Graham Corporation

Greetings. Welcome to Graham Corporation's first quarter fiscal year 2022 financial results. At this time, all participants will be in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero from your telephone keypad. Please note this conference is being recorded. At this time, I'll now turn the conference over to Deborah Pulaski, Investor Relations for Graham Corporation. Ms. Pulaski, you may now begin.

Thank you, Rob, and good morning, everyone. We certainly appreciate your joining us today to discuss Graham's first quarter fiscal 2022 financial results. We announced those results earlier this morning, and you should have a copy of that along with the slides that will accompany our conversation today. If you do not have the releases or the slides, you can find them on the company's website at www.gram-mfg.com. We also simultaneously this morning announced the planned retirement of Jim Lines, our Chief Executive Officer. He's on the call today with us and will be making some formal remarks. Also joining us are Jeff Gleick, our Chief Financial Officer, and Dan Thorin, our President and Chief Operating Officer, who has been named effective with Jim's retirement our new Chief Executive Officer. Jim will start with his overview and then cover the brief results of the quarter. Jeff will then review details of the financial results and then we'll have Dan close out with his remarks. As you are aware, we may make some forward-looking statements during this discussion as well as during the Q&A session. These statements apply to future events and are subject to risks and uncertainties as well as other factors which could cause actual results to differ materially from what is stated on the call today. These risks and uncertainties and other factors are provided in the release and in the slides as well as with other documents filed by the company with the Securities and Exchange Commission. These documents can be found on our website or at sec.gov. I would like to point out that during today's call we may also discuss some non-GAAP financial measures which we believe are useful in evaluating our performance. You should not consider the presentation of this additional information in isolation or as a substitute for the results prepared in accordance with GAAP. We have provided the reconciliations of comparable GAAP with non-GAAP measures in the tables accompanying today's release. So with that, it's my pleasure to turn the call over to Jim Lyons. Jim?

Thank you, Debbie, and good morning, everyone. I will begin my remarks at slide three and provide a brief review of the financial results before discussing my planned retirement. Revenue in the quarter was $20.2 million. $16.7 million was organic, and $3.5 million was due to the acquisition of Barber Nichols that closed June 1st. Defense revenue was 35% of total revenue in the quarter. We do expect that defense revenue will approach 50% of total quarterly revenue with Barbara Nichols fully in future quarters. This acquisition and the shift in revenue mix is a major transformation for Graham and measurably advanced our diversification strategy. On an organic basis, revenue was similar year over year. However, it was for different reasons. You might recall that our first quarter last year operated at nominally 50% capacity due to COVID-19, thus impacting revenue and profitability due to under-adsorption. In the most recent quarter, our workforce utilization was at capacity. However, mix was very different. Orders from our crude oil refining and petrochemical markets were very low during the third and fourth quarters last fiscal year, where non-Navy orders totaled $17.5 million for both quarters. Consequently, greater production resources were pulled into Navy backlog, which are lower margin due to first article work and also due to contract structure for a large order and backlog. Those headwinds work out of backlog across the next few quarters and largely behind us as we exit this current fiscal year. Organic revenue and profitability are expected to improve across the fiscal year. Orders in the first quarter were $20.9 million and were principally organic. Barbara Nichols' orders were $200,000 for the month of June. Somewhat encouragingly, there were strong orders from our crude oil refining market in the quarter that totaled $11.5 million. We did have a significant win in the quarter for a domestic refiner revamping their facility to improve crude oil feedstock processing flexibility. That particular win was gratifying for me. I still remember losing the original order to a domestic competitor in the mid-1990s. And now, 25 years later, we won back the installation and replace the original supplier with our own vacuum systems. Consolidated backlog at June 30th was $236 million, of which 80% is for defense. Importantly, as we work through the more challenging margin backlog that impacts the current fiscal year, margin potential for our defense backlog improves measurably. The Barbers Nichols acquisition provides additional market diversity to our profile as it also adds backlog for new markets including space and advanced energy industries. While we put considerable cash toward acquiring Barbara Nichols to strengthen and diversify revenue along with earnings, our balance sheet remains strong and our opportunity to drive our return on assets improves. As announced earlier today and as Debbie had mentioned, I am very pleased to confirm that I will retire effective August 31st at the end of this month. And Dan Thorin will succeed me as president and CEO of the corporation. He also will join our board of directors at that time. It has been a tremendous honor and great privilege for me to serve Graham shareholders and the corporation as its principal executive officer since 2006. I believe I am departing on a high note. as this is an incredibly exciting time for the company considering, first, the strength of our organic defense strategy, having advanced to preferred supplier status for many of the products the company provides to the U.S. Navy, and in some cases, we are now bidding on a sole source basis. The credit goes to Alan Smith and his team for executing well our defense strategy. Secondly, the progress we have had innovating execution to become successful in price-focused international crude oil refining and petrochemical markets. The sales team has proven we can take market share, and also the operations team has shown we're able to realize or beat target margins. Thirdly, the investments we've made in IT tools, systems, and resources to leverage our installed base and the expected benefit that will provide. I believe crude oil refining and chemical petrochemical customers will invest in existing facilities for greater throughput before investing in new capacity. I feel we are ahead of competitors regarding commitment to the installed base. Lastly, the transformational acquisition of Barbara Nichols creates a new, strong growth platform for both organic and M&A expansion. I've had the opportunity to work with Dan through the acquisition process for over nearly three years, and most recently the last two months as he onboarded with the Graham team. I believe that Dan is well equipped to lead Graham and has a terrific and broad vision for the next phase of growth for the company. I'm thrilled this acquisition has proved to be as transforming as we had envisioned, and part of that transformation is building out the bench strength of our leadership team. Ultimately, over the last couple of months, it became more clear to me that this has provided for my succession plan as well. I'm thrilled that the board saw the same potential in Dan that I have seen. As a Graham shareholder, I'm looking forward to benefiting from the value of Dan's strategic direction. Congratulations, Dan. You have my full support, not only through this transition, but well into the future. I also want to take a moment as well to thank our shareholders. I have enjoyed our many conversations all these years and have very much appreciated your ongoing support. With that, I will turn the call over to Jeff for his review of the financial results. Jeff?

