SIFCO INDUSTRIES INC - Quarter Report: 2011 December (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

For the quarterly period ended December 31, 2011

or

For the transition period from             to             

Commission file number 1-5978

SIFCO Industries, Inc.

(Exact name of registrant as specified in its charter)

(216) 881-8600

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer”, “non-accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

    Yes  ¨    No  x

The number of the Registrant’s Common Shares outstanding at December 31, 2011 was 5,290,328.

Part I. Financial Information

Item 1. Financial Statements

SIFCO Industries, Inc. and Subsidiaries

Consolidated Condensed Statements of Operations

(Unaudited)

(Amounts in thousands, except per share data)

See notes to unaudited consolidated condensed financial statements.

2

SIFCO Industries, Inc. and Subsidiaries

Consolidated Condensed Balance Sheets

(Amounts in thousands, except per share data)

See notes to unaudited consolidated condensed financial statements.

3

SIFCO Industries, Inc. and Subsidiaries

Consolidated Condensed Statements of Cash Flows

(Unaudited)

(Amounts in thousands)

See notes to unaudited consolidated condensed financial statements.

4

SIFCO Industries, Inc. and Subsidiaries

Notes to Unaudited Consolidated Condensed Financial Statements

(Dollars in thousands, except share and per share data)

1.         Summary of Significant Accounting Policies

A. Principles of Consolidation

The accompanying unaudited consolidated condensed financial statements include the accounts of SIFCO Industries, Inc. and its wholly-owned subsidiaries (the “Company”). All significant intercompany accounts and transactions have been eliminated.

The U.S. dollar is the functional currency for all of the Company’s U.S. operations and its Irish subsidiary. For these operations, all gains and losses from completed currency transactions are included in income currently. For the Company’s other non-U.S. subsidiaries, the functional currency is the local currency. Assets and liabilities are translated into U.S. dollars at the rates of exchange at the end of the period, and revenues and expenses are translated using average rates of exchange. Foreign currency translation adjustments are reported as a component of accumulated other comprehensive loss in the unaudited consolidated condensed financial statements.

These unaudited consolidated condensed financial statements should be read in conjunction with the consolidated financial statements and related notes included in the Company’s fiscal 2011 Annual Report on Form 10-K. The results of operations for any interim period are not necessarily indicative of the results to be expected for other interim periods or the full year. Certain prior period amounts may have been reclassified in order to conform to current period classifications.

B. Net Income Per Share

The Company’s net income per basic share has been computed based on the weighted-average number of common shares outstanding. Net income per diluted share reflects the effect of the Company’s outstanding stock options under the treasury stock method. The dilutive effect of the Company’s stock options was 26,000 and 31,000 shares for the three months ended December 31, 2011 and 2010, respectively. However, during periods when operating losses may occur, outstanding stock options would not be included in the calculation of net loss per diluted share because such inclusion would be anti-dilutive.

C. Derivative Financial Instruments

The Company uses an interest rate swap agreement to reduce risk related to variable-rate debt, which is subject to changes in market rates of interest. The interest rate swap is designated as a cash flow hedge. At December 31, 2011, the Company held one interest rate swap agreement with a notional amount of $9,500. Cash flows related to the interest rate swap agreement are included in interest expense. The Company’s interest rate swap agreement and its variable-rate term debt are based upon LIBOR. During the first quarter of fiscal year 2012, the Company’s interest rate swap agreement qualified as a fully effective cash flow hedge against the Company’s variable-rate term note interest risk. The following table reports the effects of the mark-to-market valuation of the Company’s interest rate swap agreement for the three months ended December 31, 2011:

2.         Inventories

Inventories consist of:

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Inventories are stated at the lower of cost or market. Cost is determined using the last-in, first-out (“LIFO”) method for 48% and 54% of the Company’s inventories at December 31, 2011 and September 30, 2011, respectively. The first-in, first-out (“FIFO”) method is used for the remainder of the inventories. If the FIFO method had been used for the inventories for which cost is determined using the LIFO method, inventories would have been $8,132 and $7,974 higher than reported at December 31, 2011 and September 30, 2011, respectively.

