SYPRIS SOLUTIONS INC - Quarter Report: 2015 October (Form 10-Q)

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		Three Months Ended								Nine Months Ended
		October 4,				September 28,				October 4,				September 28,
		2015				2014				2015				2014
		(Unaudited)								(Unaudited)
Net revenue:
Outsourced services		$	29,089			$	82,417			$	93,903			$	242,170
Products			9,348				7,787				22,299				25,391
Total net revenue			38,437				90,204				116,202				267,561
Cost of sales:
Outsourced services			29,278				74,965				100,390				216,762
Products			6,691				7,030				16,535				21,199
Total cost of sales			35,969				81,995				116,925				237,961
Gross profit (loss)			2,468				8,209				(723	)			29,600
Selling, general and administrative			5,969				8,273				22,414				25,406
Research and development			119				116				647				277
Severance			457				0				1,023				0
Operating (loss) income			(4,077	)			(180	)			(24,807	)			3,917
Interest expense, net			1,783				179				3,271				466
Other (income) expense, net			(7,841	)			(397	)			(8,595	)			(850	)
Income (loss) before taxes			1,981				38				(19,483	)			4,301
Income tax expense			2,255				1,197				2,240				3,438
Net (loss) income		$	(274	)		$	(1,159	)		$	(21,723	)		$	863
(Loss) income per share:
Basic		$	(0.01	)		$	(0.06	)		$	(1.10	)		$	0.04
Diluted		$	(0.01	)		$	(0.06	)		$	(1.10	)		$	0.04
Weighted average shares outstanding:
Basic			19,654				19,612				19,684				19,564
Diluted			19,654				19,612				19,684				19,607
Dividends declared per common share		$	0.00			$	0.02			$	0.00			$	0.06

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		Three Months Ended								Nine Months Ended
		October 4,				September 28,				October 4,				September 28,
		2015				2014				2015				2014
		(Unaudited)								(Unaudited)
Net (loss) income		$	(274	)		$	(1,159	)		$	(21,723	)		$	863
Other comprehensive (loss) income:
Foreign currency translation adjustments			(995	)			(657	)			(2,048	)			(558	)
Total comprehensive (loss) income		$	(1,269	)		$	(1,816	)		$	(23,771	)		$	305

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		October 4,				December 31,
		2015				2014
		(Unaudited)
Assets
Current assets:
Cash and cash equivalents		$	1,773			$	7,003
Accounts receivable, net			13,647				47,666
Inventory, net			23,348				29,031
Other current assets			4,829				5,666
Total current assets			43,597				89,366
Property, plant and equipment, net			26,464				37,654
Other assets			2,613				2,661
Total assets		$	72,674			$	129,681
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable		$	12,821			$	39,027
Accrued liabilities			13,022				18,775
Current portion of long-term debt			2,893				17,000
Total current liabilities			28,736				74,802
Note payable – Meritor			3,780				0
Note payable – related party			5,500				0
Long-term debt			3,369				0
Other liabilities			7,532				7,991
Total liabilities			48,917				82,793
Stockholders’ equity:
Preferred stock, par value $0.01 per share, 975,150 shares authorized; no shares issued			0				0
Series A preferred stock, par value $0.01 per share, 24,850 shares authorized; no shares issued			0				0
Common stock, non-voting, par value $0.01 per share, 10,000,000 shares authorized; no shares issued			0				0
Common stock, par value $0.01 per share, 30,000,000 shares authorized; 20,826,236 shares issued and 20,788,544 outstanding in 2015 and 20,567,735 shares issued and 20,485,043 outstanding in 2014			208				206
Additional paid-in capital			151,952				151,314
Retained deficit			(101,319	)			(79,596	)
Accumulated other comprehensive loss			(27,083	)			(25,035	)
Treasury stock, 37,692 and 82,692 shares in 2015 and 2014, respectively			(1	)			(1	)
Total stockholders’ equity			23,757				46,888
Total liabilities and stockholders’ equity		$	72,674			$	129,681

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		Nine Months Ended
		October 4,				September 28,
		2015				2014
		(Unaudited)
Cash flows from operating activities:
Net (loss) income		$	(21,723	)		$	863
Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities:
Depreciation and amortization			7,022				7,987
Deferred income taxes			2,436				0
Stock-based compensation expense			717				1,235
Deferred revenue recognized			(4,200	)			(6,493	)
Deferred loan costs recognized			1,929				58
Gain on sale of assets			(7,423	)			(4	)
Provision for excess and obsolete inventory			1,305				897
Other noncash items			(1,478	)			(135	)
Contributions to pension plans			(315	)			(907	)
Changes in operating assets and liabilities:
Accounts receivable			23,384				(23,041	)
Inventory			2,154				(1,955	)
Other current assets			(4,332	)			(835	)
Accounts payable			(12,051	)			22,993
Accrued and other liabilities			860				5,376
Net cash (used in) provided by operating activities			(11,715	)			6,039
Cash flows from investing activities:
Capital expenditures, net			(1,155	)			(4,462	)
Proceeds from sale of assets			15,700				8
Net cash provided by (used in) investing activities			14,545				(4,454	)
Cash flows from financing activities:
Net change in debt under revolving credit agreements			(10,738	)			1,000
Proceeds from note payable – related party			5,500				0
Debt modification costs			(2,335	)			0
Common stock repurchases			0				(357	)
Indirect repurchase of shares for minimum statutory tax withholdings			(77	)			(420	)
Cash dividends paid			(410	)			(1,225	)
Proceeds from issuance of common stock			0				4
Net cash used in financing activities			(8,060	)			(998	)
Net (decrease) increase in cash and cash equivalents			(5,230	)			587
Cash and cash equivalents at beginning of period			7,003				18,674
Cash and cash equivalents at end of period		$	1,773			$	19,261