Thank you, Jim, and good morning, everyone. If you could move to slide four. As Jim mentioned, we had a very rough first quarter. As I discussed that first quarter, I would like to keep in mind that our full year guidance is unchanged. Therefore, we expect to see improvements as the year goes on, and we expect sequential quarterly improvement across each quarter for the rest of fiscal 2022. Sales in the quarter improved by $3.5 million, which was due to the one month that we owned Barbara Nichols. The comparable quarter last year was early on during the COVID pandemic, And as Jim mentioned, we ran the company at half capacity during that quarter. However, in that quarter, we did have a $5 million project, which was recognized on a completed contract basis, and because of COVID, had shifted from fiscal 2020 into Q1 of 2021. Gross profit and EPS were dramatically affected by a very poor mix of projects, and some timing and some cost items. Namely, we had some liquidated damages due to COVID in the quarter and some timing of expenses which were pulled into Q1. We also had a small amount of acquisition expenses, about $169,000 pre-tax, and the first month of purchase price accounting related costs for Barbara Nichols. To clarify the latter, the purchase accounting amortization costs were $225,000 before taxes in June. Before we move on, I want to mention that we expect approximately $2.7 million pre-tax and $2.15 million after tax related to acquisition purchase accounting. 90% of this is amortization costs, with the rest being a step up in depreciation and inventory. We will be filing an 8K later this week with much more detail on the purchase accounting and pro forma income statements. We expect the amount of amortization will be similar in fiscal 2023 as fiscal 2022, since we will have 12 rather than 10 months of amortization in fiscal 2023. It will decrease in future years and level off at approximately $1.1 million pre-tax. On to slide five, with the acquisition of Barbara Nichols, we have moved from a very inefficient to a much more efficient balance sheet. We have added $20 million of low-cost term debt as part of the acquisition, and we have access to a much larger revolving line of credit. This term loan and the line of credit will provide ongoing flexibility. We expect the acquisition of Barbara Nichols to be accretive in fiscal 2022, even with the $2.15 million or approximately 20 cents a share in added amortization costs. We will continue to look for both organic and M&A-related growth opportunities and believe we have the financial strength to invest in both areas. With the addition of Barbara Nichols, we believe there are some excellent opportunities in both arenas. On to slide six. Orders in the commercial markets picked up in Q1 off a very low base in the previous two quarters. With a $236 million backlog, we are well positioned for long-term growth. 80% of that backlog is in the defense market, which provides an excellent baseline for our business, not just this year, but in upcoming years as well. We expect approximately 50% of our forward-looking business to come from the defense market, and with the opportunities for growth in the space market, and recovery in the energy markets, we are excited about the future. Before I pass it over to Dan, I would be remiss if I didn't recognize Jim for his 37 years of service at Graham, the last 15 years being its leader. He has transitioned Graham from a company which was capacity limited and had minimal growth engines to a much broader organization with strong footprints in defense, and the Asian energy markets to couple with a long history in the United States and Middle East. Look nearly anywhere in the world and you will see Graham Equipment in many world-class refining and petrochemical facilities. You will also see Graham Equipment playing a key role on U.S. Navy vessels which support our country's national defense. I also want to welcome Dan. I've known Dan for the past three years, including negotiating the acquisition with or perhaps against Him during part of that time Dan is a very high character leader with a great history at Barbara Nichols And I expect him to do the same at Graham over the past many months When the board members have asked for my view as Dan as a potential CEO I was and continue to be unequivocal unequivocal in my belief that Dan is the right CEO to take Graham forward Now that I've set the bar high Dan. I'll pass the call over to you. I