3.         Goodwill and Intangible Assets

The Company’s intangible assets by major asset class subject to amortization consist of:

Included in the intangible assets at December 31, 2011 are intangible assets acquired in connection with the purchase of the forging business and substantially all related operating assets from GEL Industries, Inc. (DBA Quality Aluminum Forge, Inc.) on October 28, 2011, as discussed more fully in Note 11. These acquired intangible assets consist of:

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The amortization expense on identifiable intangible assets for the three months ended December 31, 2011 and 2010 was $815 and $57, respectively. Amortization expense associated with the identified intangible assets is expected to be as follows:

The Company’s goodwill is not being amortized, but is subject to an annual impairment test. All of the goodwill is expected to be deductible for tax purposes. Changes in the net carrying amount of goodwill were as follows:

Total comprehensive income is as follows:

The components of accumulated other comprehensive loss are as follows:

Long-term debt consists of:

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In October 2011, the Company entered into an amendment to its existing credit agreement (the “Credit Agreement Amendment”) with its bank increasing the maximum borrowing amount from $30.0 million to $40.0 million, of which $10.0 million is a five (5) year term loan and $30.0 million is a five (5) year revolving loan, secured by substantially all the assets of the Company and its U.S. subsidiaries and a pledge of 65% of the stock of its non-U.S. subsidiaries. The term loan is repayable in quarterly installments of $0.5 million starting December 1, 2011.

The term loan has a Libor-based variable interest rate that was 2.3% at December 31, 2011 and which becomes an effective fixed rate of 2.9% after giving effect to an interest rate swap agreement. Borrowing under the revolving loan bears interest at a rate equal to Libor plus 0.75% to 1.75%, which percentage fluctuates based on the Company’s leverage ratio of outstanding indebtedness to EBITDA. The loans are subject to certain customary financial covenants including, without limitation, covenants that require the Company to not exceed a maximum leverage ratio and to maintain a minimum fixed charge coverage ratio. There is also a commitment fee ranging from 0.10% to 0.25% to be incurred on the unused balance. The Company was in compliance with all applicable loan covenants as of December 31, 2011.

In connection with the acquisition of the QAF business, as discussed more fully in Note 11, the Company issued a non-interest bearing promissory note to the seller, which note is payable by the Company in November, 2013.

In the past, the Company received grants from certain government entities as an incentive to invest in facilities, research and employees. Remaining grants, principally capital in nature, are amortized into income over the estimated useful lives of the related assets. The unamortized portion of deferred grant revenue recorded in other long-term liabilities at December 31, 2011 and September 30, 2011 was $354 and $375, respectively. The Company’s grants are denominated primarily in Euros. The Company adjusts its deferred grant revenue balance in response to currency exchange rate fluctuations for as long as such grants are treated as obligations.

For each interim reporting period, the Company makes an estimate of the effective tax rate it expects to be applicable for the full fiscal year. This estimated effective rate is used in providing for income taxes on a year-to-date basis. The Company’s effective tax rate through the first three months of fiscal 2012 is 32%, compared to 35% for the same period in fiscal 2011, and differs from the U.S. federal statutory rate due primarily to (i) the impact of U.S. state and local income taxes, (ii) a domestic production activities deduction, (iii) application of tax credits and (iv) the recognition of U.S. federal income taxes on undistributed earnings of non-U.S. subsidiaries. The income tax provision consists of the following:

The Company is subject to income taxes in the U.S. federal jurisdiction, and various state, local and non-U.S. jurisdictions. The Company is no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations by tax authorities for fiscal years prior to 2006.

8

At December 31, 2011 and September 30, 2011, the Company recorded liabilities of $94 and $96, respectively, for uncertain tax positions and any related interest and penalties. The Company classifies any interest and penalties related to uncertain tax positions in income tax expense. A summary of activity related to the Company’s uncertain tax positions is as follows:

The Company and certain of its subsidiaries sponsor defined benefit pension plans covering most of its employees. The components of net periodic benefit cost of the Company’s defined benefit plans are as follows:

Through December 31, 2011, the Company has made contributions in the amount of $202 to its defined benefit pension plans. The Company anticipates making $972 of additional contributions to fund its defined benefit pension plans during the balance of fiscal 2012.

In previous periods, the Company has awarded stock options under its shareholder approved 1995 Stock Option Plan (“1995 Plan”) and 1998 Long-term Incentive Plan (“1998 Plan”). No further options may be awarded under either the 1995 Plan or the 1998 Plan. Option exercise price is not less than fair market value on date of grant and options are exercisable no later than ten years from date of grant. All options awarded under both plans are fully vested as of December 31, 2011.

Aggregate option activity is as follows:

As of December 31, 2011, there was no unrecognized compensation cost related to the stock options granted under either the 1995 or 1998 Plans.

