Graham Corporation

Greetings and welcome to the Graham Corporation fourth quarter 2023 financial results conference call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Deborah Pawlowski, Investor Relations for Graham Corporation. Thank you. You may begin.

Thank you, Christine. And good morning, everyone. We certainly appreciate your time today and your interest in Graham Corporation. Here with me on the call are Dan Thorne, our President and CEO, and Chris Thome, our Chief Financial Officer. You should have a copy of the fourth quarter fiscal 23 financial results, which we released earlier this morning. And if not, you can access the release on our website at ir.gramcorp.com. You will also find on our website the slides that will accompany our conversation today. Dan and Chris are going to provide their formal remarks, after which we open the line for questions. But if you will turn to slide two in the deck, I'll review the Safe Harbor Statement. You should be aware that we may make some forward-looking statements during the formal discussion as well as during the Q&A session. These statements apply to future events that are subject to risks and uncertainties as well as other factors that could cause actual results to differ materially from what is stated here today. These risks and uncertainties and other factors are provided in the earnings release as well as with other documents filed by the company with Securities and Exchange Commission. You can find those documents on our website or at sec.gov. During today's call, we will also discuss some non-GAAP financial measures. We believe these will be useful in evaluating our performance. However, you should not consider the presentation of this additional information in isolation or the substitute for results prepared in accordance with GAAP. We have provided reconciliation of non-GAAP measures with comparable GAAP measures in the tables that accompany today's releases and slides. We also use key performance indicators to help gauge the progress and performance of the company. These key performance metrics are orders, backlog, and book-to-bill. They are operational measures, and the company's methodology for calculating these numbers does not meet the definition of a non-gap measure, as that term is defined by the SEC. So a quantitative reconciliation of each of these is not required or provided. But you can find the disclaimer regarding our use of key performance metrics at the back of our deck in the supplemental slides. So with that, please advance to slide three, and I'll turn the call over to Dan to begin.

Thank you, Debbie. Good morning, everyone. We made excellent progress with our strategy in fiscal 2023. We stabilized our vacuum and heat transfer technology business in Batavia, expanded our turbo machinery operations in Denver, and further diversified our revenue with more defense, space, and new energy business. We had record revenue of $157 million for the year, a 28% increase over the prior year. This included about $8.9 million of acquired revenue. Importantly, our revenue growth reflected the success we have had with diversifying our markets. Defense was 42% of total revenue, and our refining and petrochem markets combined were 31% of revenue. Space grew to 13% of revenue for the year, and our other market category, driven by new energy, was 14% of sales. We are excited about the many opportunities we see in new energy. The hydrogen market is developing quickly, and we provide both thermal machinery, and heat transfer equipment for these applications. Another interesting market is lithium extraction from geothermal brine. We have historically provided surface condensers for geothermal power plants, but the added value of lithium extraction to the process is driving more investment into geothermal projects. We ended the year on a strong note with orders of $50.8 million in the fourth quarter and a record $202.7 million of orders for the year. Fourth quarter orders included the $23 million follow-on to provide power hardware for the Mark 48 torpedo. Booked a bill for the quarter and the year was quite healthy at 1.2 and 1.3x respectively. We continue to strengthen our operations, improve productivity, and deliver better gross margins. A better mix of business also helped. Gross margin was 16.2% for the year compared to just 7.4% last year due to the impact of cost and labor overruns on our US Navy programs. As we complete the remaining two first articles from orders received several years ago, and as we have more revenue from better price contracts, we expect margins to further expand. We aren't stopping there, though, as there is still much more work to be done to drive operational excellence, which I'll discuss after Chris presents our financials. One other topic I would like to address is related to a large space customer that filed for bankruptcy during the quarter. It was a disappointment, to say the least. This had a net impact of about $2.5 million on our results, or approximately 19 cents per diluted share. I was very pleased at the outcome for the year, as we were able to achieve our adjusted EBITDA guidance provided at the beginning of the year, despite this event, and it exceeded our raised revenue guidance. With that, let me turn it to Chris to go into greater detail on the results. Chris.