Thank you, Jim. Thank you, Jeff. Very kind words, very kind introduction. Good morning, everyone. I'd like to start by thanking the Board of Directors and Jim Lyons specifically for placing their confidence in me to lead Graham Corporation. I've spent two and a half years getting to know Graham, their leadership, and at a high level, their business. Indirectly, I've learned a little about their culture, their people, their customers and their board. Over the last two months, I've met with the executive team, managers, employees, customers and the board to understand the company in more depth. These interactions have helped me understand the proud engineering and manufacturing heritage at Graham, the importance of the company in the community of Batavia, New York and how they have become a trusted partner to their customers across the world in the critical process industries that they serve. As I go through my slides, I'll give you an idea of how we are developing our strategy to build upon our strong legacies while leveraging our opportunities in the defense and space industries. Specifically, we'll be working to generate sustainable earnings growth reduce that earnings volatility, improve operating performance, generate strong cash flows to reinvest in our business, and provide a dividend to stockholders. The ultimate goals are to provide an acceptable return to our stockholders and provide benefit to all of our stakeholders. Now let's focus on slide seven. When Graham Corporation acquired Barbara Nichols, We recognize that the two businesses have individual strengths serving their respective markets that we do not want to disrupt. Our strategy is to leverage the strengths of each as platforms that provide potential for both organic and inorganic growth. As such, Graham operations and BM operations both operate under the Graham Corporation umbrella. As we consider future capital investments, our plan is to add new companies and technologies with related engineer product that can stand alone, yet collaborate to win bigger business, leverage best practices between subject matter experts in the companies, share services across the organizations, and provide career paths for key employees. When we do these things, each member company can remain focused and agile while accomplishing more than they could alone. As you look at slide seven, this depicts our two platforms for expansion. Barbara Nichols is currently in space and defense predominantly. Graham Manufacturing is currently in defense, energy, and petrochemical. For the space industry, we believe there are acquisition opportunities in this expanding market as it gains more interest in private investment. We will be looking for small acquisitions that we can tuck in, as well as medium acquisitions that can stand on their own and are complementary to our current businesses. We are also focused on internal investments to develop new products and technologies in that space industry. Both Graham and Barbara Nichols are well engaged in the defense industries. We'll be looking for new areas to provide value, as well as internal investment and acquisitions that can help us grow into new and more sophisticated product. Graham has been a world leader in vacuum and heat transfer products for energy and chemical petrochemical applications. As Jim and Jeff had discussed over many years, The domestic market is flat and the international markets have room for growth. We intend to focus on our domestic installed base and provide customers the support they need to keep those plants running at an optimized level. We'll continue to invest in international markets and grow our presence around the world through our successful shared margin strategy. More recently, both companies are seeing opportunities to engage in the alternative and clean energy markets through turbo machinery and heat transfer products. Clean energy is actually an area where synergy between companies is possible. Strategically, we plan to both service and grow our legacy business while having the engineering and new product capability to participate in these new alternative and clean energy markets. Each one of these markets that I've gone over have their own risk and reward profiles. Having teams focused in each area is paramount, and we are well along with the organizational changes needed to successfully execute our strategies in each of the markets. Let's move to slide eight. As Jim and Jeff discussed earlier, we look at fiscal 22 as a transition year, with a tough start getting better sequentially by quarter. Meanwhile, we are seeing a stronger pipeline with more inquiries and new orders in the second quarter. Graham Manufacturing's second quarter orders are $9.5 million to date, while Barbara Nichols has booked $9.1 million. Based on the timing of customers' projects, we are holding our revenue guidance at $130 to $140 million, of which Barbara Nichols is expected to contribute between $45 and $48 million. Combined, the defense segment is expected to account for almost half of the revenue, and EBITDA is expected to be in the $7 to $9 million range Capital expenditures are planned to be in the $3.5 to $4 million range, including the Barbara Nichols capital expenditure. Let's go to slide nine. As alluded to in my initial remarks, we are transforming Graham Corporation. Barbara Nichols was the initial transformational acquisition. We will be looking to solidify the Barbara Nichols investment through further investment on its platform to enable growth in the defense and space industries as well as other industries as opportunities arise. Coincident with the acquisition, we believe we are at or near the bottom of the energy and petrochem cycle. We have been preparing for an upcycle expansion that we believe will start in FY 2023. Our welder training program has been very successful in refilling our pipeline of future employees. We are qualifying additions to our supply base to enable additional capacity with the expectation of a potential upcycle. Our plans include expanding our international offices with sales, quality, and project management personnel. Both Barbara Nichols and Graham have leading market positions, and strong brand recognition. We believe that strong engineering, working hand in hand with customers on challenging applications, and delivering high quality products on time will enable us to maintain those brand strength and market leadership positions. As we advance our transformation, we will be improving our market presence with linked and updated websites and social media. We believe that this will expand our exposure to a broader audience that doesn't yet recognize our growth and earnings potential. Personally, I have a strong interest in being a great corporate citizen and working with all of our stakeholders to build a better, stronger business for us all. With the BN acquisition, Graham puts its large cash reserves to work and creates and created a more efficient balance sheet. As we continue to improve our business and further our strong cash generating capabilities, we'll intend to make smart choices to allocate that capital for further growth with a keen focus on returns. We are very optimistic about this new combination and the future it presents for all of us. When you have a talented team of people that can see problems for your customers, work with them to design and build solutions to those problems, and then shift when the markets change, you will be successful. At Graham Corporation, we have that ability, and we will be looking to add more. With that, operator, we are ready to open the call for questions.

Thank you. At this time, we'll be conducting a question and answer session. If you'd like to ask a question, please press star 1 from your telephone keypad, and a confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Once again, that's star 1. Thank you. Our first question comes from the line of Theodore O'Neill with Litchfield Hills Research. Please proceed with your question.

Thanks very much. So first question, in your slide presentation you used an image of the Blue Origin New Shepard reusable launch vehicle. Can you give us a little more detail on Graham's Opportunity and Space Development programs?

Yeah, Barbara Nichols is involved in quite a few different new space as well as existing space applications. And so historically we've been involved in the propulsion side, so rocket engine turbo pumps, the pumps that basically take the fuel out of the tanks and supply it to the combustion chamber to provide propulsion. We're seeing more and more applications for the next journey in space. So you worry about launch first and then you worry about or think about living in space or operating in space second. And so we're starting to get more opportunities for turbo machinery, fluid and power systems for space-based vehicles. And so I won't talk about specific customers or very specific applications, but think about launch and then think about living and operating in space as kind of the follow-on to that. And that's where Barbara Nichols has been involved and has future opportunities. Okay.

In the prepared remarks, you say that margins were impacted by your aggressive strategies to enter the Naval Nuclear Propulsion Program. which clearly was successful. Does this mean you underpriced the project to get the business?

Theo, this is Jeff. No, we aggressively, we did aggressively price to get in. Some of these are first projects for a particular vessel, so they obviously have some operational challenges to them also, but We knew going in that these were going to be some rough jobs, but we're successful getting them. We've been successful from a customer standpoint executing them, and very importantly, we've transitioned the business where the vast majority of our current backlog is sole sourced. So if you look at what's in backlog today, and I'm speaking specifically on the historic Graham side, not talking to Barbara Nichols, here. Most of what's come in the backlog over the past couple of years has been sole sourced.

Great. Thanks very much.

Thanks, Leo.

The next question is from the line of Dick Ryan with Collier's. Please proceed with your questions.