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(1)	Nature of Business

  

All references to “Sypris,” the “Company,” “we” or “our” include Sypris Solutions, Inc. and its wholly-owned subsidiaries. Sypris is a diversified provider of outsourced services and specialty products. The Company performs a wide range of manufacturing, engineering, design, and other technical services, often under multi-year, sole-source contracts with corporations and government agencies in the markets for truck components and assemblies and aerospace and defense electronics. The Company provides such services through its two segments, Sypris Technologies, Inc. (Sypris Technologies) and Sypris Electronics, LLC (Sypris Electronics). See Note 13, “Segment Data,” to the consolidated financial statements.

 

(2)	Basis of Presentation

 

The accompanying unaudited consolidated financial statements include the accounts of Sypris Solutions, Inc. and its wholly-owned subsidiaries, and have been prepared by the Company in accordance with the rules and regulations of the Securities and Exchange Commission. The Company’s operations are domiciled in the United States (U.S.), Mexico and the United Kingdom (U.K.) and serve a wide variety of domestic and international customers. All intercompany transactions and accounts have been eliminated. These unaudited consolidated financial statements reflect, in the opinion of management, all material adjustments (which include only normal recurring adjustments) necessary to fairly state the results of operations, financial position and cash flows for the periods presented, and the disclosures herein are adequate to make the information presented not misleading. Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses (see, e.g., Note 12 “Debt,” to the consolidated financial statements). Actual results for the three and nine months ended October 4, 2015 are not necessarily indicative of the results that may be expected for the year ending December 31, 2015. These unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements, and notes thereto, for the year ended December 31, 2014 as presented in the Company’s Annual Report on Form 10-K.

 

(3)	Recent Accounting Pronouncements

 

In April 2014, the Financial Accounting Standards Board (“FASB”) issued guidance that revises the definition of a discontinued operation. The revised definition limits discontinued operations reporting to disposals of components of an entity that represent strategic shifts that have (or will have) a major effect on operations and financial results. The guidance also requires new disclosures of both discontinued operations and certain other disposals that do not meet the definition of a discontinued operation. The guidance will apply to covered transactions that occur after 2014 and was optional for the initial reporting of disposals completed or approved in 2014. The Company adopted the standard effective January 1, 2015.

 

In May 2014, the FASB issued Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers.” This ASU supersedes the revenue recognition requirements in “Accounting Standard Codification 605 - Revenue Recognition” and most industry-specific guidance. The standard requires that entities recognize revenue to depict the transfer of promised goods or services 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 new guidance will also require new disclosures about the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. ASU 2014-09 was originally effective for us on January 1, 2017; however, in July 2015 the FASB decided to defer the effective date by one year. Early application is not permitted, but reporting entities may choose to adopt the standard as of the original effective date. The standard permits the use of either the retrospective or cumulative effect transition method. The Company is currently assessing the impact of the adoption of ASU 2014-09 on its results of operations, financial position and cash flows.

 

In August 2014, the FASB issued ASU No. 2014-15 Presentation of Financial Statements—Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern, which requires management to evaluate whether there are conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern, and to provide certain disclosures when it is probable that the entity will be unable to meet its obligations as they become due within one year after the date that the financial statements are issued. ASU 2014-15 is effective for the annual period ended December 31, 2016 and for annual periods and interim periods thereafter with early adoption permitted. We are currently evaluating the new guidance to determine the impact it may have on our consolidated financial statements.

  

 

In April 2015, the FASB issued ASU 2015-03, Interest — Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs. ASU 2015-03 changes the presentation of debt issuance costs for term debt in the balance sheet by requiring the debt issuance costs to be presented as a direct deduction from the related debt liability, rather than recorded as an asset. The standard is required to be adopted by public business entities in annual periods beginning on or after December 15, 2015, and interim periods within those annual periods and will need to be applied retrospectively. Early adoption is permitted. The adoption of this standard is not expected to have a material effect on our consolidated results of operations and financial condition.

 

In July 2015, the FASB issued ASU No. 2015-11, which simplifies the subsequent measurement of inventory. It replaces the current lower of cost or market test with a lower of cost or net realizable value test. The standard is effective for public entities for annual reporting periods beginning after December 15, 2016, and interim periods therein. Early adoption is permitted. The new guidance must be applied prospectively. The Company is currently evaluating the impact of adopting the standard on its consolidated financial statements.