Thank you, Dan, and good morning, everyone. If you turn to slide four, you can see that we had strong organic sales growth for our fourth quarter fiscal 2023, with record sales of 43 million. This was up roughly 8% over the prior year period, as well as the trailing third quarter. Our space market led the way with 6.9 million in revenue, which was up $4.6 million year over year. This 200% increase was due to growing demand from several key industry customers, some which have multiple programs with us in this expanding market. Aftermarket sales to the refining and petrochemical markets increased 45% to $7.1 million, or 17% of total revenue. Although aftermarket was up, Refining sales were down 4.2 million. This reflects both lower capital projects in this market as well as tough comparables due to timing as last year's fourth quarter had the benefit of a major project in India. We continue to be encouraged regarding the opportunities in the refining market given the continued strength in aftermarket demand and the activity with our customers. While defense sales were flat year over year, they were still very strong and represented 44% of our quarterly revenue. And at $18.9 million was the second highest quarter for fiscal 2023. For the quarter, sales in the U.S. were up 9% and represented 83% of our sales. International sales accounted for 17% of total sales and were 5% higher than last year. Gross profit and margin improved measurably over last year, given our much improved execution on our U.S. Navy projects related to our vacuum and heat transfer business in Batavia. We also benefited from higher volume and pricing, as well as improved mix with strong space and aftermarket sales. This more than offset the 800,000 net impact to gross profit related to reserves for one of our space customers bankruptcy that Dan discussed. Selling general and administrative expenses in the fourth quarter of fiscal 2023 were 7.5 million, up 1.4 million over the prior year. The increase was the result of 1.7 million in reserves related to our space customer net of the associated performance-based compensation. Excluding the impact of this bankruptcy, SG&A improved to 13.7% of revenue, compared with 15.4% in the fourth quarter of fiscal 2022, and reflects our improved fiscal discipline and cost containment measures. If you will turn to slide five, you can see we had a net loss in the quarter of $0.05 per diluted share, or $481,000. On a non-GAAP basis, which adjusts for amortization of intangibles, adjusted diluted net income and net income per share were breakeven. The net impact related to our space customer had an approximate $0.19 per share impact on diluted earnings per share in the quarter and was not added back in the computation of our adjusted amount. Adjusted EBITDA was $1.2 million for the quarter, which was 200% higher than last year's fourth quarter of $400,000. I will remind you that last year's fourth quarter was impacted by higher costs associated with the investments we made to ensure we could meet our commitments for our strategic U.S. Navy programs, which is now paying dividends. Turning to slide six, I will now touch on our full-year results. As Dan mentioned, fiscal 2023 sales grew by 28% to a record 157.1 million with all markets and regions showing growth. We are extremely happy with this result as it was above the high end of our guidance that was raised last quarter. Sales to the space industry increased 269% or 15.4 million to 21.2 million. and represented 13% of total revenue. Additionally, aftermarket sales to the refining and petrochemical markets increased 26% to $24.9 million. Sales in the U.S. increased 30% to $127.5 million and were 81% of total sales for fiscal 2023. Given our shift over the last couple of years to become much more of a defense business, our geographic mix of revenue is now more heavily weighted in the U.S. International sales were also up, increasing 18% to 29.6 million. Year over year, gross margin improved 880 basis points to 16.2%. This reflects an improved mix of sales related to higher margin projects, such as commercial space and aftermarket, and improved execution and pricing on our defense contracts. These increases were partially offset by the 0.8 million net impact related to our space customer. Gross profit in fiscal 2022 included an estimated 10 million impact related to labor and material cost overruns for First Article US Navy projects. In fiscal 2023, We completed four First Article U.S. Navy projects, which were the source of these losses, and remain on schedule to complete our remaining two First Article projects by the end of the second quarter of fiscal 2024. SG&A expenses in the full year of fiscal 2023 were $24.2 million, including intangible amortization of $1.1 million, an increase of $2.9 million, or 13%. The increase reflects the $1.7 million net impact related to our space customer and $1.4 million incremental SG&A expense from the acquisition given the two additional months of Barbara Nichols operations in our current year results. Offsetting these increases were improved financial discipline as well as cost containment measures such as the reduction of outsized sales agents and delayed hiring of non-critical positions. as well as the elimination of 0.6 million in acquisition and integration costs incurred last year. Gap net income and net income per diluted share were 0.4 million and 3 cents, respectively. On a non-GAAP basis, adjusted net income and adjusted diluted net income per share were 2.5 million and 24 cents, respectively. Turning to slide seven, you can see how we are improving our balance sheet through improved profitability and fiscal discipline, all while to leveraging and investing for the future. Cash and cash equivalents on March 31st, 23 were 18.3 million, up 1 million compared with the end of the third quarter, and up 3.6 million from the end of fiscal 2022. Cash generated from operations in the fourth quarter was 5 million, and 13.9 million for the year. I should point out that cash flows for the year reflect the impact of 13 million of customer deposits received from materials related to larger defense contracts. Going forward, we expect our cash flow to be lumpy due to the nature of these large contracts. Capital expenditures for the fourth quarter of fiscal 2023 were 1.4 million and were 3.7 million for the year. or 2.4% of sales. This elevated level reflects our expansion and productivity improvement initiatives, which will support our organic growth opportunities. This strong cash generation allowed us to reduce our debt by $6.6 million during the year, and our leverage ratio, as calculated in accordance with the terms of our credit facility, was 2.1 times at year end. At March 31st, 2023, the amount available under our revolving credit facility was approximately 10 million, providing us ample liquidity to support our strategic investments. If you will now turn to slide eight, I'll review our orders for the quarter and the year. We had orders of 40 point, sorry, We had orders of $50.8 million in the quarter, which were up $27.2 million, or 115%, and included the previously announced $23 million follow-on order for the MK48 Mod 7 heavyweight torpedo, and a $5 million order for a vacuum system for geothermal and lithium power production. Aftermarket orders for the refining and petrochemical markets were $11.5 million in the fiscal quarter, 2023 fourth quarter, an increase of 37%. The aftermarket business tends to be a leading indicator of future capital investments by customers in these markets. For the year, orders reached a new record of 202.7 million, driven by our defense business that was up 53.5 million to 116.7 million. This represented 58% of total orders for the year. We believe these record orders validates the investments we made, our customers' confidence in our execution, and the success we are having in winning new business across our diversified markets. This is not to discount demand growth in our other markets, including space and new energy, as well as aftermarket demand in our refining and petrochemical markets, which we are also excited about. Aftermarket orders were up 34% for the year to $40.6 million. If you turn to slide 9, we show our backlog, which, given the heavy weighting now to defense, provides us with strong visibility. Backlog at fiscal year end was up 18% to $301.7 million, compared with the end of fiscal 2022. I should point out that there are no orders in backlog related to the space customer who filed for bankruptcy. Approximately 50 to 55% of orders currently in backlog are expected to convert to sales in fiscal 2024, giving us strong confidence in our ability to deliver on a revenue and margin guidance. Approximately 25% to 30% of backlog is expected to convert to sales in fiscal 2025. and primarily relate to the defense industry. Turning to slide 10, we can review our guidance for fiscal 2024. We believe revenue will be between 165 to 175 million, which suggests top-line growth over fiscal 2023 of about 8% at the midpoint of that range. This is right in line with our long-term strategy to grow revenue 8% to 10% per year. These expectations, as well as the results for fiscal 2023, allow us to raise our fiscal 2027 revenue goal, which is now expected to exceed $200 million, the target just set a year ago. From an adjusted EBITDA perspective, we expect $10.5 million to $12.5 million for next year. which suggests an adjusted EBITDA margin of about 6% to 7%. I should point out that these adjusted measures exclude approximately $2 million to $3 million related to the Barbara Nichols acquisition earn-out bonus, as well as $0.5 million to $1 million of planned ERP implementation costs for our vacuum system and heat transfer operations in Batavia. We will still be impacted in the year by the first article in lower margin projects, that we entered into several years ago. As those roll out and we start to work on our better price contracts, employing our improved processes, we expect margins to expand more meaningfully in fiscal 2025 and beyond to achieve our low to mid-teen adjusted EBITDA margin goal. With that, I will pass the call back to Dan.