Thank you. On the margin question again, can you give us the impact and which vessel programs those were tied to? And then maybe looking down the road, With being a sole source, what kind of margins should we consider going forward?

Dick, I can't really provide much detail on your first question other than I will say it is across multiple boats. As we look forward, particularly as we get into fiscal 2023 and beyond, We expect a pretty substantial step up, not a couple hundred basis points, but well beyond that, to a more reasonable and more normal level of profitability. So I can't provide, again, that specific margin number, but I assure you it's not a couple hundred basis points. It's much more than that.

Okay, thank you. On your commercial side, the increased business coming through there, how does that margin profile stack up? I thought you said it was more domestic business, and I know the Chinese and Indian markets are probably more price sensitive, so can you kind of handicap that going forward?

Dick, as Jim mentioned, we had the one order in the first quarter, I believe – He was speaking on the domestic side, but we've also had some orders, some of the ones that Dan mentioned were in the international markets. Even the ones that are in the international markets are not at a poor margin level. They're actually at a pretty decent margin level. So the orders that have come in in the first quarter and the ones so far in the second quarter that Dan talked about are all at a better margin level than what we've been pulling out of backlog recently. over this past quarter. Again, a lot of that was due to a really low order level in the second half of fiscal 2021.

I know you haven't published the target model, but when you get into 23 and 24 with the rebound and energy and defenses, kicking in, can you give us a range of where do you think gross margins should be coming in when kind of both sides, the commercial and the defense market are operating more efficiently?

Dick, at this point we've not provided anything in the future looking at gross margins. I will talk a little bit about EBITDA margins and those we do expect. If you look at this year's EBITDA margins relative to our guidance, you'd see that they would be kind of in the 5% to kind of 6% range. We expect those to noticeably step up as we get into fiscal 23. Okay.

Thank you.

You're welcome, Dick.

The next question is from the line of Andrew Shapiro with Lawndale Capital. Pleased to see you with your question.

Hi, thank you. Sorry to pile on on this issue, but margins are, I think, the main focus here. Maybe I could throw out the question in a different way, if you could help clarify or maybe bridge the steps to achieving the normalized range of margin, and can you at least identify what kind of range of margin? Would be appropriate and when I'm asking about the clarification of bridging us from our current below expected margins to a normalized margin This is independent of The overhead absorption of revenue growth.

I want to get to that in a follow-up question Okay, Andrew, this is Jeff again As we a couple of things first off if you look at the first quarter and results, and we talked about that of the $20 million in revenue, about 3.5 million was Barbara Nichols, the rest being the historic grant business. Most of the challenges that we had from a margin standpoint, and I'll talk even to margin if that's okay, were on the historic grant side. Those will start to work their way out in the second half of the year. and we would expect those to turn positive in the second half of the year. Some of it will be due to the transition from the mix of – away from the mix of some of the lower profit projects that we had that will run through the first quarter, and we'll be running through some – be running throughout the year, but will be a lesser percentage of our business going forward, and we'll be through with most of that as we get through the end of the year. So some of it is a mix of projects on the Graham side, and, again, we'll move that toward a positive profitability level. In addition, the first quarter only had one month of Barbara Nichols in it and had Barbara Nichols at probably a little lower revenue number than we would expect across the year. Dan mentioned $45 million to $48 million is our guidance for the full year for Barbara Nichols. Since that's only 10 months, do the math, it's $4.5 to $4.8 million on a monthly basis, and our Barbara Nichols revenue in the June quarter was only $3.5 million. So it was a lower revenue number than normal for them, and the profit was also tagged down a little bit because of that. As we move into the current quarter and as we move through this third and fourth quarter, we expect Barbara Nichols to be executing at a higher revenue level and that will help their profitability also. So if I look at the business combined, you'll see the historic Graham business moving toward positive EBITDAs as we get, particularly in the third and fourth quarter, and the Barbara Nichols business. If you think about the direction that we provided on the Barbara Nichols call on June 1st, we had We talked about an EBITDA level that if you kind of backed into, you would get into low double-digit EBITDA levels. We would expect to be in that level in the second, third, and fourth quarters in general. They may be a little higher one quarter, a little lower another, but throughout the next nine months of the year. So the EBITDA, which was obviously quite poor in the first quarter, if you look at the last three quarters, our expectation of revenue, again, just taking our guidance and backing up the first quarter was, is $37 to $40 million of revenue per quarter and a positive EBITDA margin sequentially growing lower in the second quarter but growing into the third and fourth quarter. I do want to expand on one thing if I can. It's probably related to your question and certainly related to Dick Ryan's question that he asked a few minutes ago. If we think about EBITDA margins this year, at 5% to 6%. And quite frankly, you back out the first quarter, you get to high single-digit EBITDA margins. As I think about, without giving a lot of direction in fiscal 23, but as I think about fiscal 23, I'm expecting that we will be into that, transitioning into the low double, at least the low double-digit EBITDA margins as we step into fiscal 23. So I probably should have been clearer on Dick's question, and perhaps this is a little bit of the the bridge that you're looking for as we see our EBITDA margins grow. So I hope that helps. If there's something there, please let me know.

Yes, no. It very much helped in terms of the follow-up. In terms of the coming rest of the fiscal year and then early to the next year, and you talk about the revenue streams, Is that revenue streams with respect to existing backlog in orders, or does that include certain anticipated growth in revenues above and beyond what you have as book business already?