 

In September 2015, the FASB issued ASU 2015-16, Simplifying the Accounting for Measurement-Period Adjustments. ASU 2015-16 requires that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. ASU 2015-16 is effective for fiscal years and interim reporting periods within those fiscal years, beginning after December 15, 2015. Prospective adoption is required. This ASU is not expected to have a material impact on the Company's consolidated financial statements.

 

(4)	Management’s Plans

 

Our supply agreement with Dana Holding Corporation (“Dana”) was originally scheduled to expire on December 31, 2014. For the year ended December 31, 2014, Dana represented approximately 59% of our net revenue.

 

In July 2013, Sypris and Dana signed an amended and restated supply agreement to extend the supply agreement term beyond December 31, 2014, the binding effect of which is currently in dispute. Dana has repudiated this July 2013 agreement, and Dana has ordered a minimal amount of components from us since December 31, 2014. Sypris disputes Dana’s ability to do so and is seeking to recover its lost margins and additional remedies with respect to the revenues to which Sypris was entitled under the renewed agreement.

 

Dana initiated an ancillary action in Ohio state court challenging the arbitrability of the existence and enforceability of the amended and restated July 2013 supply agreement on January 17, 2014. The parties have conducted discovery, and the Ohio trial court has granted an initial motion for judgment on the pleadings or summary judgment, which Sypris has appealed. If the case goes to trial and if ruled in the Company’s favor, the dispute would revert to an arbitrator to determine damages.

 

Additionally, the parties also asserted various damages claims against each other arising out of their prior supply agreement and sought the assistance of an arbitrator in connection with these disputes. The parties had an arbitration hearing in January 2015, and the ruling was received on April 29, 2015, awarding Sypris $505,000.

 

As a result of these disputes with Dana and the loss of the Dana business, the Company has taken significant actions during the fourth quarter of 2014 and the first nine months of 2015, including but not limited to the following: (i) selling certain assets used in the Company’s manufacturing facility in Morganton, North Carolina within the Sypris Technologies segment (ii) bid on significant new business opportunities with existing and potential customers resulting from the strength of the commercial vehicle market and a perceived shift in market share among tier one suppliers, (iii) reduced workforce at the locations most impacted by the loss of Dana, (iv) reduced employment costs by reduced work schedules, senior management pay reductions, deferral of merit increases and certain benefit payments, and (v) utilized labor for preventative maintenance on equipment and facilities, and deployment of Toyota Production System management and production practices. The Company is in the advanced stages of negotiations with several customers about potential new programs, although the typical cycle time for adding such programs can require six months or more.

  

 

The Company engaged an investment banking firm who provided financial advisory services in connection with its successful effort to secure new loan agreements and a financial advisor to assist in the management of the Company’s cash flows and expense levels. Separately, the Company has engaged Needham & Co., Inc. to assist in the potential sale of other appropriate business lines. The Company has also engaged a commercial real estate firm to provide advisory and brokerage services related to the potential disposition of certain real property owned by the Company. There can be no assurance that our plans to mitigate the loss of the Dana business and to effectively manage our costs during the transition will be successful.

 

The Company amended its Credit Facility in March, July and September 2015, the most recent of which provided for borrowings up to $8,500,000 through October 30, 2015. On October 30, 2015, the Company secured debt financing of up to $27,000,000 that supports short-term funding needs, which replaced the Company’s Credit Facility and Meritor Note, which expired on October 30, 2015. See Note 12 “Debt,” to the consolidated financial statements for more detail on the Credit Facility, these recent amendments to the Credit Facility, our other debt arrangements and our current liquidity position.

 

Since the loss of the Dana business, the Company has also experienced negative cash flow from operating activities which could hamper or materially increase the costs of the Company’s ability to comply with various covenants.  The Company’s consolidated financial statements have been prepared assuming the ongoing realization of assets, satisfaction of liabilities and continuity of operations as a going concern in the ordinary course of business. These assumptions are based upon the Company’s current initiatives and forecasts, including the launch of new products and services to replace legacy programs, and the execution of our ongoing, contingency planning efforts to reduce operating costs if our forecasted revenues do not materialize. However, there can be no assurances that these initiatives, forecasts and plans will ultimately prove to have been accurate or successful, and our failure or inability to realize our key financial objectives could materially and adversely impair the Company’s ability to operate, its cash flows, financial condition and ongoing results.

 

(5)	Morganton Sale

 

On July 9, 2015, the Company entered an asset purchase agreement (the “Agreement”) to sell certain assets used in the Company’s manufacturing facility in Morganton, North Carolina, to its largest customer, Meritor, Inc. (“Meritor”). The Company retained the Morganton plant’s axle shaft manufacturing lines and certain related assets, intellectual property and inventories, which was transitioned to the Company’s Louisville, Kentucky plant in October 2015. All other Morganton equipment, related assets and intellectual property were sold to Meritor (the “Morganton Sale”) for $10,500,000 in cash paid at the closing and other consideration. Meritor purchased related inventories and accounts receivable and assumed or released certain accounts payable and other accrued liabilities, for $2,000,000 (subject to customary post-closing adjustments to actual). Meritor also agreed to purchase the Morganton facility for $3,200,000. The total proceeds received of $15,700,000 in consideration for the Morganton sale was used to pay down the Company’s outstanding debt with PNC Bank, National Association (“PNC”). As a result of the Morganton sale, the Company recognized a gain of $7,744,000.