Thank you, Chris. Let's turn to slide 11. We continue to evolve our strategy as we advance the organization through steady growth and stronger profitability. Our vision is to build an exceptional company that provides mission critical high compliance products to diverse markets. We believe we can succeed with our highly skilled workforce that is fully engaged because of our open culture that challenges each of us to do our best and aligned with our customers' engineering expertise, responsive service, and timely deliveries. Our focus is on serving markets where our technology is critical to the success of our customers' process or application. This is how we have succeeded over time with our vacuum and heat transfer technology, as well as our turbo machinery equipment. Think about the critical nature of our vacuum system on a refinery's distillation column. If it doesn't work, the output of the refinery is severely compromised. Similarly, failure of a torpedo propulsion system in an ocean conflict could be catastrophic. Space communication satellites quit working if our thermal management pumps fail. Our engineering expertise in vacuum heat transfer and turbo machinery and our high compliance processes developed to create and qualify these solutions are key to our technology differentiation. A second pillar of our strategy is operational excellence. We have many initiatives to continually improve the processes we employ in our operations. We have been consistently upgrading information systems in our turbo machinery operation and will initiate a long overdue ERP system upgrade for a vacuum system heat transfer operation. We are making more investments in equipment like automated welding that eliminates rework and provides quick payback. Finally, expanding our shared services to gain economic advantage will continue. A third pillar is our people. Our people are our most valuable asset, and we are committed to grow and develop them to maintain a competitive advantage. We have had good success using engagement surveys to identify gaps in engagement. We then follow through with initiatives such as improved instruction, tools, communication, development programs, and other resources to fill the identified gaps. Leadership development is actually quite advanced for a company of our size, and we have expanded skilled trades training through in-house weld schools, partnerships with community and academic resources, and initiating a machinist apprenticeship program. Finally, we will leverage our external stakeholders, including our communities, our suppliers, our lenders, and our shareholders to be a better business. This means strengthened relationships, improved communications, and finding win-win solutions. We are making steady progress against our plan, and we're quite excited about the opportunities in front of us and encouraged with our stakeholders' support of our journey of building better companies. With that, Christine, we can open the call for questions.

