approximately of which $8.8 million of insurance proceeds have been received as of June 30, 2020. Of the proceeds received, $6.2 million have been used towards capital expenditures and the remaining $2.6 million received is offsetting operating costs.
Financing Activities
Cash used by financing activities was $1.1 million in the first nine months of fiscal 2020, compared with cash used by financing activities of $8.7 million in the first nine months of fiscal 2019.
As discussed in Note 5, Debt, of the consolidated condensed statements the Company received cash proceeds of $5.0 million as it relates to the Paycheck Protection Program (or "PPP") of the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act") and made repayments of $0.8 million of long-term debt, which $0.5 million were from the Company's foreign term loan, compared with repayments of $1.1 million in the comparable period.
In August 2018, the Company entered into an asset-based Credit Agreement ("Credit Agreement") and Security Agreement ("Security Agreement") with a lender. See Note 5, Debt, of the consolidated condensed statements for further discussion related to the Credit Agreement and the First, Second, Third and Fourth Amendment to the Credit Agreement.
The Company had net repayments from the revolver under the Credit Agreement of $4.2 million and $8.6 million in the first nine months of fiscal 2020 and fiscal 2019, respectively.
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 rates or LIBOR, plus the applicable margin as set forth in the Credit Agreement. The revolver has a rate based on LIBOR plus 1.5% spread, which was 1.7% at June 30, 2020 and the Export Credit Agreement as discussed in Note 5, Debt, has a rate
based on LIBOR plus 1.0% spread, which was 1.2% at June 30, 2020. 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. The availability at June 30, 2020 was $13.5 million. If availability had fallen short, the Company would be required to meet the fixed charge coverage ratio ("FCCR") covenant, which must not be less than 1.1 to 1.0. In the event of a default, we may not be able to access our revolver, which could impact the ability to fund working capital needs, capital expenditures and invest in new business opportunities. Because the availability was greater than the 10% of the Revolving Commitment as of June 30, 2020, 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, (ii) funds available under the Credit Agreement for its domestic locations and (iii) funds received pursuant to the Paycheck Protection Program Loan. The Company continues to seek alternatives with its lenders and other potential partners to refinance certain debt obligations at its Maniago location to provide Maniago with sufficient future liquidity. If Maniago is unsuccessful in obtaining additional financing, it may experience certain challenges in meeting certain obligations. This foreign debt is collateralized by Maniago’s assets. The U.S. operations of the Company have not pledged any assets as collateral or guaranteed Maniago’s debt. The consolidated condensed financial statements do not include any adjustments to reflect the possible future effect on the recoverability and classification of the Maniago assets or the amounts and classifications of the Maniago liabilities that may result from the outcome of this uncertainty. Management believes that the actions presently being taken to obtain additional funding and implement its strategic plan will provide adequate liquidity to finance Maniago operations.
Additionally, the 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. Critical Accounting Policies and Estimates
The Company's disclosures of critical accounting policies in its Annual Report on Form 10-K for the year ended September 30, 2019 have not materially changed since that report was filed, except for the following:
Effective October 1, 2019, the Company adopted ASC 842 Leases ("Topic 842"). Prior to the adoption of Topic 842, operating leases were maintained as off balance sheet arrangements. Under the transition method selected by the Company, leases that are not short-term in nature existing at, or entered on October 1, 2019 were required to be recognized and measured. Prior period amounts were not adjusted and continue to be reflected with the Company's historical accounting.
The Company determines if a contract contains a lease when the contract conveys the right to control the use of identified assets for a period in exchange for consideration. Upon identification and commencement of a lease, the Company establishes a right of use ("ROU") asset and a lease liability. Operating leases are included in ROU assets, short-term operating lease liabilities, and long-term operating lease liabilities on the consolidated condensed balance sheets. Finance leases are included in property, plant, and equipment, current maturities of long-term debt and long-term debt on the consolidated condensed balance sheets.
The total lease term is determined by considering the initial lease term per the lease agreement, which is adjusted to include any renewal options that the Company is reasonably certain to exercise as well as any period that the Company has control before the stated initial term of the agreement. If the Company determines there exists a reasonable certainty of exercising termination or early buyout options, then the lease terms are adjusted to account for these facts.
The Company elected the package of practical expedients permitted under the transition guidance within the new standard which, among other things, allowed the Company to carry forward the historical lease classification.