 

At closing, the parties also entered into a Meritor Note Amendment, whereby the Company has issued an additional secured obligation to Meritor of $412,000 on July 9, 2015. The parties also agreed to increase the Meritor Note by an additional $321,000 in September to reflect certain roof repairs required at the Morganton facility. The Company repaid the Meritor Note on October 30, 2015. See Note 12 “Debt,” to the consolidated financial statements for more detail on the Meritor Note.

 

(6)	Milestone Revenue Recognition

 

The Company periodically enters into research and development contracts with customers related primarily to key encryption products. When the contracts provide for milestone or other interim payments, the Company will recognize revenue under the milestone method in accordance with Accounting Standards Codification (“ASC”) 605-28 Revenue Recognition, Milestone Method. The milestone method requires the Company to deem all milestone payments within each contract as either substantive or non-substantive. That conclusion is determined based upon a thorough review of each contract and the deliverables to which the Company has committed in each contract. For substantive milestones, the Company concludes that upon achievement of each milestone, the amount of the corresponding defined payment is commensurate with the effort required to achieve such milestone or the value of the delivered item. The payment associated with each milestone relates solely to past performance and is deemed reasonable upon consideration of the deliverables and the payment terms within the contract. Milestones may include, for example, the successful completion of design review or technical review, the submission and acceptance of technical drawings, delivery of hardware, software or regulatory agency certifications. The Company had one such milestone contract in process at December, 31, 2014. All milestones under that contract were deemed substantive. During the nine months ended October 4, 2015 and September 28, 2014, revenue recognized through the achievement of multiple milestones amounted to $300,000 and $2,375,000, respectively. There are no performance, cancellation, termination or refund provisions in the arrangement that contain material financial consequences to the Company. As of October 4, 2015, all contracts utilizing the milestone method were completed.

  

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(7)	Dana Claim

 

On March 3, 2006, Dana and 40 of its U.S. subsidiaries, filed voluntary petitions for reorganization under Chapter 11 of the U.S. Bankruptcy Code in the U.S. Bankruptcy Court for the Southern District of New York. On August 7, 2007, the Company entered into a comprehensive settlement agreement with Dana to resolve all outstanding disputes between the parties, terminate previously approved arbitration payments and replace three existing supply agreements with a single, revised contract running through 2014. In addition, Dana provided the Company with an allowed general unsecured non-priority claim in the face amount of $89,900,000 (the “Claim”).

 

The Claim provided to the Company was agreed to by the Company and Dana as consideration for the aggregate economic impact of the various elements the two parties were negotiating. After the aggregate Claim value of $89,900,000 was established, the Company recorded the claim at the estimated fair value of $76,483,000 and allocated the estimated fair value to each commercial issue negotiated. The revenues and resulting net income associated with each of those issues requiring the Company’s continued involvement were deferred and were recognized over the applicable period of the involvement. For the nine months ended September 28, 2014, the Company recognized into revenue $6,493,000 related to the Claim. The Claim was fully amortized as of December 31, 2014.

 

(8)	Other Income, Net

 

During the three and nine months ended October 4, 2015, the Company recognized other income of $7,841,000 and $8,595,000, respectively, which consisted primarily of a gain of $7,744,000 related to the Morganton sale (see Note 5 “Morganton Sale” to the consolidated financial statement in this Form 10-Q). Additionally, during the nine months ended October 4, 2015, the Company recognized $505,000 related to an arbitration settlement in the Dana dispute received in the second quarter (see Note 4 “Management’s Plans” to the consolidated financial statements in this Form 10-Q). During the three and nine months ended October 4, 2015, the company recognized net foreign currency related gains of $105,000 and $276,000, respectively related to the U.S. dollar denominated monetary asset position of our Mexican subsidiaries for which the Mexican peso is the functional currency.

 

During the nine months ended September 28, 2014, the Company recognized net gains of $714,000 within the Sypris Technologies segment from the receipt of federal grant funds for improvements made under a flood relief program. Additionally, for the three and nine months ended September 28, 2014, the Company recognized foreign currency translation gains of $314,000 and $219,000, respectively.

 

(9)	Earnings (Loss) Per Common Share

 

The Company computes earnings per share using the two-class method, which is an earnings allocation formula that determines earnings per share for common stock and participating securities. Restricted stock granted by the Company is considered a participating security since it contains a non-forfeitable right to dividends.

 

Our potentially dilutive securities include potential common shares related to our stock options and restricted stock. Diluted earnings per share considers the impact of potentially dilutive securities except in periods in which there is a loss because the inclusion of the potential common shares would have an anti-dilutive effect. Diluted earnings per share excludes the impact of common shares related to our stock options in periods in which the option exercise price is greater than the average market price of our common stock for the period. For the three and nine months ended October 4, 2015, diluted weighted average common shares do not include the impact of any outstanding stock options and unvested compensation-related shares because the effect of these items on diluted net loss would be anti-dilutive.