Thank you. We will now be conducting a question-and-answer session. If you would like to ask a question, please press star 1 on your telephone keypad. 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. Thank you. Our first question comes from the line of Theodore O'Neill with Litchfield Hills Research. Please proceed with your question.

Thank you, and congratulations on a good quarter.

Thanks, Leo.

You've got some remarkable growth in orders here, and I was wondering if you could give us a little more insight into your success there. Is that new products? Is it taking market share from others? Was this business just there all along and you just started asking for it?

I think it starts with performance. As our businesses can really perform for our customers, they're rewarding us with additional orders. I think both companies have an established relationship with lots of customers, and those customers continue to come back as we perform. It just really points out the importance of the actions that we made a year, year and a half ago to invest in our businesses, to bleed a little bit to make sure that our customers were satisfied. And ultimately, they're coming back to us. We are seeing some expansion in certain areas. But honestly, I'd say it's mostly that our customers are saying, thank you for really helping us out, and here's more work to continue to help us out. I'll expand that answer just a little bit, Theo, and give you a sense. A year and a half ago, two years ago, a year and a half ago, supply chain was a challenge, and everything was really hard to get. And we attempted to go through heroic efforts again to help our customers get the equipment that they needed in that process. The supply chain has improved some, but we are still seeing challenges in pocket areas. And in particular where we're seeing challenges is in some of this high compliance related stuff. Lead times are still relatively long for raw material and simpler components. What we see is that whenever we're asking for something that's special above and beyond, has high compliance, high testing requirements, et cetera, the supply chain is struggling with that. And it just goes to show that if you can perform at a high level and provide some really high-level service, high-level equipment that is checked out extremely well before supplying to the customer so they don't have problems once it's delivered to them, That scene is very valuable, and so I really like our niche of this mission-critical high-compliance equipment, and I think the world is struggling there. So I think our customers are starting to see how valuable that can be.

