Graham Corporation — Form 10-Q Summary
Reporting period: Three and six months ended September 30, 2021, fiscal 2022. The request metadata identifies “2020 Q2,” but the supplied filing is the September 30, 2021 Form 10-Q.
Business Context and Reporting Period
Graham designs and manufactures critical equipment and systems for defense and space, energy and new energy, and chemical and petrochemical markets. Operations include facilities in Batavia, New York; Barber-Nichols, LLC (“BN”) in Arvada, Colorado; and subsidiaries in China and India.
On June 1, 2021, Graham acquired BN for a preliminary purchase price of $72.0 million, consisting of $61.2 million of cash and $9.0 million of Graham common stock. BN contributed $16.5 million of second-quarter sales and $20.0 million of first-half sales.
Key Financial Metrics
| Metric | Q2 FY2022 | Q2 FY2021 | Six Months FY2022 | Six Months FY2021 |
|---|---|---|---|---|
| Net sales | $34.1 million | $28.0 million | $54.3 million | $44.7 million |
| Gross profit | $3.4 million | $7.7 million | $4.4 million | $9.3 million |
| Gross margin | 10% | 28% | 8% | 21% |
| Operating income/(loss) | $(0.7) million | $3.4 million | $(4.7) million | $1.1 million |
| Net income/(loss) | $(0.5) million | $2.7 million | $(3.6) million | $0.9 million |
| Diluted EPS | $(0.05) | $0.27 | $(0.35) | $0.09 |
Second-quarter SG&A was $5.2 million, or 15% of sales, versus $4.3 million, also 15% of sales, in the prior-year quarter. First-half SG&A was $10.2 million, or 19% of sales, versus $8.2 million, or 18%.
Cash used in operating activities was $8.7 million in the first six months, compared with $2.3 million used in the prior-year period. Capital expenditures were $1.2 million, and dividends paid were $2.4 million.
At September 30, 2021, cash and cash equivalents were $16.5 million, compared with $59.5 million at March 31, 2021. Working capital was $36.5 million, with a current ratio of 1.6.
Total debt consisted of $4.0 million drawn under the revolving facility, $2.0 million of current long-term debt, and $17.5 million of long-term debt. The company reported $25.6 million of availability under its Bank of America and HSBC credit facilities, excluding other considerations such as borrowing-base or covenant limitations.
Material Changes Versus the Prior Comparable Period
- Sales increased 22% in both the quarter and first six months, primarily because of the BN acquisition. Organic sales declined.
- Defense-related sales increased substantially, while international refining, chemical, and petrochemical sales declined. Domestic sales represented 77% of quarterly sales versus 62% in the prior-year quarter.
- Gross margin fell to 10% from 28% in the quarter and to 8% from 21% for the first half. Management attributed the decline to lower-margin defense work, fabrication-order cost and margin timing, and a prior-year benefit from a large one-time defense material order.
- The company incurred acquisition-related amortization and higher interest expense following the BN transaction. First-half interest expense rose to $0.2 million from less than $0.1 million.
- Other operating income included a $1.9 million gain from terminating the BN earn-out liability, partly offset by $0.8 million of CEO severance and transition costs.
- Backlog increased to $233.2 million at September 30, 2021 from $137.6 million at March 31, 2021, although it declined modestly from $235.9 million at June 30, 2021. Approximately 78% of backlog was related to U.S. Navy projects.
Guidance, Outlook, Risks, and Unusual Items
- Fiscal 2022 revenue guidance was $130 million to $140 million, including $45 million to $48 million from BN for the ten months owned.
- Management expects fiscal 2022 gross margins of 17% to 18%, SG&A of 15% to 16% of sales, and an effective tax rate of 24% to 25%, inclusive of purchase-accounting costs.
- Adjusted EBITDA for the combined business was expected to be approximately $7 million to $8 million. The filing does not provide a reconciliation to the most comparable GAAP measure.
- Management expected gross margins to improve materially in the second half as lower-margin Batavia defense projects were completed and expected positive operating cash flow during the remaining six months of fiscal 2022.
- Defense demand was described as strong, with fiscal 2022 U.S. Navy revenue projected at $60 million to $70 million. Energy and petrochemical markets remained pressured by COVID-19 effects, reduced capital spending, energy-transition trends, and challenging pricing.
- Key risks include COVID-19 impacts and potential vaccine mandates, execution and integration of BN, retention of BN employees, contract-cost estimates, material-price volatility, foreign exchange, project cancellation, customer concentration, government contracting, and asbestos-related litigation.
- The company had no projects on hold at September 30, 2021. Management stated that pending legal matters were not expected to have a material adverse effect, although potential losses could not be estimated for most claims.
- Internal-control assessment excluded BN because it was recently acquired; implementation of BN’s internal-control structure was expected to continue through fiscal 2023.
- On October 26, 2021, Graham entered into a performance bonus agreement for certain BN employees tied to BN results for fiscal years ending March 31, 2024 through 2026.
Investor Verification Checklist
- Verify the sustainability of BN’s revenue and profitability contribution and the progress of its integration.
- Reconcile the sharp margin decline and assess whether the projected second-half margin recovery occurs.
- Monitor operating cash flow, working-capital usage, and liquidity after the acquisition-related cash outlay.
- Review compliance with the credit facilities’ leverage and fixed-charge coverage covenants.
- Assess the conversion timing, cancellation risk, and customer concentration of the $233.2 million backlog.
- Evaluate the impact of purchase-accounting amortization, earn-out termination, CEO severance, and future BN performance bonuses.
- Track COVID-19, vaccine-mandate, labor availability, supply-chain, material-cost, and government-contracting risks.