The Company has made an accounting policy election to not separate non-lease components from lease components when allocating consideration for the buildings and machinery and equipment ROU asset classes. The election was made to reduce the administrative burden that would be imposed on the Company.
ROU assets and liabilities are recognized based on the present value of the future minimum lease payments over the lease term at commencement date. As most of the leases do not provide an implicit rate, the Company uses the incremental borrowing rate based on the information available at commencement date in determining the present value of the future payments. Lease expense for operating leases is recognized on a straight-line basis over the lease term, while the expense for finance leases is recognized as depreciation expense and interest expense using the accelerated interest method of recognition. A lease asset and lease liability are not recorded for leases with an initial term of 12 months or less and the lease expense related to these leases is recognized as incurred over the lease term.
D. Impact of Recently 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 are considered smaller reporting companies ("SRC"), as defined by the Securities and Exchange Commission, to fiscal years beginning 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 condensed statements of operations and financial condition.
In December 2019, ASU 2019-12, "Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes" was issued to (i) reduce the complexity of the standard by removing certain exceptions to the general principles in Topic 740 and (ii) improve consistency and simplify other areas of Topic 740 by clarifying and amending existing guidance. This ASU is effective for fiscal years and interim periods within those fiscal years, beginning after December 15, 2020. The Company is currently in the process of evaluating the impact of adoption of the rules on the Company's financial condition, results of operations and disclosure.
E. Recently Adopted Accounting Standards
For recently adopted accounting standards refer to Note 1, Summary of Significant Accounting Policies - Recently Adopted Accounting Standards for further detail.
Item 4. Controls and Procedures
As defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), disclosure controls and procedures are controls and procedures designed to ensure that information required to be disclosed in reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported on a timely basis, and that such information is accumulated and communicated to management, including the Company’s Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. The Company’s disclosure controls and procedures include components of the Company’s internal control over financial reporting. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Management of the Company, under the supervision and with the participation of the Chief Executive Officer and Chief Financial Officer, carried out an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(e) as of June 30, 2020 (the “Evaluation Date”). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the Evaluation Date, the Company’s disclosure controls and procedures were not effective, as a result of the continuing existence
of the material weakness in the Company's internal controls over financial reporting described in Item 9A of the Company's 2019 Annual Report on Form 10-K.
A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected and corrected on a timely basis.
The following material weakness related to our control environment existed as of June 30, 2020.
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Key controls around segregation of duties and periodic access reviews within IT general and application controls for the Cleveland operation were not designed or operating effectively.
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The control environment deficiencies described above could have resulted in a failure to prevent or detect a material misstatement in our financial statements due to the omission of information or inappropriate conclusions regarding information required to be recorded, processed, summarized, and reported in the Company’s SEC reports. Notwithstanding the identified material weakness, management believes the condensed consolidated financial statements included in this Quarterly Report on Form 10-Q fairly represent in all material respects our financial condition, results of operations and cash flows at and for the periods presented in accordance with U.S. GAAP.
Remediation Plan for Material Weakness in Internal Control over Financial Reporting
Management and the Company's Board of Directors are committed to improving the Company's overall system of internal controls over financial reporting.
To address the material weakness identified in our control environment, the Company is taking the following actions to remediate the material weakness:
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Implement robust security and access reviews at a level of precision necessary to ensure they are timely and appropriate. The Company is making progress by utilizing external assistance. Using a risk-based approach, management will implement detective and monitoring business process controls to further mitigate IT risks over financial reporting.
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With the oversight of senior management and the Company's Board of Directors, the Company continues to take steps and additional measures to remediate the underlying causes of the identified material weakness, including but not limited to (i) evaluating our information technology systems or invest in improvements to our technology sufficient to generate accurate, transparent, and timely financial information, and (ii) continue to strengthen organizational structure by holding individuals accountable for their internal control responsibilities.
Although we continue to make meaningful progress on our remediation plan during fiscal year 2020, we cannot estimate how long it will take to complete the process or the costs of actions required. There is no assurance that the aforementioned plans will be sufficient and that additional steps may not be necessary.
Changes in Internal Control over Financial Reporting and other Remediation
No material changes in our internal control over financial reporting (as defined in Rules 13a‑15(f) and 15d‑15(f) under the Exchange Act) occurred during the period covered by this Quarterly Report on Form 10‑Q that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.