So you're saying that the high-compliance products that you're providing your customers is a differentiator compared to other suppliers?

Absolutely.

Okay. I wanted to ask about Virgin Orbit. I just did some quick look up online during the call here. It doesn't look like that's coming back. Is that correct?

That is correct. They filed for Chapter 11. But in the Chapter 11 process, they did not find a going concerned bidder. So they kind of transitioned to let's... essentially get rid of the assets and lots, and so they've liquidated the majority of their assets at this point in time, and they don't appear to be coming back. Probably the good news is that some of the other launch market customers were interested in some of their assets, so they had bidders for their buildings their inventory, et cetera. It's not wrapped up at this point in time. It's still an ongoing bankruptcy process. But, yeah, they were able to sell assets to other space companies.

Okay. Thanks very much.

Our next question comes from the line of Dick Ryan with Oak Ridge Financial. Please proceed with your question.

Thank you and also congrats on the good performance and guidance for the current year, Dan and Chris. The question on the guidance, you know, in the slide deck it shows virtually all the revenue you're guiding to is already covered by what's in backlog and expected to be delivered. You know, you have this vulnerability with space customer that doesn't appear to be included in that. Any other vulnerable areas within your backlog? And maybe the contrary or the complementary question there would be what could happen on the turn side of the business so that, you know, somebody could look at this and say, hey, there's upside to what you're currently guided.

Yeah, Dick, you know, very good observation on your part. You know, like other companies, you know, we're still seeing pressures as Dan just talked about a little bit on the supply chain side, as well as the labor side. Although we have seen these conditions improve, they're still not where they were, you know, where we were pre-COVID. So really, you know, as you point out, we have the backlog. It just comes down to execution. So it really just comes to our team continuing to perform well. and risks outside our control, such as supply chain and labor.

Okay. Of course, as a follow-on, looking at the year, you've got some delivery on the remaining two first articles during Q1 and Q2, but how should we look at the top line? How should the revenue line... flow as we look at fiscal 24. Any other seasonality or as you look at projects, how should we kind of model the revenue growth for 24?

Sure. As you know, Dick, we really don't have a lot of seasonality in our business. Our fourth quarter does at times tend to be a little bit higher as our teams are working to hit the goals for the year. So, we don't see a lot of seasonality built into our guidance.

Okay. Say, Dan, on the aftermarket and the refining and petrochem side, you know, your large install base, you know, kind of drives that aftermarket business, but you indicate or you said that that could be a leading indicator down the road. What does new projects in the refining and petrochem space look like, either domestically or, you know, you've had some interest in expansion in China and India?

Yeah, so... Domestically, it is picking up. We are seeing inquiry rates and opportunities domestically continue to grow. So it has been just horribly slow coming back domestically, but we're certainly seeing that coming back. As you noted earlier, we've We've kind of got our year already booked, and Chris indicated that it's all up to us to execute it. So if it doesn't come back as strongly as our pipeline has indicated, we've got plenty of work domestically for our crew here. What we're seeing internationally is China has opened up after their COVID shutdown, but it's a slow reopening. So we are seeing an increased level of requests to quotes on different programs. And we are quoting on those. How fast it comes back, not entirely clear. But as it comes back, we'll start to see more orders in the second half of the year that then start to build into our fiscal 2025. NDF. We've got several different bids that are out there that are close to being announced. And so we're hopeful that we can continue our India presence. And then India looks like it kind of flattens out for a year or maybe two as they go through their election process. And then we fully expect that it kind of comes back on. So It's really interesting to kind of follow all of these different markets. They're all in kind of different places. And so the ability to be flexible and be able to move with the market is something that the diversification that Graham has has really been able to build over the last two years provides a ton of value. So we're able to kind of move from one market to the other, you know, use our backlog to fill holes and provide a lot more stability. And so we're, you know, we're in a much better place than we have been in prior years. You know, Dick, you followed us for a long time and you watched the cycles. And so we're in a much better place.

