Graham Corporation — Form 10-Q Summary
Reporting period: Quarterly and six-month periods ended September 30, 2022, representing the second quarter and first six months of fiscal 2023. The request metadata identifies “2021 Q2,” but the filing is for September 30, 2022. Results are unaudited and include Barber-Nichols, LLC (BN), acquired June 1, 2021.
Business context
Graham designs and manufactures mission-critical fluid, power, heat-transfer, vacuum, and turbomachinery products serving defense, space, energy, refining, chemical and petrochemical, and other commercial markets. Management is increasing its exposure to defense and space markets while developing commercial aftermarket and clean-energy opportunities.
Financial performance
| Metric | Three months ended Sept. 30, 2022 | Three months ended Sept. 30, 2021 | Six months ended Sept. 30, 2022 | Six months ended Sept. 30, 2021 |
|---|---|---|---|---|
| Net sales | $38.1 million | $34.1 million | $74.2 million | $54.3 million |
| Gross profit | $5.3 million | $3.4 million | $12.0 million | $4.4 million |
| Gross margin | 14% | 10% | 16% | 8% |
| Operating income (loss) | $(0.1) million | $(0.7) million | $0.9 million | $(4.7) million |
| Net income (loss) | $(0.2) million | $(0.5) million | $0.5 million | $(3.6) million |
| Diluted earnings (loss) per share | $(0.02) | $(0.05) | $0.05 | $(0.35) |
| Adjusted EBITDA | $1.5 million | $0.1 million | $4.3 million | $(2.8) million |
Quarterly sales increased 12%, while six-month sales increased 37%. Improvement reflected higher-margin space and commercial aftermarket work, new-energy program growth, improved defense execution and pricing, and additional BN contribution. Quarterly defense sales declined because of project timing.
SG&A, including amortization, was $5.3 million for the quarter and $11.1 million for the six-month period, representing 14% and 15% of sales, respectively, compared with 15% and 19% in the prior-year periods. Net interest expense increased to $0.2 million for the quarter and $0.4 million for six months due to higher interest rates and acquisition-related borrowings.
Cash flow, liquidity and debt
- Cash and cash equivalents were $14.1 million at September 30, 2022, compared with $14.7 million at March 31, 2022. Approximately $6.4 million secured letters of credit and $1.8 million was held by China and India operations.
- Six-month operating cash flow was negative $0.4 million, improved from negative $8.7 million in the prior-year period. Capital expenditures were $1.2 million; fiscal 2023 capital expenditures are expected to be approximately $3.0 million to $4.0 million.
- Total debt consisted of $17.5 million of principal under the Bank of America term loan and $2.5 million drawn on the revolving facility. The term loan bears interest at BSBY plus 1.50%; BSBY was 3.9509% at September 30, 2022.
- Revolving-facility availability was $7.7 million, subject to liquidity and leverage covenants. Letters of credit totaled $12.1 million, including $5.7 million with Bank of America and $6.4 million with HSBC.
- The company was previously out of compliance with certain bank covenants at December 31, 2021 and received a waiver. Amendments modified covenant requirements, and management stated that the company was in compliance with the amended covenants at September 30, 2022.
- Working capital was $28.3 million, with a current ratio of 1.4. Dividends were suspended in the fourth quarter of fiscal 2022 and no dividends were paid in the six months ended September 30, 2022.
Material changes versus the prior comparable period
- Revenue growth was driven by commercial space, new energy, refining and chemical/petrochemical aftermarket activity, partly offset by lower defense revenue caused by project timing.
- Gross margin improved materially, primarily from sales mix, better defense contract execution and pricing, despite higher incentive compensation.
- The prior-year quarter benefited from a $1.9 million reversal of BN contingent consideration and was burdened by $0.8 million of CEO severance costs. These unusual items affect comparability.
- Orders increased to $91.5 million from $31.4 million in the prior-year quarter. Six-month orders were $131.8 million compared with $52.3 million.
- Backlog increased to $313.3 million at September 30, 2022 from $256.5 million at March 31, 2022; 79% was related to defense projects, primarily U.S. Navy programs.
- Space represented 15% of six-month sales, compared with no reported space sales before the BN acquisition. Defense and space together represented approximately 50% of second-quarter sales.
Guidance, outlook and risks
- Fiscal 2023 guidance calls for sales of $135 million to $150 million, gross margin of approximately 16% to 17%, SG&A of 15% to 16% of sales, and adjusted EBITDA of $6.5 million to $9.5 million.
- Management said first-half results were in line with expectations and supported achievement of the full-year outlook. Large, lower-margin first-article U.S. Navy projects are expected to pressure results through the first quarter of fiscal 2024; remaining significant first-article projects are expected to be completed by then.
- Approximately 40% to 45% of backlog is expected to convert to revenue within one year and 25% to 30% in one to two years. Defense backlog generally has longer conversion periods, potentially up to six years.
- Key risks include labor, raw-material and supply-chain inflation; COVID-19-related disruption; geopolitical events including the Russia-Ukraine conflict; foreign-exchange movements; project timing and execution; challenging pricing in traditional energy markets; variable-rate debt; and reliance on defense and U.S. Navy programs.
- The company faces asbestos-related lawsuits and other ordinary-course claims. Management stated that the likely outcomes are not expected to have a material adverse effect, but the filing does not provide a reasonably possible loss estimate for most claims.
- The company expects no defined-benefit pension contributions for the remainder of fiscal 2023 and expects approximately $0.1 million of postretirement benefits to be paid during that period.
Important facts for investors to verify
- Confirm the applicable reporting period: this filing covers fiscal 2023 second-quarter results ended September 30, 2022, not 2021 Q2.
- Reconcile adjusted EBITDA and adjusted net income with GAAP results, particularly the effects of amortization, debt amendment costs, and prior-year acquisition and severance items.
- Monitor compliance with amended Bank of America covenants, the $7.7 million borrowing availability, liquidity requirements, and the potential $0.7 million back-end fee.
- Assess whether the $313.3 million backlog converts on schedule and whether its high defense concentration increases customer, timing, or program risk.
- Evaluate cash conversion, unbilled revenue of $30.7 million, customer deposits of $26.1 million, and the company’s ability to fund operations without additional borrowing.
- Compare actual fiscal 2023 sales, margins and adjusted EBITDA with management’s guidance of $135 million to $150 million, 16% to 17% gross margin and $6.5 million to $9.5 million adjusted EBITDA.