 

For the three months ended September 28, 2014, diluted weighted average common shares do not include the impact of any outstanding stock options and unvested compensation-related shares because the effect of these items on diluted net loss would be anti-dilutive. There were 786,000 potential common shares excluded from diluted earnings per share for the nine months ended September 28, 2014.

  

 

A reconciliation of the weighted average shares outstanding used in the calculation of basic and diluted earnings (loss) per common share is as follows (in thousands):

 

  

(10)

Inventory

 

Inventory consists of the following (in thousands):

 

 

(11)	Property, Plant and Equipment

 

Property, plant and equipment consists of the following (in thousands):

 

  

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(12)	Long-Term Debt

 

Long-term debt consists of the following:

 

 

 

Revolving Credit Facility:

 

The Company’s Revolving Credit and Security Agreement, dated May 12, 2011 with PNC (which we refer to as the "Loan Agreement" or our “Credit Facility”) was amended during the first quarter of 2015 to, among other things: (i) waive certain existing or potential events of default, (ii) limit total borrowings to $25,000,000, (iii) restrict the payment of dividends, (iv) increase the applicable margin on borrowings which will result in an initial interest rate of approximately 6% and increasing by 50 basis points beginning June 2015 and each month thereafter to an estimated interest rate of 10% in January 2016, (v) revise the maturity date to January 15, 2016, (vi) revise certain financial covenants to include a minimum cumulative free cash flow covenant, (vii) establish minimum excess availability of $1,000,000 initially, through May 31, 2015, and then in the amount of up to $5,000,000 on or before September 30, 2015, and (viii) require the Company to raise new capital by securing subordinated debt or divesting certain real property or a combination thereof on or before September 30, 2015 (and, if earlier than September 30, 2015, to maintain minimum excess availability of up to $5,000,000 thereafter). Obligations under the Credit Facility are guaranteed by all of our U.S. subsidiaries and are secured by a first priority lien on substantially all domestic assets of the Company.

 

The Company engaged an investment banking firm on March 20, 2015 to provide financial advisory services in connection with its efforts to secure new subordinated debt. The Company also engaged a commercial real estate firm to provide advisory and brokerage services related to a potential disposition of certain real property owned by the Company.

 

On July 2, 2015, the Company further amended its Credit Facility to reduce the reserved amount available to be borrowed under the Loan Agreement from $25,000,000 to $22,500,000 prior to the sale of certain assets used in the Company’s manufacturing business in Morganton, North Carolina (see Note 13, “Morganton Sale,” to the consolidated financial statements), and to further reduce such reserved amount to $10,000,000 after the Morganton Sale. The Amendment also waives certain existing or potential events of default under the Loan Agreement, amends the Company’s borrowing base formula, relaxes the Company’s financial covenants to reflect its near term forecasts, and commits the Company to repay all amounts borrowed under the Loan Agreement on or before September 30, 2015 and to take a number of mutually agreed actions designed to accomplish that goal, including the continued retention of various advisers to assist in the Company’s efforts to divest non-core, underutilized or other appropriate assets and to modify its cost structure as needed, and the completion of the Morganton Sale. The Company agreed to pay PNC a fee of $500,000 in connection with the execution of the Amendment and a success fee of $500,000 on September 30, 2015 (or upon any earlier acceleration or repayment of the Loan Agreement).

 

On September 30, 2015, the Company further amended its Credit Facility to reduce the reserved amount available to be borrowed under the Loan Agreement from $10,000,000 to $8,500,000 and extend the maturity date from September 30, 2015 to October 30, 2015 in order to provide the Company with additional time to refinance its obligations to PNC with another lender. The Company agreed to continue its efforts to refinance its obligations to PNC and agreed to pay the Lender a fee of $500,000 in the event a new lending arrangement was not in place by October 30, 2015.

  

 

Actual borrowing availability under the Credit Facility was determined by a daily borrowing base collateral calculation that is based on specified percentages of the value of eligible accounts receivable, inventory and machinery and equipment, less certain reserves and subject to certain other adjustments. Based on that calculation, at October 4, 2015, we had actual total borrowing availability under the Credit Facility of $8,500,000, of which we had drawn $6,262,000, leaving $2,238,000 available for borrowing. Standby letters of credit up to a maximum of $5,000,000 could be issued under the Credit Facility. There were no outstanding letters of credit at October 4, 2015 and $755,000 was outstanding at December 31, 2014.

 

On October 30, 2015, all outstanding principal and interest obligations outstanding under the Credit Facility were repaid in full in conjunction with the Company’s new financing agreements. The Credit Facility was replaced by the new financing agreements.

 

Note Payable – Related Party

 

In connection with the amendments to the Credit Facility, the Company has received the proceeds of subordinated indebtedness from Gill Family Capital Management in an amount of $5,500,000. Gill Family Capital Management (GFCM) is an entity controlled by our president and chief executive officer, Jeffrey T. Gill and one of our directors, R. Scott Gill. Gill Family Capital Management, Inc., Jeffrey T. Gill and R. Scott Gill are significant beneficial stockholders of the Company. The promissory note bears interest at a rate of 8.00% per year. All principal and interest on the promissory note will be due and payable at maturity. On October 30, 2015, the Company amended the GFCM note to extend the maturity date from April 12, 2016 to January 30, 2019.

