Graham Corporation — Form 10-Q Summary
Reporting period: Three months ended June 30, 2021, Graham Corporation’s first quarter of fiscal 2022. The request metadata identifies “2020 Q1,” but the filing itself reports June 30, 2021 and compares with June 30, 2020.
Business Context
Graham designs and manufactures mission-critical equipment and systems for defense, energy, chemical and petrochemical, aerospace, space, and related industrial markets. On June 1, 2021, the Company acquired Barber-Nichols, LLC, a turbomachinery business serving aerospace, cryogenic, defense, and energy markets.
Key Financial Metrics
| Metric | Q1 FY2022 | Q1 FY2021 | Change |
|---|---|---|---|
| Net sales | $20.2 million | $16.7 million | Up 21% |
| Gross profit | $0.9 million | $1.6 million | Down $0.7 million |
| Gross margin | 5% | 9% | Down 4 percentage points |
| SG&A | $4.9 million | $3.9 million | Up $1.0 million |
| Operating margin | (19%) | (14%) | Down 5 percentage points |
| Net loss | $3.1 million | $1.8 million | Loss increased $1.3 million |
| Diluted loss per share | $0.31 | $0.18 | Higher loss |
| Cash flow from operations | $(7.1) million | $(4.4) million | Greater use of cash |
| Cash and investments | $19.1 million | $65.0 million at March 31, 2021 | Down $45.9 million |
| Backlog | $235.9 million | $137.6 million at March 31, 2021 | Up 72% |
Revenue included $3.5 million from Barber-Nichols for the one month owned during the quarter. Sales recognized over time represented approximately 65% of revenue, compared with 40% in the prior-year quarter. SG&A increased because of Barber-Nichols, purchase-price amortization, acquisition costs, and organizational development costs. The Company reported a 19% effective tax rate and a $0.7 million income-tax benefit.
Liquidity, Debt, and Capital Resources
- Cash and cash equivalents were $19.1 million at June 30, 2021; no investments were held.
- Working capital was $36.8 million, with a current ratio of 1.7, compared with $76.7 million and 2.8 at March 31, 2021.
- The Company used $7.1 million in operating cash and $54.5 million in investing cash, primarily reflecting the $59.6 million cash outlay for Barber-Nichols.
- Financing activities provided $21.1 million, including a $20.0 million five-year term loan and $2.5 million of revolving borrowings.
- Debt at June 30, 2021 consisted of $2.5 million of short-term revolving debt, $2.0 million current long-term debt, and $18.0 million of long-term debt, before considering lease obligations.
- The Bank of America facilities include a $30.0 million revolving line, expandable to $40.0 million with approval. Availability under the Bank of America and HSBC facilities was reported at $28.0 million.
- Credit agreements require a maximum total leverage ratio of 3.0 to 1.0 and a minimum fixed-charge coverage ratio of 1.20 to 1.0. The filing states that management expects available cash, operating cash flow, and financing capacity to meet near-term needs.
- Capital expenditures were $0.4 million in the quarter; fiscal 2022 capital spending is expected to be approximately $3.5 million to $4.0 million.
Material Changes Versus the Prior Comparable Period
- Sales increased 21%, primarily due to the Barber-Nichols contribution and recovery from the COVID-19-related production restrictions affecting the prior-year quarter.
- Gross profit and gross margin declined because of project mix, lower-margin work, COVID-19-related liquidated damages, and expense timing.
- Net loss widened from $1.8 million to $3.1 million, while SG&A rose 26% to $4.9 million.
- Orders increased to $20.9 million from $11.5 million. Backlog increased $98.4 million, including $94.4 million acquired from Barber-Nichols.
- The business mix shifted toward defense. Defense represented 35% of current-quarter sales versus 21% in the prior-year quarter, and U.S. Navy projects represented 80% of June 30 backlog.
- International sales declined 14%, while domestic sales increased 47%.
- Cash declined materially because of the acquisition, operating cash usage, dividends, and capital expenditures; the transaction was funded with cash, debt, and 610,000 shares of common stock.
Acquisition, Outlook, Risks, and Unusual Items
- Barber-Nichols was acquired for preliminary consideration of $72.0 million, including $61.2 million cash and $9.0 million of Graham stock. Goodwill of $22.9 million and acquisition-related intangible assets were recorded.
- The sellers may receive up to $14.0 million under a contingent earn-out; a $1.9 million liability was recorded at June 30, 2021. The purchase-price allocation remains preliminary and could change materially.
- Management expects fiscal 2022 revenue of $130 million to $140 million, including $45 million to $48 million from Barber-Nichols for the ten-month ownership period.
- Management expects fiscal 2022 gross margins of 17% to 18%, SG&A of 15% to 16% of sales, a tax rate of 24% to 25%, and adjusted EBITDA of approximately $7 million to $9 million. These are management estimates and are not guaranteed.
- Management expects positive operating cash flow during the remaining nine months of fiscal 2022 and expects approximately 35% to 40% of June 30 backlog to convert to sales during that period.
- Commercial energy and petrochemical markets remain weak because of COVID-19 effects, energy-market disruption, reduced capital spending, and geopolitical conditions. Pricing and project timing remain challenging.
- Key risks include COVID-19 effects, successful integration of Barber-Nichols, customer and employee retention, execution of long-term contracts, material-cost volatility, foreign exchange, trade policy, project cancellation, and dependence on U.S. Navy demand.
- The Company is subject to asbestos-related and other ordinary-course legal claims. Management cannot estimate losses for most claims but does not believe the matters will have a material adverse effect.
- Daniel J. Thoren was appointed President and CEO effective August 31, 2021, succeeding retiring CEO James R. Lines. A one-time separation charge is expected in the second quarter of fiscal 2022.
- Internal-control assessment excluded Barber-Nichols under the SEC’s one-year acquisition guidance. The Company expects to complete implementation of Barber-Nichols internal controls during fiscal 2023.
Investor Verification Checklist
- Verify the final purchase-price allocation for Barber-Nichols, including goodwill, intangible values, amortization, and the potential earn-out.
- Assess whether the Company can achieve the stated fiscal 2022 revenue, margin, adjusted EBITDA, and cash-flow outlook.
- Monitor leverage, covenant compliance, revolving availability, interest-rate exposure, and the reduction in cash following the acquisition.
- Evaluate the quality and timing of the $235.9 million backlog, particularly the long conversion cycle and concentration in U.S. Navy projects.
- Review gross-margin recovery, contract estimates, liquidated damages, material costs, and performance on contracts recognized over time.
- Track Barber-Nichols integration, internal-control implementation, customer and employee retention, and any unforeseen liabilities.
- Consider the effects of continued weakness in commercial energy and petrochemical markets and ongoing COVID-19-related disruptions.