Sure. Thanks for that. one the last one on capital allocation you know when you look back Graham had a nominal dividend that was you know eliminated during the tough couple of years you had now that you're back in compliance does the dividend come back up in a discussion format at the board level or how should we look at you know your capital allocation priorities over the next few years yeah Dick you know as Dan and I laid out

last year when we released our long-term strategic plan. Our capital allocation starts with organic growth, right? We feel we have an abundance of capital organic growth opportunities to take advantage of. From there, if we have excess capital, we'll use it to pay down debt. And then hopefully within the next few years, we can start looking at M&A again. And then after that, we would look to returning that back to shareholders. So we're comfortable with the capital allocation strategy that we have.

Okay, great. Again, great job on the execution, guys.

Thanks. Thank you, Dick.

As a reminder, if you would like to ask a question, press star 1 on your telephone keypad. Our next question comes from the line of Brett Carney with Gabelli. Please proceed with your question.

Hi, guys. Good morning, and congrats on the continued momentum. Hey, thanks, Brett. Good morning, Brett. And, Dan, absolutely agree with your assessment of, you know, the landscape in, you know, U.S., I guess, potentially even global manufacturing, the ability for differentiation through reliability and performance. I guess, can you talk about the opportunities you're seeing, some of the investments you're making, the ERP system? You noted some digital and automated tools to kind of cement I guess that vision for differentiation you see across the platforms?

Yeah, let me hit it generally, and then I'll give you some specific examples. This continual improvement, continual investment in our business is, in our minds, extremely important. It's kind of like compounding and investing. When we're investing capital continually and wisely in our business, it becomes incrementally stronger, kind of like your bank account does as you continue to put money in there and compound. So we love the notion of continuing to invest in ourselves and building a better company in the process. If we don't, it's, you know, this... There's an engineering term called entropy that basically means everything starts to come apart. So your processes drift, you don't have as well-trained employees, and ultimately you have lower performance. In investing, inflation is that entropy. If you're not continuing to invest, the value of your investment starts to become less. So, you know, they kind of go hand in hand, which is really kind of interesting. So we are continuing to invest in our businesses. Just last year, we put some significant money into Barbara Nichols to expand their capacity to support the Mark 48 program. And And that facility, our GM, Matt Malone, in Denver has told me that that facility is within a week of going live. The Navy is excited about it. Our customer, our direct customer, SAIC, is really excited about it. And, you know, essentially that kind of foresight of, you know, investing in that facility is going to serve the Navy well as geopolitical tensions continue to rise. And we've all read more and more about that. So that was one investment that we've made. Another one is on this automated welding equipment. And as we've got more and more manufacturing expertise within Graham to review our processes and review our product and kind of look at areas to expand, we've identified in these really tough welds that are hard for a person to actually follow a very complex weld path and be very, very consistent, we think that the automated welding equipment will enable us to have less defects, it'll go faster, ultimately better quality in these really challenging welds. And so this investment where it makes the most sense, where you can get good payback by investing in equipment like that is extremely important. The ERP upgrade that you had asked about, you know, In any business, especially a manufacturing business, the flow in the business is extremely important. And if there's lots of handoffs between people, there's lots of opportunities for confusion or mistakes or whatever. And as we can automate this more and more, and be working with the same information throughout the value-add process, the quicker it goes and the less mistakes there are. And so we're really excited about being able to upgrade the ERP system in Batavia. We think that it's going to have a significant improvement on the flow of product through our through our factory as well as reduce some of the mistakes or process reworks essentially that we have seen. So that whole information realm is getting tougher and tougher as our customers are wanting high compliance equipment and they want the proof to back it up, that it is high compliance. And so there's a ton of information that goes along with our hardware. And making it available and trackable and findable and communicable within a digital platform is really important. And so we continue to think about people and process and systems and investments in those. You know, then we've got our business unit saying, and product, don't forget about the product because we have some really cool opportunities. And so, you know, to Chris's point, there are a ton of, you know, organic growth opportunities in front of us that we believe that we can give stockholders a really nice return on investment as we allocate that capital appropriately. Okay.