The Company has awarded performance and restricted shares under its shareholder approved 2007 Long-Term Incentive Plan (“2007 Plan”). The aggregate number of shares that may be awarded under the 2007 Plan is 600,000 less any shares previously awarded and subject to an adjustment for the forfeiture of any unissued shares. In addition, shares that may be awarded are subject to individual recipient award limitations. The shares awarded under the 2007 Plan may be made in multiple forms including stock options, stock appreciation rights, restricted or unrestricted stock, and performance related shares. Any such awards are exercisable no later than ten years from date of grant.

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The performance shares that have been awarded under the 2007 Plan generally provide for the issuance of the Company’s common shares upon the Company achieving certain defined financial performance objectives during a period up to three years following the making of such award. The ultimate number of common shares of the Company that may be earned pursuant to an award ranges from a minimum of no shares to a maximum of 150% of the initial target number of performance shares awarded, depending on the level of the Company’s achievement of its financial performance objectives.

With respect to such performance shares, compensation expense is being accrued at (i) 100% of the target levels for recipients of the performance shares awarded during fiscal 2012, (ii) 100% of the target levels for recipients of the performance shares awarded during fiscal 2011 and (iii) approximately 140% of the target levels for recipients of the performance shares awarded during fiscal 2010. During each future reporting period, such expense may be subject to adjustment based upon the Company’s subsequent estimate of the number of common shares that it expects to issue upon the completion of the performance period. The performance shares were valued at the closing market price of the Company’s common shares on the date of grant, and such value was recorded as unearned compensation. The vesting of such shares is determined at the end of the performance period.

During fiscal 2011, the Company awarded restricted shares to certain of its directors. The restricted shares were valued at the closing market price of the Company’s common shares on the date of grant, and such value was recorded as unearned compensation. The unearned compensation is being amortized ratably over the restricted stock vesting period of one (1) year.

If all outstanding share awards are ultimately earned and issued at the target number of shares, then at December 31, 2011 there are approximately 429,800 shares that remain available for award. If any of the outstanding share awards are ultimately earned and issued at greater than the target number of shares, up to a maximum of 150% of such target, then a fewer number of shares would be available for award.

Compensation expense related to all performance and restricted shares awarded under the 2007 Plan was $238 and $54 during the first three months of fiscal 2012 and 2011, respectively. As of December 31, 2011, there was $1,610 of total unrecognized compensation cost related to the performance and restricted shares awarded under the 2007 Plan. The Company expects to recognize this cost over the next 2.8 years.

The following is a summary of activity related to the target number of shares awarded and the actual number of shares earned under the 2007 Plan:

The Company identifies reportable segments based upon distinct products manufactured and services performed. The Forged Components Group (“Forge Group”) consists of the production, heat-treatment, surface-treatment, non-destructive testing and some machining of both conventional and precision forged components in various steel, titanium and aluminum alloys utilizing a variety of processes for application principally in the aerospace and power generation industries. The Turbine Component Services and Repair Group (“Repair Group”) consists primarily of the repair and remanufacture of small aerospace and industrial turbine engine components, and is also involved in providing precision component machining and industrial coating of turbine engine components. The Applied Surface Concepts Group (“ASC Group”) is a provider of specialized selective plating processes and services used to apply metal coatings to a selective area of a component. The Company’s reportable segments are separately managed.

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The following table summarizes certain information regarding segments of the Company:

On October 28, 2011, through its wholly-owned subsidiary, Forge Acquisition, LLC – now known as Quality Aluminum Forge, LLC (“QAF”), the Company completed the purchase of the forging business and substantially all related operating assets from GEL Industries, Inc. (DBA Quality Aluminum Forge). The forging business is operated in QAF’s Orange and Long Beach, California facilities, all of which are leased. The purchase price for the forging business and related operating assets was approximately $24.8 million payable in cash, subject to certain adjustments related principally to the delivered working capital level and/or indemnification holdback provisions under the purchase agreement. In addition, the Company has assumed certain current operating liabilities of the forging business.

The QAF purchase transaction is accounted for under the purchase method of accounting. The Company has not yet completed the purchase accounting related to the QAF acquisition. The final purchase price allocation will be allocated to the assets acquired and liabilities assumed based upon their fair values when appraisals, other studies and additional information become available.

11

The preliminary allocation of the purchase price and the estimated goodwill and intangible assets, all of which belong to the Forge Group, are as follows:

On December 10, 2010, through its wholly-owned subsidiary, TWF Acquisition, LLC – now known as T&W Forge, LLC (“TWF”), the Company completed the purchase of the forging business and substantially all related operating assets from T&W Forge, Inc. (“T&W Forge”). TWF operates in T&W Forge’s Alliance, Ohio facility under a long-term lease arrangement, with an option to purchase the facility at a nominal price. The TWF purchase transaction is accounted for under the purchase method of accounting.