Sure. The vast, vast majority of it includes things that are already in our backlog, and I will include our backlog to include some of the orders that Dan mentioned that came in during the month of July. Okay, that's fine. And let me, if I can expand a little bit here, because I think it will help, I think. So if you think about our guidance, $130 to $140 million, I'm going to make math easy and put it right in the middle and take $135 million. And you talk about Barbara Nichols, which is $45 to $48. So I picked that midpoint at $46.5. Back that out and you look at the historic gram business and And I already talked about the growth we expect to see in Barbara Nichols. That would back into about $88.5 million for the historic gram business. The first quarter was $16.5 or so, which means there's about $72 million left for the rest of the year. So that sees a revenue number on average in the next three quarters for the historic gram business of something around $24 million a year. So that's an increase of about 50% from what we saw in the first quarter. That growth, I don't expect it to be 24-24-24, and rather I actually expect it will grow as the year goes on. So the second quarter may be lower than that, certainly will be lower than that, but the third and fourth quarter we would expect to be at or above that number. So I think part of that ramp to get you more comfortable with the ramp in profitability, is a pretty significant ramp in the historic gram business, along with the ramp in the Barbara Nichols business. So I hope that a little extra color was helpful.

Yes. And then regarding the shortfall or the disappointment in the margins of some of the legacy gram business, were these on – My assumption is these are fixed-price contracts. Did they encounter unexpected difficulties? Were they bid too tight and they were just low-margin businesses? What was encountered in these projects that eventually, obviously, they worked themselves out and then leave the books to be the drag on this quarter and somewhat of a declining albatross in the coming quarters. Sure.

Much of the above that you mentioned, they were bid aggressively. We knew when we bid them that they weren't going to be fantastic projects, but they weren't going to be terrible projects. And as we've executed, the team has executed well, but particularly when you're looking at a first project of a particular vessel, that can provide some challenges from an operations standpoint. I think our team has done a great job of overcoming those challenges, but there's cost, and cost typically falls in the category of additional labor to get those executed. There's one additional thing that's a little hard to explain, but I'll try it. On some of our orders, we've received some short-term orders material orders, which ultimately became part of a larger order. Unfortunately, the way the profit worked out, we ended up with a little more profit in that material portion of the order, which makes the execution part of the order a little less profitable also. So all of those weighed in together. As we talk about the projects going forward, again, what's coming to backlog that are sole sourced, are at a better position because they're not aggressively competitively bid. They're certainly not projects that we're going to make an enormous amount of percentage margin on, but they will be much fairer to both the customer and to Graham as the vendor.

If I could add a little bit of color to that, Barbara Nichols has seen that same thing. on some of our DOD projects, Navy projects. And it's fairly typical across the industry where you're relatively aggressive when you're competing for this new work and trying to break into a particular area. And so you're bidding it aggressively, not overly aggressive, but you are bidding it tight. The first articles, you're learning a lot. there's process that you're developing, there's engineering that you're putting into developing these processes, et cetera. And that investment in the first article is not reinvested in the second and the third. And so you kind of have this steep learning curve where the first one is, it's a challenge for sure. And as we're recognizing this revenue Over time and as we as we go through each one of these subsequent units We're getting better and better and better and so so I think Jeff and Jim have have described what we've seen at Barbara Nichols Where these first articles are a drag? And once you once you kind of get through those first articles then the subsequent ones start to get better and better and and and frankly that's that's kind of what we're predicting and going forward is this improvement sequentially, kind of quarter by quarter. And that follows a pretty typical new project for Navy business.

So these projects that contributed to the disappointment in this quarter and then are going to be worked off, if you could clarify, the bulk of these are on products or programs that are not like working themselves off and they're done. These are like the first round of what is going to be successive orders and successive similar products from which you will have obviously developed production efficiencies and workarounds, et cetera. Is that correct?

Andrew, that is correct. And not only are they projects, they're programs that we are continuing to be in. But in most cases, we already have those in our backlog for the next article.

Okay. So that actually helps a lot. I do have some knowledge in some of this Navy work, but I didn't know if this was like these are projects that were you know, you're just finishing up and we're just so happy to be done with them versus this is really the inefficient initial ramp-ups for what will then be follow-on similar business for which you'll have efficiencies. And it sounds what I just described here in the latter is what was the bulk of the issues here in Q1.

Is that right? Correct. We are happy. We're actually happy that we have Article 2 and beyond. we're excited about not only executing, but also the profitability of these projects going forward, or these programs going forward.

And then moving on to, go on, Dan.

I will say, Andrew, that this is good business, and we'll continue to chase additional Navy opportunities where we will do first articles, and the first articles will be a challenge to get through, and then subsequent ones will get better and better. So So this will be kind of a recurring theme, and we've seen it at Barbara Nichols, too, where when you first get into it, they're tough.

Yeah, the challenge is it's a much heavier portion of the quarter than normal.

Right. I saw this at Spartan Corp with their sauna buoys as well. So moving on to one last other topic here was your discussion on – future growth, deploying of capital, capital allocation opportunities. And one of those things you described was, it seems like then there was greater language of this than, you know, in the past maybe is an acquisition focus. And so I was wondering, and acquisitions is, is, is where is your focus? Is it just in space? As you mentioned, there's some opportunities. Is there already a pipeline of acquisitions you're evaluating? And, and, I know Barbara Nichols' acquisition was three years in the making. Do you have somewhat of a timing thought process on all of this? Is there a certain amount of absorption, swallowing, integration to go on with Barbara Nichols before the next acquisition is compelling and teed up for the board and for you to present to a shareholders?

So Andrew, this is Jeff. I'll start, and then I think I'd like Dan to add his thoughts also. You're correct, the Barbara Nichols was three years, and I will facetiously blame Dan for the negotiations there, but no, that was not it at all. But to answer one of your questions, from an integration standpoint, because of how the businesses are run and the leadership that's in place, there's not going to be too much of a challenge from an integration standpoint, it's not going to take us an enormous amount of time to integrate, and then that will slow down our acquisition process. But rather, what we're doing now is we're looking at the organization, looking at the capabilities that we have in the markets that we have, looking at the markets themselves, and trying to identify which are the markets that we want to go after more aggressively. We want to prioritize. We don't want to try to go after it and say, hey, we're going to go after everything. We're looking at prioritizing. And so Part of the activity over the next couple of quarters is looking at those markets, having the Barbara Nichols and historic Graham team work together to look at where those opportunities are and what are the right ones for us to be going after. Is space an opportunity? Absolutely. Is defense an opportunity? Absolutely. Is energy an opportunity? Perhaps to some extent, but not to the level maybe that those other two are. But we want to look at the markets and look at how we want to position ourselves in those markets and do it thoughtfully. So rather than running out and saying, there are a pipeline of a bunch of companies, but I really don't want to be chasing those too hard immediately until we get our feet under us a little better on where do we really want to focus that activity. There's fruitful opportunities out there. I'm not worried about the number of targets that are out there. What I'm worried about is let's make sure that we laser in as best as we can on the ones that we want to go after. With that, I'll pass it over to Dan if he has anything he'd like to add.

That's actually very well said. The prioritization is going to be probably our biggest internal challenge. We feel like we've got lots of different opportunities that we can go chase. Ultimately, from a direction standpoint, what we're looking for is these smaller companies that we can either tuck into to one of our existing companies or a company that can stand on its own and is complementary to our other businesses. We like to think about companies that are complementary and can join together to go after larger business. That engineered product is really key. That complementary piece is very key. that enables us to go after larger, more sophisticated systems. So the challenge will be, again, you know, where do we prioritize? And we're definitely deep into that process right now.

And is the focus primarily defense, or would you be looking for something in petrochemical or something like that as well?

We're very open. We're evaluating space, defense. There's fluid systems in general that we're looking at that you can kind of apply fluid systems across a bunch of different markets. So, yeah, we're pretty open at this point and trying to understand where the best opportunity is earliest that would provide the focus that we want to go chase for our next acquisition.

Dan, we'll call it acquisition infrastructure. Obviously, Graham had been spending three years focused on acquiring Barbara Nichols. Barbara Nichols had been spending three years, in a sense, focusing on its perspective being acquired. Is there... was there looking for acquisition type of focus at all at Barbara Nichols that was brought in other than of course yourself and your strategic vision that was brought in, or is it primarily the Graham acquisition infrastructure that you're obviously layering on top of?

Hey Andrew, this is Jeff. I'm going to, I'm going to jump in first and then let Dan add on. Um, from my perspective, um, The acquisition team that we have at Graham, which is relatively small, it's mostly myself and Chris Johnson, our head of business development. We've always been focused on looking at the external opportunities for us, and we will continue to be going forward. What's exciting to me about the Barbara Nichols team is they have done a great deal of work looking at the platforms within their business and looking at what, not necessarily as much from a company, other companies out there standpoint, that they want to grow, but rather what technologies, what areas, what products they would like to grow on. So I think there's probably been more of a market focus and less on a specific company focus, and now we're marrying the two groups together. In fact, we're doing it as currently as today. There are meetings today with our... external with, with, with, with Chris Johnson and his team and with the Barbara Nicker, Chris Johnson and some folks with him from, from the Graham business, as well as a large contingent from the team here at Barbara Nichols. So I'm excited about the, the ability to, to pull out that knowledge from Barbara Nichols and then have them work with the, the, I'll call it the corporate acquisition team, which is again, really Chris and I at how we go after it. And, um, Dan has a tremendous amount of knowledge in the markets that Barbara Nichols are in, and so he's providing a tremendous amount of guidance and direction to our team as we're looking forward. So Barbara Nichols was probably less focused on acquisitions per se, but they did a really, really deep analysis and continue to do a deep analysis of of the markets that they're in and where the opportunities would make sense to expand Barbara Nichols, whether it was organically or perhaps inorganically. We're going to take advantage of that as a total company and see what we can do, again, both organically and via the M&A route.

Awesome.

Thank you, guys. For me, I think I would just throw out an example and say, As Barbara Nichols looks at our markets, we provide very simplistically. We will supply a pump for transferring fluid between point A and point B. There's lots of other things between point A and point B. There might be control valves, there might be plumbing, there might be a skid that everything sits on, there might be heat exchangers, et cetera. And so when we think about fluid systems, for instance, we think about the system and what are all the pieces. And as Jeff alluded to, we've done a pretty decent job of understanding where our gaps are. And before the acquisition, we really looked at more organic growth. What is the next piece that we would want to bring on to enable us to move higher in the food chain? and provide that next level of system or subsystem. And so, yeah, less on the specific companies, but a very clear vision of what are the pieces that we would need to build up to the next higher sophistication or system.

Our next question is from the line of William Bremer with Vanquish Capital Partners. Please proceed with your question.

Hey, Jeremy, can you hear me? Yes. First, hey, Jim, it's been a pleasure all these years. Congrats on the retirement. Daniel, welcome. I look forward to meeting with you. And Jeff, you did a great job just now in that clarity, not just on the financials but in end market. My question is specifically on, and you just touched on this, on the fluid handling systems. I'd like you to go into your opportunity primarily in hydrogen and what you're seeing there and educate us a little bit on if these projects that they're dicey, they're lumpy. I understand that. A little bit on the permitting issues that you may be seeing and how long it takes. But more importantly, your exposure and potential margins there.