 

Note Payable – Meritor

 

On July 2, 2015, the Company entered into a secured promissory note (the “Meritor Note”) in the principal amount of $3,047,000, with Meritor, in exchange for the release of certain outstanding net trade payables owed to Meritor for ongoing purchases of raw materials and the guarantee of certain inventory values related to Meritor’s business as collateral under the Credit Facility. The Meritor Note was secured by substantially all of the collateral for the Credit Facility, was senior to the promissory note previously issued to GFCM and was subordinate to the rights under the Credit Facility. The Meritor Note bears interest at a rate of 10.0% per year and all principal and interest on the Meritor Note was due and payable on the maturity date.

 

On July 9, 2015, the Company entered an asset purchase agreement to sell certain assets and related liabilities used in the Company’s manufacturing facility in Morganton, North Carolina, to Meritor for $12,500,000. Meritor also agreed to purchase the Morganton facility for $3,200,000. At closing, the parties also entered into a Meritor Note Amendment, whereby the Company issued an additional secured obligation to Meritor of $412,000 on July 9, 2015 for the release of certain outstanding net trade payables and other accrued liabilities and further agreed to increase the Meritor Note by an additional $320,000 in September to reflect certain potential roof repairs required at the Morganton facility.

 

On September 30, 2015, the Meritor Note was amended to extend the maturity date from September 30, 2015 to October 30, 2015 or upon any earlier acceleration or repayment of the Credit Facility.

 

On October 30, 2015, the Meritor Note and interest were repaid in full in conjunction with the Company’s new financing agreements.

 

New Credit Facility and Term Loan

 

On October 30, 2015, the Company secured debt financing consisting of a $12,000,000 term loan (“Term Loan”) and a $15,000,000 revolving credit facility (“New Credit Facility”). Proceeds from the two new financing arrangements (collectively the “New Loan Agreements”) were used to repay the Credit Facility and the Meritor Note. Borrowing availability under the New Credit Facility is determined by a weekly borrowing base collateral calculation that is based on specified percentages of the value of eligible accounts receivable and inventory, less certain reserves and subject to certain other adjustments (see Note 19 “Subsequent Events”). Borrowing availability under the Term Loan is also evaluated using a separate borrowing base collateral calculation that includes designated percentages of real estate, machinery and equipment appraisals, in each case less certain reserves and subject to certain other adjustments; if the appraised values of such collateral causes the Term Loan borrowing base to fall below the then current Term Loan balance, the Company can be required to make a partial prepayment of such difference and related fees.

 

Obligations under the New Loan Agreements are guaranteed by all of our U.S. subsidiaries and are secured by a first priority lien on substantially all assets of the Company.

  

 

The New Loan Agreements contain a number of affirmative, negative and financial maintenance covenants, representations, warranties, events of default and remedies upon default, including acceleration and rights to foreclose on the collateral securing each lender. Among other covenants, the New Loan Agreements require the Company to use its best efforts to enter a satisfactory sale-leaseback of the Toluca, Mexico property and buildings, and upon closing any such transaction, to prepay on the Term Loan, either $5,000,000 or all net cash proceeds, at the election of the term lender. (Under certain circumstances, the Company may also satisfy the foregoing requirement by depositing $5,000,000 of such net cash proceeds into a controlled cash collateral account; however, if such sale-leaseback transaction has not closed before April 30, 2016, then the Company must contribute $5,000,000 in alternative proceeds from the sale of new equity, subordinated debt or certain permitted collateral assets.) If the Company’s borrowing availability under the New Credit Facility falls below $4,000,000, the Company must maintain a fixed charge coverage ratio of at least 1 to 1, as measured on a trailing twelve months’ basis.

 

Non-compliance with the Company’s debt covenants would provide the debt holders with certain contractual rights, including the right to demand immediate repayment of all outstanding borrowings.  Since the loss of the Dana business (see Note 4 “Management’s Plans”), the Company has also experienced negative cash flows from operating activities which could hamper or materially increase the costs of the Company’s ability to comply with such covenants.  The Company’s consolidated financial statements have been prepared assuming the ongoing realization of assets, satisfaction of liabilities and continuity of operations as a going concern in the ordinary course of business, but there can be no assurances that the Company’s current initiatives, forecasts and plans will ultimately succeed, which could materially and adversely impair the Company’s ability to operate, its cash flows, financial condition and ongoing results.

 

The classification of debt as of October 4, 2015 considers the debt refinanced on a long-term basis. However, the New Credit Facility allows the lender to accelerate payment in the event of a “material adverse change.” Because such an event is not objectively measureable in advance and because the Company is required to maintain a lock-box arrangement, ASC 470-10-45 requires the otherwise long-term revolving advances to be classified as a current liability. As a result, all borrowings under the revolving advances have been classified in the accompanying consolidated balance sheets as a current liability.

 

(13)	Segment Data

 

The Company is organized into two business groups, Sypris Technologies and Sypris Electronics. These segments are each managed separately because of the distinctions between the products, services, markets, customers, technologies and workforce skills of the segments. Sypris Technologies provides manufacturing services for a variety of customers that outsource forged and finished steel components and subassemblies. Sypris Technologies also manufactures high-pressure closures and other fabricated products. Sypris Electronics provides manufacturing and technical services as an outsourced service provider and manufactures complex data storage systems, trusted solutions for identity management, cryptographic key distribution and cyber analytics. There was no intersegment net revenue recognized in any of the periods presented.

 

The following table presents financial information for the reportable segments of the Company (in thousands): 

 

  

 

 

 

 

 

(14)	Commitments and Contingencies

 

The provision for estimated warranty costs is recorded at the time of sale and periodically adjusted to reflect actual experience. The Company’s warranty liability, which is included in accrued liabilities in the accompanying balance sheets as of October 4, 2015 and December 31, 2014, was $808,000 and $825,000, respectively. The Company’s warranty expense for the nine months ended October 4, 2015 and September 28, 2014 was $112,000 and $108,000, respectively.

 

Additionally, the Company sells three and five-year extended warranties for one of its link encryption products. The revenue from the extended warranties is deferred and recognized ratably over the contractual term. As of October 4, 2015 and December 31, 2014, the Company had deferred $579,000 and $839,000, respectively, related to extended warranties.

 

The Company bears insurance risk as a member of a group captive insurance entity for certain general liability, automobile and workers’ compensation insurance programs and a self-insured employee health program. The Company records estimated liabilities for its insurance programs based on information provided by the third-party plan administrators, historical claims experience, expected costs of claims incurred but not paid, and expected costs to settle unpaid claims. The Company monitors its estimated insurance-related liabilities on a quarterly basis. As facts change, it may become necessary to make adjustments that could be material to the Company’s consolidated results of operations and financial condition. The Company believes that its present insurance coverage and level of accrued liabilities are adequate.

 

As of October 4, 2015, the Company had outstanding purchase commitments of approximately $6,515,000, primarily for the acquisition of inventory and manufacturing equipment.

 

The Company is involved in certain litigation and contract issues arising in the normal course of business. As a result, contingencies may arise resulting from an existing condition, situation, or set of circumstances involving an uncertainty as to the realization of a possible loss.

 

The Company accounts for loss contingencies in accordance with GAAP.  Estimated loss contingencies are accrued only if the loss is probable and the amount of the loss can be reasonably estimated.  With respect to a particular loss contingency, it may be probable that a loss has occurred but the estimate of the loss is within a wide range or undeterminable.  If the Company deems an amount within the range to be a better estimate than any other amount within the range, that amount will be accrued.  However, if no amount within the range is a better estimate than any other amount, the minimum amount of the range is accrued.

  

 

The Company’s lease for its Tampa, FL facility will expire on December 31, 2016 unless the Company exercises its option to renew a five year extension prior to December 31, 2015. If the Company does not exercise this option, it is reasonably possible that the Company may be required to make certain repairs to the facility, which may be significant. While the Company believes that a potential loss contingency may exist, it cannot currently estimate the amount of the contingency. The Company believes that a reasonable determination of the loss will be possible if the Company chooses not to exercise the lease term extension. If the Company chooses to exercise the extension option, any costs incurred would be capitalized as a leasehold improvement and amortized over the remaining term of the lease.

 

(15)	Income Taxes

 

The provision for income taxes includes federal, state, local and foreign taxes. The Company’s effective tax rate varies from period to period due to the proportion of foreign and domestic pre-tax income expected to be generated by the Company. The Company provides for income taxes for its domestic operations at a statutory rate of 35% and for its foreign operations at a statutory rate of 30% in 2015 and 2014. The Company’s foreign operations are also subject to minimum income taxes in periods prior to 2015 where positive cash flows exceed taxable income. Reconciling items between the federal statutory rate and the effective tax rate also include the expected usage of federal net operating loss carryforwards, state income taxes, valuation allowances and certain other permanent differences.

 

The Company recognizes liabilities or assets for the deferred tax consequences of temporary differences between the tax bases of assets or liabilities and their reported amounts in the financial statements in accordance with ASC 740, Income Taxes. These temporary differences will result in taxable or deductible amounts in future years when the reported amounts of assets or liabilities are recovered or settled. ASC 740 requires that a valuation allowance be established when it is more likely than not that all or a portion of a deferred tax asset will not be realized. The Company evaluates its deferred tax position on a quarterly basis and valuation allowances are provided as necessary. During this evaluation, the Company reviews its forecast of income in conjunction with other positive and negative evidence surrounding the realizability of its deferred tax assets to determine if a valuation allowance is needed. Based on its current forecast, the Company has established a valuation allowance against the domestic net deferred tax asset.

 

As a result of the increased uncertainty surrounding the Company’s forecast of taxable income in Mexico, it was determined that the Company no longer met the “more likely than not” threshold required under ASC 740-10 in order to maintain the Mexico deferred tax asset. Accordingly, the Company recorded a valuation allowance on its net deferred tax asset related to certain non-U.S. tax benefits, resulting in deferred tax expense of $2,436,000 during the third quarter ended October 4, 2015. Until an appropriate level and characterization of profitability is attained, the Company expects to continue to maintain a valuation allowance on its net deferred tax assets related to future U.S. and non-U.S. tax benefits.