Excellent. And actually, the follow-up I had was on this new opportunity, or I guess expanded opportunity you guys are seeing with the geothermal lithium. Curious, you know, what the potential funnel or kind of magnitude of market opportunity you guys are seeing there. And then I guess broadly with all the developments in new energy and potentially the traditional energy markets coming back, Yeah, I guess how you're thinking about resources, prioritization, both capacity and personnel across the organization.

Yeah, it's a great question. You know, as you show the world that you're more and more capable, people want more out of you. And it does come down to prioritization and choosing the best programs to go after. the ones that have strategic importance, the ones that you can price higher for the benefit of higher returns for our shareholders. Those are the ones that we're kind of focusing on right now. Again, you kind of point out some really cool opportunities that hydrogen You know, the geothermal power has been around for a long, long time, but coupling it with this lithium extraction all of a sudden makes that a lot better for investors in those processes because there's additional yield other than the power that comes out of that process. So, you know, being able to be flexible, work with your customers to develop new equipment, that's better suited for these new applications that come out, including hydrogen, are, you know, ultimately what we are trying to do as a business is make sure that we have that really strong capability, the ability to work with our customers to develop new product, modify existing product, and follow them into some of these awesome opportunities. So it's lot of opportunity, and it comes down to prioritization and picking the right opportunities that benefit us long-term, i.e. strategic, as well as the highly profitable ones that benefit our stockholders.

And, Fred, just to address your comment about resources, right, we really have, you know, a top-notch human resources function within Graham at both our Arvada and our Batavia locations. Since last year we increased our total workforce by 10% and we increased our welding workforce by 25%. All that in a very difficult market. So we're going to continue to look for different ways to improve such as our welder training program. And, you know, some of the other apprenticeship programs that we have in place and working with our local community colleges and trade schools. And, you know, we're really excited about some of the opportunities that we have in front of us. And that's going to allow us to achieve this growth.

Excellent. Thanks so much, Chris and Dan.

Thanks, Brett.

Our next question comes from the line of Bill Baldwin with Baldwin Anthony Securities. Please proceed with your question.

Thank you very much. I've got a couple of areas here I'd like to focus on if I could, Dan and Chris. On the aftermarket business, primarily almost entirely a domestic business for Graham in the refining and petrochemical area? Yes. And is that heavily weighted towards the refining side? Would that comprise the majority of the aftermarket beyond petroleum refining?

And petrochemical, yes.

So how would that break out between petrochemicals and petroleum refinery, roughly? Just half and half?

It's going to be heavier towards the refinery, Bill. You're exactly right. I don't know that we have that breakdown between the two.

Well, I'm just trying to get a feel for how the business breaks out. Is most of your inquiries as far as aftermarket business going forward, is that primarily weighted to petroleum refineries? Is that where the heavy inquiries are and where you would expect the heavier capital projects to eventually unfold would be on the refinery side?

Yeah, you know, historically, the majority of our equipment has been on the refinery side, and we would expect that the aftermarket inquiry follows that because that's the source, the installed base is the source.

Right, right.

Yeah, absolutely.

With your very strong order picture there in aftermarket, how are you performing on the execution side, would you say, Dan and Chris, or? Are you pretty much on time with your deliveries and so forth on that, or is that a – here again, is raw material and labor shortages impacting the ability to handle that business as efficiently as you'd like to?