Yeah, so the hydrogen economy is very old and it's very new. So Barbara Nichols played in the hydrogen economy very early when a lot of the automotive companies were looking at hydrogen-powered fuel cells. And so, gosh, you know, 15 years ago, some of the larger automotive companies were starting to look at that, and we were providing anode cathode blowers for their R&D types of systems. Kind of fast forward to today, and hydrogen economy is still a discussion. I think the position that Graham and Barbara Nichols play there is really on the component side and less on the system side. We are, both companies, are talking to various potential customers and customers about what they are doing with the hydrogen, how you make hydrogen, how you distribute hydrogen, how you fuel different vehicles with hydrogen. So we're involved in all of those discussions. Boy, it's way too premature to talk about exactly what our play will be there as well as what our margins will be, but you can be sure that we are engaged in that and having some very great conversations with customers that we hope to be able to talk a lot about in the future, but right now, too premature.

No, I completely agree. Fair. Would you be selling this potentially direct or through distributors?

I would guess it's going to be direct, yeah. You know, I don't see it really getting to the point where it's commercial off the shelf for quite a while. So it would be going direct to the OEMs that are building the larger systems.

Great. Thank you. That's all I have.

Thank you. As a reminder, we press star 1 to ask a question. The next question is from the line of Gary Schwab with Valley Forge Capital Management. Please go ahead with your question.

Yeah, hi. In your fourth quarter conference call, one of the priorities was to speed up your backlog conversion by growing your workforce capacity. I think Jim said he wanted to grow it by 20%. he also said that Batavia currently has the infrastructure to handle the workforce expansion. Can you just talk us through that growth plan and its timing? I know that you said that the welder pipeline is picking up.

Gary, this is Jeff. We are looking to continue and looking to grow. Obviously, as many companies are finding, it's challenging to bring on new employees. So what we're doing is, Dan talked about part of it with the welder training that we have in-house. We also have engaged with a third party to provide additional welders, really to source additional individuals and provide additional welder training for us. And some of these folks come in fairly fresh with minimal capabilities on the welding side, but they're being taught what we need them to have those capabilities to to ultimately join our organization. So I don't have a great timeline on you just because the uncontrollable variable is the number of individuals that are available or they're making themselves available. And certainly we've seen, as many other companies have, have seen challenges in hiring. But we're trying to bring on, you know, kind of five or six a quarter if we can possibly do that as we go forward. Do we get there in the next – Nine to 12 months, we hope so. But I can't guarantee anything because, again, there is that uncontrollable variable, which is there needs to be the supply. But we're putting out multiple approaches rather than simply saying we're doing our own recruiting and just letting them come to us. We're looking for other avenues. And our operations team and our human resources team has done a great job of expanding those those areas such as this new program that we just signed up for a couple of weeks ago.

Yeah, and I guess I'd add on to that. From Barbara Nichols' perspective, as we've grown, you can grow too fast. The people that we're looking to train and develop have to have very consistent skills the ability to produce our equipment, our fabrications, in a very, very consistent, high-quality manner. And so you can absolutely grow too fast. I don't think that we're quite there with Graham. We're still kind of bottlenecked on the training piece, but absolutely, Alan and his team have done a great job of developing curriculum and and being very proactive in priming our pipeline. And I think we're seeing benefits from that. So can't quantify it real well right now, but we're definitely headed in the right direction.

Okay. And also, when you talk about backlog conversion, speeding it up, can you just – you have a tremendous backlog now, but – Do you also have set delivery schedules? In other words, if you speed up your conversion, can you do that? Or do you have to basically base it on your delivery rates, on your delivery schedules?

Both. So yes, we have long-term contracts and then we have delivery dates with those contracts, and they're aligned with the shipbuilders so that they get there at the right time. Certainly there's the ability to speed it up to some level, but if we go too fast, then the shipyards actually can't use them. They won't accept them. And so there's certainly some give and take there, and we've got enough different programs that in some cases they're looking to accelerate Our deliveries, in some cases, there might be something that's slower that's bottlenecked their production and potentially they don't need it as fast as we've got it scheduled. But there's enough of those variables, enough of those programs that we actually have some operational ability to kind of speed up here, slow down there if need be.

Okay. And then I just have one more. I have a housekeeping question. You know, the acquisition of BNI is now two and a half months old. But when you go onto the Graham website, you still have your old website up. And if you look at the Graham's corporate profile, it doesn't say anything about defense. If you do a financial search on Yahoo or Wall Street Journal, it says Graham's an industrial machinery company. So anybody who's doing a search for defense companies... Graham doesn't even show up. When will that be updated?

Hey, Gary, this is Jeff, and I appreciate you bringing this up, and you and I have talked about this one-on-one. We are working on updating our website, both the Graham website and the interaction with the Barbara Nichols website. We recognize that if there's one area we've let slip through the cracks, that's clearly been it. But we are working on improving our website, and we should hopefully be seeing some impact of that soon, and then over time, much greater impact. Barbara Nichols has done a great job over the last year focusing on their website and improving it. and we're looking to do the same for the Graham website and linking the two. So I appreciate your frustration. I have it also, but that's on us, and we need to get that to work.

Can't you at least change the wording on your profile and send out, you know, contact information to different financial companies saying that you're now a new company, please change our profile, don't put us in industrial machinery anymore?

Yes, we are doing that. We are actually working on that, Gary. Okay, great. Thank you. Thanks, Jeff.

Thank you. At this time, I'll hand the floor back to Dan Thorne for closing remarks.

We do have one more. I'm sorry, but we do have one more in the queue if you'd like to take that call right now.

Sure, my apologies. That's one of Andrew Shapiro with Lundale Capital.

Oh, sure.

Great. Hi. Thanks for the follow-up. It's actually a follow-up on Gary's comments or questions. In addition to, obviously, the website, and it sounds like changing the wording and all of that, what are your planned investor outreach or engagement events in terms of, I know I think you're doing the Seaport Global. You may be doing Midwest Ideas or something. But what are the planned upcoming investor relations events and steps that you might take to position the company to be in front of defense sell side analysts, not just industrial machinery analysts themselves? Because we only have a few sell side that covers the company. And I think there may be more people on the sell side around in the defense space.