 

The Company expects to repatriate available non-U.S. cash holdings in 2016 to support management’s strategic objectives and fund ongoing U.S. operational cash flow requirements; therefore current earnings from non-U.S. operations are not treated as permanently reinvested. The U.S. income tax expense recorded in 2015 on these non-U.S. earnings is expected to be offset by the benefit of a partial release of a valuation allowance on U.S. net operating loss carryforwards. Should the U.S. valuation allowance be released at some future date, the U.S. tax expense on foreign earnings not permanently reinvested might have a material effect on our effective tax rate. For the year ending December 31, 2015, the Company expects any additional tax expense from non-U.S. withholding and other taxes expected to be incurred on repatriation of current earnings would not be material.

 

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(16)	Employee Benefit Plans

 

Pension expense (benefit) consisted of the following (in thousands):

 

  

(17)	Accumulated Other Comprehensive Loss

 

The Company’s accumulated other comprehensive loss consists of employee benefit-related adjustments and foreign currency translation adjustments.

 

Accumulated other comprehensive loss consisted of the following (in thousands):

 

 

(18)	Fair Value of Financial Instruments

 

Cash, accounts receivable, accounts payable and accrued liabilities are reflected in the consolidated financial statements at their carrying amount which approximates fair value because of the short-term maturity of those instruments. The carrying amount of debt outstanding at October 4, 2015 under the Credit Facility, the Meritor Note and the related party note payable approximates fair value because borrowings mature between October 2015 and April 2016.

 

(19)	Subsequent Events

 

On October 30, 2015, the Company entered into New Loan Agreements providing for a $12,000,000 Term Loan and a $15,000,000 New Credit Facility. See Note 12 “Debt,” to the consolidated financial statements for more detail on the New Loan Agreements, the New Credit Facility and the Term Loan. Proceeds from New Loan Agreements were used to repay the Credit Facility and the Meritor Note. Interest will accrue on the New Credit Facility at an annual rate of 2.50% above a “Base Rate” equal to the greatest of the “Prime Rate” published in the Wall Street Journal, the Federal Funds Rate plus 0.5%, or 3.25%, and on the Term Loan at an annual rate of 9% above the same Base Rate. The Company must also pay an unused facility fee (currently set at 0.5%) under the New Credit Facility if utilization under the facility is less than the maximum borrowing availability, among other fees due to each lender.

 

Loans made under the New Loan Agreements will mature and the commitments thereunder will terminate in October 2018. Specific borrowing availability levels under the New Loan Agreements are determined by a borrowing base collateral calculation that includes designated percentages of eligible inventory values and accounts receivable for the New Credit Facility, and, in the case of the Term Loan, designated percentages of real estate, machinery and equipment valuations, in each case less certain reserves and subject to certain other adjustments. Borrowing availability under the Term Loan is also evaluated using a separate borrowing base collateral calculation that includes designated percentages of real estate, machinery and equipment appraisals, in each case less certain reserves and subject to certain other adjustments; if the appraised values of such collateral causes the Term Loan borrowing base to fall below the then current Term Loan balance, the Company can be required to make a partial prepayment of such difference and related fees.

  

 

Obligations under the New Credit Facility and Term Loan are guaranteed by all of our U.S. subsidiaries and are secured by a first priority lien on substantially all assets of the Company.

 

The New Loan Agreements contain a number of affirmative, negative and financial maintenance covenants, representations, warranties, events of default and remedies upon default, including acceleration and rights to foreclose on the collateral securing each lender. Among other covenants, the New Loan Agreements require the Company to use its best efforts to enter a satisfactory sale-leaseback of the Toluca, Mexico property and buildings, and upon closing any such transaction, to prepay on the Term Loan, either $5,000,000 or all net cash proceeds, at the election of the term lender. (Under certain circumstances, the Company may also satisfy the foregoing requirement by depositing $5,000,000 of such net cash proceeds into a controlled cash collateral account; however, if such sale-leaseback transaction has not closed before April 30, 2016, then the Company must contribute $5,000,000 in alternative proceeds from the sale of new equity, subordinated debt or certain permitted collateral assets.) If the Company’s borrowing availability under the New Credit Facility falls below $4,000,000, the Company must maintain a fixed charge coverage ratio of at least 1 to 1, as measured on a trailing twelve months’ basis.

 

On October 30, 2015, the Company entered into a non-binding letter of intent to sell and lease-back its land and facility in Mexico, which is part of Sypris Technologies. The purchase price is expected to be $13,000,000, with $5,200,000 to be paid upon signing of the definitive purchase agreement and the remaining amount to be paid upon closing. The closing is scheduled to occur no later than March 15, 2016. The non-binding term sheet provides that a portion of the proceeds will be used to pay down a portion of the Term Loan. The assets had a net book value of $3,316,000 as of October 4, 2015. The transaction is subject to the negotiation of definitive agreements and the Company can give no assurance that it will be successful in completing this sale on these terms.

 

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