The results of operation of QAF and TWF from their respective dates of acquisition are included in the Company’s unaudited consolidated condensed statements of operations and are reported in the Forge Group. The following unaudited pro forma information presents a summary of the results of operations for the Company including QAF and TWF as if the acquisitions had occurred on October 1, 2011 and 2010, respectively:

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 product in the aerospace and power generation industries in particular, of the global economic outlook, including the availability of capital and liquidity from banks and other providers of credit; (2) future business environment, including capital and consumer spending; (3) competitive factors, including the ability to replace business which may be lost; (4) successful development of turbine component repair processes and/or procurement of new repair process licenses from turbine engine manufacturers and/or the Federal Aviation Administration; (5) metals and commodities price increases and the Company’s ability to recover such price increases; (6) successful development and market introduction of new products and services (7) continued reliance on consumer acceptance of regional and business aircraft powered by more fuel efficient turboprop engines; (8) continued reliance on military spending, in general, and/or several major customers, in particular, for revenues; (9) 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; (10) stable governments, business conditions, laws, regulations and taxes in economies where business is conducted and (11) the ability to successfully integrate businesses that may be acquired into the Company’s operations.

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The Company and its subsidiaries engage in the production and sale of a variety of metalworking processes, services and products produced primarily to the specific design requirements of its customers. The processes and services include both conventional and precision forging, heat-treating, coating, welding, precision component machining and selective plating. The products include conventional and precision forged components, machined forged components, other machined metal components, remanufactured component parts for turbine engines, and selective plating solutions and equipment. The Company’s operations are conducted in three business segments: (1) Forged Components Group, (2) Turbine Component Services and Repair Group, and (3) Applied Surface Concepts Group. The Company endeavors to plan and evaluate its businesses’ 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 build rate for industrial gas turbine engines, (iii) the projected maintenance, repair and overhaul schedules for commercial, business and military aircraft as well as the engines that power such aircraft, and (iv) anticipated exploration and production activities relative to oil and gas products, etc.

A. Results of Operations

Three Months Ended December 31, 2011 compared with Three Months Ended December 31, 2010

Net sales in the first quarter of fiscal 2012 increased 33.2% to $28.5 million, compared with $21.4 million in the comparable period in fiscal 2011. Net income in the first quarters of both fiscal 2012 and fiscal 2011 was $1.2 million. On October 28, 2011, the Company completed the purchase of the forging business and substantially all related operating assets of QAF.

Forged Components Group (“Forge Group”)

The Forge Group consists of the production, heat-treatment, surface-treatment, non-destructive testing, and machining of both conventional and precision forged components in various steel, titanium and aluminum alloys utilizing a variety of processes for application principally in the aerospace and power generation industries. The Forge Group’s results for the first quarter of fiscal 2012 include the results of QAF from the date of its acquisition. The Forge Group’s results for the first quarter of fiscal 2011 include the results of TWF from the date of its acquisition. Net sales in the first quarter of fiscal 2012 increased 44.6% to $22.7 million, compared with $15.7 million in the comparable period of fiscal 2011. The Forge Group produces forged components for (i) turbine engines that power commercial, business and regional aircraft as well as military transport and surveillance aircraft; (ii) airframe applications for a variety of aircraft; (iii) armored military vehicles; (iv) industrial gas turbine engines for power generation units; and (v) other commercial applications. Net sales comparative information for the first quarter of fiscal 2012 and 2011, respectively, is as follows:

The increase in net sales of forged components for fixed wing aircraft during the first quarter of fiscal 2012, compared with the comparable period in fiscal 2011, is principally due to the impact of the acquisition of QAF during the first quarter of fiscal 2012. The increase in net sales of engine components for power generation units is due to the impact of the acquisition of TWF during the first quarter of fiscal 2011. Net sales of aerospace components for rotorcraft decreased in the first quarter of fiscal 2012 principally due to the reduced sales volumes to one customer that was in the process of adjusting its inventory levels of certain components.

The Forge Group’s aerospace components have both military and commercial applications. Net sales of such components that solely have military applications were $7.8 million in the first quarter of fiscal 2012, compared with $7.6 million in the comparable period in fiscal 2011. Demand for additional military helicopters and related replacement components are the primary driver of sales demand of components that are for military applications.

