Graham Corporation — Form 10-Q Summary
Reporting period: Three and nine months ended December 31, 2021, fiscal 2022. The request metadata identifies “2020 Q3,” but the supplied filing is the December 31, 2021 Form 10-Q.
Business Context
Graham designs and manufactures critical equipment and systems for defense and space, energy, chemical and petrochemical markets. On June 1, 2021, the Company acquired Barber-Nichols, LLC (“BN”), a turbomachinery manufacturer serving aerospace, cryogenic, defense and energy markets. BN contributed $11.968 million of third-quarter sales and $31.925 million of nine-month sales.
Financial Performance and Liquidity
| Metric | Three Months Ended December 31 | Nine Months Ended December 31 | ||
|---|---|---|---|---|
| 2021 | 2020 | 2021 | 2020 | |
| Net sales | $28.774 million | $27.154 million | $83.077 million | $71.818 million |
| Gross profit | $0.561 million | $6.227 million | $4.918 million | $15.488 million |
| Gross margin | 2% | 23% | 6% | 22% |
| Operating income (loss) | $(4.582) million | $1.291 million | $(9.293) million | $2.397 million |
| Net income (loss) | $(3.730) million | $1.060 million | $(7.348) million | $1.986 million |
| Diluted EPS | $(0.35) | $0.11 | $(0.70) | $0.20 |
- Operating cash flow was $(14.552) million for the first nine months of fiscal 2022 versus $0.670 million of cash provided in the prior-year period.
- Cash and investments were $13.991 million at December 31, 2021, down from $65.032 million at March 31, 2021.
- Working capital was $32.007 million, with a 1.5 working-capital ratio, versus $76.675 million and 2.8, respectively, at March 31, 2021.
- Capital expenditures were $1.909 million year to date; fiscal 2022 capital expenditures were expected to be approximately $2.5 million to $3.0 million.
- Total debt consisted of a $19.0 million term-loan balance and $9.750 million outstanding under the Bank of America revolving facility at December 31, 2021. Letters of credit outstanding totaled $8.399 million.
- The Company had $196.080 million of total assets and $97.539 million of stockholders’ equity at December 31, 2021.
Material Changes Versus the Prior Comparable Period
- Third-quarter sales increased 6%, while nine-month sales increased 16%, primarily because of BN. Organic sales declined by $10.378 million in the quarter and $20.666 million year to date.
- Gross margin fell sharply because of cost and schedule problems on defense contracts at the Batavia facility, including labor shortages, use of higher-cost contract welders, outsourcing and additional material and production-hour requirements.
- Management attributed the fiscal 2022 losses primarily to Navy project labor and material cost overruns. BN’s performance partly offset the Batavia losses.
- Domestic sales increased substantially as the business mix shifted toward defense and BN; international sales declined, particularly from prior-year China refining projects.
- Orders increased 10% in the third quarter to $67.964 million and 11% year to date to $120.217 million. Backlog reached a record $272.599 million, nearly double the March 31, 2021 balance of $137.567 million.
- The acquisition added $22.823 million of goodwill and significant identifiable intangible assets; acquisition-related amortization was $1.765 million year to date.
- The quarterly dividend was $0.11 per share through the reported period, but the Company subsequently suspended dividends as a condition of its debt covenant waiver.
Guidance, Outlook, Risks and Unusual Items
- Fiscal 2022 revenue guidance was $120 million to $125 million, including $45 million to $48 million from BN for the ten months owned.
- Management expected gross margin of 8% to 10%, SG&A of 16% to 17% of sales, and an effective tax rate of 18% to 20%, inclusive of approximately $2.7 million of purchase-accounting costs.
- Adjusted earnings before net interest expense, taxes, depreciation and amortization for the combined business were expected to be a loss of approximately $5 million. The filing does not provide a reconciliation to GAAP.
- Management expected positive operating cash flow during the final three months of fiscal 2022, but stated that cash flow had been negative during the first three quarters.
- Defense demand remained strong. Defense represented 52% of year-to-date sales and 77% of backlog; management expected defense to represent 45% to 50% of fiscal 2022 sales. U.S. Navy sales were expected to be $60 million to $65 million for fiscal 2022.
- Energy and petrochemical markets remained challenging, although management cited improving North American aftermarket and short-cycle orders. Approximately 40% to 50% of backlog was expected to convert to revenue within one year.
- The Company was out of compliance with its maximum leverage and minimum fixed-charge coverage covenants at December 31, 2021. On February 4, 2022, Bank of America granted a limited waiver and capped Bank of America revolving borrowings at $15 million pending receipt and review of the March 31, 2022 financial information.
- Management anticipated that, absent an amendment or additional waiver, the Company would again fail its covenants at March 31, 2022. Acceleration of the term loan and revolver would exceed available cash, creating substantial doubt about the Company’s ability to continue as a going concern.
- The Company was negotiating amendments to its credit facilities, but the plan was not finalized or within its control. The filing states that management’s plans did not alleviate the going-concern uncertainty.
- Other risks include continued defense-project execution problems, labor shortages, COVID-19 effects and potential vaccine mandates, BN integration and valuation risks, material-price volatility, project cancellations, foreign-exchange exposure and asbestos-related litigation.
- The BN earn-out was terminated, resulting in $1.900 million of other operating income. The Company also recorded liabilities related to executive severance and transition agreements, including $0.798 million for a former chief executive officer and $0.140 million for another executive at December 31, 2021.
Important Facts for Investors to Verify
- Whether the Company successfully amended or refinanced its loan agreement and remained compliant with covenants after March 31, 2022.
- Actual cash generation, borrowing availability and the effect of suspended dividends on liquidity.
- Progress in resolving Batavia defense-contract cost overruns and restoring gross margins.
- Whether BN’s operating performance and backlog conversion support the stated revenue and profitability outlook.
- Final purchase-price allocation, intangible-asset valuations and related amortization or impairment exposure.
- Conversion timing and customer concentration within the $272.599 million backlog, including its 77% U.S. Navy concentration.
- Material developments in asbestos litigation and other legal proceedings.