Andrew, this is Jeff. Thank you for that question. You are correct. The two conferences at the latter part of August, I believe the last Wednesday and Thursday of August, which would be the 25th and 26th, we have those. Collier's is having a virtual conference the second week of September. Don't quote me on the date, but I believe it's. Thank you, Debbie. And then Sidoti has a conference in late September that we're attending that's also virtual. We're also planning on attending the Southwest New Ideas Conference, which is in the middle part of November. That right now is set to be in person in Dallas. And beyond that, we are welcome. We're certainly having calls and videos available. calls with investors, and I would greatly welcome some in-person meetings if investors are willing to see us in person. Dan and I have met with a couple of investors in person, actually both here in Denver, back in June, but we're more than open to going on the road and seeing people in person if they're willing to have us, given some of the COVID concerns, ongoing COVID concerns. So we're doing all of that. With regard to looking on the defense side, we're looking into that right now, and Debbie Pulaski and her folks at Key Advisors are helping us there to look and see what other arenas that we can reach out to and not move away from being an industrial company, but refocus toward being more in the defense and aerospace arenas. So we're doing all that. We want to get our message out, and Probably the biggest frustration to me is it's hard to do it in person these days, but gosh darn, if we can do it in person, we'll be there.

Yeah, if you can get into some of the databases and then you'll show up in the relative comp tables, that'll be a start.

Absolutely.

Absolutely. Great, thank you. If I can add in for everyone, I'm kind of faking all of this too, those will start to switch over as the definitions change. change in our SEC filings. That's where most of the information systems pick up the changes. And I think you'll see when you see our next 10Q that we are advancing the discussion regarding being a defense company in those disclosures.

Great.

Thank you. Thank you, Andrew.

And operator, we will take John, please.

Sure. My question is from John Dycher with Pinnacle Capital Management. Thank you.

Hi. Thanks for taking my question. First of all, I'd like to congratulate Jim. It's been a pleasure working with you. I appreciate all the assistance you've provided over the years in helping us better understand Graham, so we wish you well in your retirement.

Thank you very much, John. I enjoyed working with you, and everyone else that was on the call and other investors over the years.

Good. Oh, good luck. And my, I just have two questions. One, regarding the margins, what was the liquidated damages amount that you highlighted?

Sure. John, I can't disclose that, but what I will say is it did, it did have a, it certainly wasn't an enormous percentage of the, of the impact, but it did have an impact, a noticeable percentage of the impact on the quarter.

Can you frame it somewhat for us? Yeah, it's a few hundred basis points. A few hundred basis points impact on gross margin?

Yeah, yeah, a couple hundred. Let me clarify. A couple hundred basis points on gross margin and obviously on EBIT or EBITDA margins also. Okay, that's helpful.

And I'd like to welcome Dan. My question to you, Dan, is perhaps I would guess you have an employment agreement. And I would be curious, hopefully a large percentage of your comp is incentive-based. And I'd be curious how that's structured. I presume it might be disclosed in an 8K, or we're certainly going to see it when the proxy comes out. But I'd be curious as to what's your incentive compensation is tied to specifically?

John, this is Jeff. I'm going to jump in for one second and then let Dan jump in. The 8K on the employment agreement will be filed over the next couple of days. It does not delineate the specifics of Dan's variable comp. It does talk a little bit about it, but it does not very delineate the specifics. But I can assure you that his variable component is is a very large percentage of his total compensation. And I'll let Dan jump in and talk about what areas he is focused on to meet those goals.

Yeah, the conversation I had with the comp committee really pushed towards less fixed and more variable. I am a person that is long-term driven, and I wanted to make this statement that I'm invested in this long-term, and so I think you'll see that my compensation tends to head in that direction. Coming from a private company, I am really driven by planning and building the organization to execute the plan. And so a chunk of my compensation will be tied to my ability to get a strategic plan in place for the board that meets their expectations. Another piece as a private company leader has been that I don't have experience with investor relations and a lot of this quarterly earnings call and investor conferences and all of that. And so, again, one of my areas of learning and need to help Graham going forward is absolutely in this investor relations piece. I've got several different things that I'm doing there to get up to speed quickly so I can be a more effective leader there.

John, one last piece from me. This is Jeff again. Across our long-term incentive program, while half of it are time-vested shares, the other half are performance-vested, and the performance-vested now all going forward, not just for Dan but for all the executives are completely tied to relative total shareholder return. So we think it's important, and Dan is very strong on this. He and I have spoken about it a couple of times, that we want to align our interests with the interests of the shareholders, and the long-term incentives are tied that way. The shorter-term incentives are more focused on the next one- or two-year performance, but ultimately all of our focus is on – total shareholder return. And quite frankly, Dan, when Graham bought Barbara Nichols, took a meaningful portion of his proceeds from the sale in Graham stock. And so he is absolutely tied into the return of the shareholders.

Okay, great. And in terms of those short-term metrics, I mean, is it growth-driven? Is it EBITDA-driven? What are the key metrics there?

Sure. Historically, and I think if you look at our proxy from last year, that would probably be a good gauge. There typically are three components. There's a component which is related to in-year financial performance. Last year, that was 40%, and this year it's also 40% of the short-term incentive. Another 40% is related to our bookings, so critically important. That, while it has a little bit of an impact on this year, more importantly, it has an impact on next year and the years beyond. And then the last 20% are based on the personal goals, and Dan talked to you about a couple of his personal goals going forward. Right.

Okay. Good. Thanks very much.

Thanks, John.

Thanks, John. Thank you all for your questions and your interest in Graham Corporation. We'll look forward to updating you again in late October.

Thank you. This concludes today's conference. You may disconnect your lines at this time, and we thank you for your participation.