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The Forge Group’s selling, general and administrative expenses increased $1.3 million to $2.4 million, or 10.4% of net sales, in the first quarter of fiscal 2012, compared with $1.1 million, or 7.1% of net sales, in the comparable period in fiscal 2011. The increase in selling, general and administrative expenses is principally due to (i) a $0.8 million increase in amortization of intangible assets related to the acquisitions of TWF and QAF, and (ii) the impact of the acquisitions of TWF and QAF on relative spending levels. The Forge Group’s selling, general and administrative expenses in the first quarter of fiscal 2012, before the impact of the $0.8 million increase in amortization of intangible assets, was $1.6 million, or 7.1% of net sales.

The Forge Group’s operating income increased $0.1 million to $2.2 million in the first quarter of fiscal 2012, compared with $2.1 million in the comparable period in fiscal 2011. The following is a comparison of operating income on both a LIFO and FIFO basis:

Operating income in the first quarter of fiscal 2012 was favorably impacted by the additional product sales volumes that resulted principally from the acquisitions of TWF and QAF, which was partially offset by (i) the negative impact of the aforementioned $0.8 million increase in the amortization of intangible assets, (ii) $0.2 million recognition of the cost of the inventory fair value write-up related to the acquisition of QAF and (iii) higher labor, outside work and overhead costs principally related to the mix of product sold – a higher concentration of products sales with a higher value-added content in the first quarter of fiscal 2012, compared with the same period in fiscal 2011.

The following changes in the components of the Forge Group’s manufacturing expenditures in the first quarter of fiscal 2012, a significant portion of which was due to the acquisitions of both TWF and QAF, compared with the same period in fiscal 2011, also impacted operating income:

Manufacturing costs in the first quarter of fiscal 2012, compared with the same period in fiscal 2011, increased due to (i) an increase in manufacturing expenditures required to support the additional product sales volume and (ii) an increase in depreciation expense, both of which were primarily attributable to the acquisitions of TWF and QAF. These higher costs were partially offset by a decrease in the cost of natural gas in the first quarter of fiscal 2012, compared with the same period in fiscal 2011.

The Forge Group’s backlog as of December 31, 2011 was $110.3 million, of which $90.9 million was scheduled for delivery over the next twelve months, compared with $92.2 million as of September 30, 2011, of which $74.3 million was scheduled for delivery over the next twelve months. . $15.8 million of the Forge Group’s backlog as of December 31, 2011 is attributable to the impact of the recently acquired QAF business. All orders are subject to modification or cancellation by the customer with limited charges. Delivery lead times for certain raw materials (e.g. aerospace grades of steel) have continued to lengthen due to increased demand and the Forge Group believes that such lead time increase may ultimately result in a fundamental shift in the ordering pattern of its customers. The Forge Group believes that a likely result of such a shift is that customers may place orders further in advance than they previously did, which may result in an increase, relative to comparable prior year periods, in the Forge Group’s backlog. Accordingly, such backlog increase, to the extent it may occur, is not necessarily indicative of actual sales expected for any succeeding period.

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Turbine Component Services and Repair Group (“Repair Group”)

Net sales in the first quarter of fiscal 2012, which consists principally of component repair services (including precision component machining and industrial coatings) for small aerospace turbine engines, decreased 15.1% to $2.0 million, compared with $2.4 million in the comparable fiscal 2011 period.

During the first quarter of fiscal 2012, the Repair Group’s selling, general and administrative expenses were $0.4 million, or 18.0% of net sales, compared with $0.4 million, or 14.3% of net sales, in the comparable fiscal 2011 period.

The Repair Group’s operating income decreased $0.2 million to a loss of $0.1 million in the first quarter of fiscal 2012, compared with income of $0.1 million in the comparable period in fiscal 2011. Operating income in the first quarter of fiscal 2012 was negatively impacted by the lower product sales volumes in relation to the fixed portion of the Repair Group’s operating cost structure.

The Repair Group’s backlog was $1.2 million as of both December 31, 2011 and September 30, 2011. At December 31, 2011, $0.3 million of the total backlog was scheduled for delivery over the next twelve months.

Applied Surface Concepts Group (“ASC Group”)

Net sales in the first quarter of fiscal 2012 increased 14.5% to $3.8 million, compared with $3.3 million in the comparable fiscal 2011 period. For purposes of the following discussion, (i) product net sales consist of selective plating equipment and solutions and (ii) contract service net sales consist of customized selective plating services. Net sales comparative information for the first quarter of fiscal 2012 and 2011, respectively, is as follows: