SIFCO Industries, Inc. — Q1 FY2016 Form 10-Q
Reporting period: Three months ended December 31, 2015; comparisons are with the three months ended December 31, 2014. SIFCO produces forgings and machined components, primarily for aerospace and energy markets. Results include C*Blade, acquired in July 2015.
Financial performance
| Metric | Q1 FY2016 | Q1 FY2015 |
|---|---|---|
| Net sales | $27.2 million | $20.1 million |
| Gross profit / margin | $2.1 million / 7.8% | $3.0 million / 14.9% |
| Operating loss | $(4.2) million | $(2.0) million |
| Net loss | $(2.6) million | $(1.4) million |
| Net loss per diluted share | $(0.48) | $(0.26) |
| Operating cash flow, continuing operations | $8.3 million | $(1.6) million |
| Capital expenditures | $0.7 million | $3.5 million |
| Total debt | $41.7 million | $48.9 million at September 30, 2015 |
| Cash and cash equivalents | $1.3 million | $0.7 million at September 30, 2015 |
Q1 FY2016 gross profit and margins weakened as cost of goods sold rose faster than sales. Selling, general and administrative expenses were $5.6 million, including approximately $1.0 million of additional legal and professional fees, primarily related to the late filing of the fiscal 2015 Form 10-K. Interest expense rose to $0.4 million from $0.1 million, largely due to acquisition-related financing. The income tax benefit was $1.9 million; the reported effective tax rate was 43%, including tax credits and discrete benefits.
Operating cash flow improved mainly because working capital declined by approximately $8.0 million, including lower receivables and higher accounts payable. It was also supported by $2.9 million of non-cash items, so the quarter’s positive operating cash flow should not be read as evidence of improved earnings. Adjusted EBITDA, a non-GAAP measure, was $(0.7) million versus $0.7 million.
Changes and business drivers
- Sales increased 35.3%, or $7.1 million. Approximately $5.0 million of the increase came from C*Blade, primarily in energy components.
- Fixed-wing aircraft sales rose $2.9 million; rotorcraft sales declined $0.6 million. Management attributed these movements mainly to program build-rate changes.
- Energy component sales increased $5.4 million, including the contribution from C*Blade. Commercial sales were $17.0 million and military sales were $10.2 million.
- Gross margin fell 7.1 percentage points, primarily due to lower-margin product mix, aerospace program ramp-up costs, higher production costs, and lower-of-cost-or-market adjustments at one location.
- Goodwill declined to $15.6 million from $16.5 million, reflecting a purchase-price adjustment and currency translation. The C*Blade purchase price, including assumed debt and after an adjustment, was approximately $16.7 million.
Liquidity, outlook, and risks
At December 31, 2015, total debt was $41.7 million, including $10.8 million of current maturities; shareholders’ equity was $70.5 million. The credit facility includes a five-year revolver whose maximum availability falls from $25 million to $20 million on January 1, 2016, and a five-year $20 million term loan. The facilities are secured by substantially all U.S. company and subsidiary assets and a pledge of 65% of non-U.S. subsidiary stock. The company reported compliance with required financial covenants at quarter-end; after quarter-end it obtained a lender waiver for certain non-financial covenants and stated it expected to remain in compliance through FY2016. Management said it believed cash flows and credit-facility availability would provide adequate liquidity.
Management anticipated FY2016 capital expenditures of $4 million to $5 million, including production capability improvements, cost reductions, and plant expansion. No revenue or earnings guidance was provided. Approximately $0.9 million of cash was held by non-U.S. subsidiaries, and distributions could have adverse tax consequences. A 100-basis-point change in rates, assuming unchanged variable-rate borrowings, would affect annual interest expense by approximately $0.3 million.
Key risks cited include demand and build rates in aerospace and energy markets, reliance on military spending and major customers, competition, commodity costs and recovery, product development, pension funding, political and regulatory conditions, and integration of acquisitions. The company reported no material litigation matters in the ordinary course, while noting future litigation costs could affect results.
Controls and notable matters
Management concluded that disclosure controls and procedures were not effective as of December 31, 2015 because previously reported material weaknesses in internal control over financial reporting continued. Areas included manual journal-entry approval, system-generated report testing, account reconciliations, cash application, revenue recognition, and corporate monitoring of plant locations. Remediation was underway, but the company could not estimate how long completion would take. The filing also attributes elevated professional fees partly to the late fiscal 2015 annual report filing.
Important facts for investors to verify
- Whether remediation of the disclosed material weaknesses is completed and independently validated, and whether subsequent filings identify further reporting issues.
- Whether the company remains compliant with credit covenants and what the post-quarter waiver covers; also confirm actual revolver availability and debt repayment needs.
- Whether gross margins and operating performance recover as aerospace programs ramp and product mix changes, excluding acquisition-related sales effects.
- Whether working-capital cash generation is sustainable, given the quarter’s cash-flow improvement was largely driven by receivables and payables movements.
- Whether C*Blade integration, acquisition accounting adjustments, and planned capital spending deliver the expected operating contribution without straining liquidity.