Yeah, you hit the nail right on the head, Bill. Our on-time delivery isn't where we'd like it to be. because of the labor and the long lead times. However, we're firing on all cylinders with regards to aftermarket. In the current quarter, we had 7.1 million of aftermarket sales, which is a record for us. So the team continues to execute and is just really firing on all cylinders right now. And we're looking forward to what they can do once maybe some of these external forces free up and we get some of these process improvement and productivity initiatives in place.

So you think, compared to your competition, though, would you say that you're definitely competitive and you're likely not to lose any potential business going forward because of these issues on delivery right now?

Yeah, I think everybody's struggling in some areas with supply chain. And so, you know, some of the forgings that... A lot of the forging houses are struggling quite a bit right now. You end up kind of seeing some weirdness around some of the specialty materials like baskets, you know, for instance. And so... specialty fastener companies are struggling quite a bit. They end up being high tolerance, high, in some cases, high strength, high compliance types of components, and people are struggling with those. And so it's kind of weird, Bill. We see raw material, the pricing being a whole lot more stable, a little bit longer, in lead times, but then you get into components that we're trying to buy, and every once in a while you just run into something and it's like, okay, can't buy that and can't get that in-house for six months, and people's inventory is not built up very well yet, and so we're still running into challenges in supply chain and deliveries.

But as you know, Bill, none of these challenges are unique to us. It's everyone that's experienced it.

Right, right, right. Regarding the lumpiness of your cash flow, it looked like your unbilled revenues were pretty large. As you collect on those revenues, won't that offset quite a bit your customer deposit situation? I mean, customer deposits were a big source of revenues, but unbilled revenues were kind of a drain on you.

Yeah, absolutely. So does that kind of balance out over time in terms of your cash flow? We think we have some upside on the unbilled levels, as you astutely pointed out. You know, that's been one of the areas of focus of mine as well as the team, you know, ever since I started. And, you know, we think that's going to start to free up over the course of this year and will definitely be a positive cash generator for us. As far as our cash flows, though, given the size of these contracts and these customer deposits and the changes in the unbilled revenue, we do expect our cash flows to be very lumpy. But over time, I think if you take a look at our EBITDA levels, that's more reflective of the cash that we're generating. It just is very lumpy in nature. Over time, we'll be improving and increasing.

And lastly, can you wrap any potential numbers around the earn-out liability post-2024? Sure. Is there a cap on that? I know you announced something on that quite a while back. It's all publicly released, so we can certainly talk about it.

I couldn't locate it. No, that's okay. Yeah, no problem. Let me walk you through it. So it's a three-year program starting in our fiscal 24 year. so fiscal 24, 25, 26. The threshold level is $2 million and up to a max of $4 million each year. So over the three-year period, a max of $6 to $12 million in potential additional payouts in addition to the normal employee bonuses. And this was all negotiated in shortly after the acquisition and it's all related. Right.

I remember that. I remember that.

I just couldn't find the details. There's a growing EBITDA target. So for fiscal 2024, the target is $8.75 million. And then that goes up to $9.5 million for fiscal 2025 and $10.5 million for fiscal 2026. So even though it is going to be a higher expense, we're going to see a higher EBITDA level that goes along with it. So it's all performance-based.

Okay. That's what I was looking for. Well, you fellows and your team are doing a heck of a job at building a company here. So congratulations and best of success.

Thank you, Bill.

Thanks, Bill.

Our next question comes from the line of Gary Schwab with Valley Forge Capital Management. Please proceed with your question.

Yeah. Hi, Dan, Chris. Great job, like everybody has said. A question about the lithium on the direct lithium extraction. There's a number of companies that are involved with this. Are you talking with any other companies in the U.S. or overseas? Yes.

So in general, I would say that we talk to a lot of different companies that need surface condensers for their power cycles. So yeah, we do end up talking to quite a few of those folks. The Salton Sea application is unique. It's really kind of exciting. So this is the first one that we're providing equipment for. And when it's successful, I know that our customer wants to repeat it, and they've talked about that in the press. So I think that there's this ongoing opportunity to continue to support that. Again, geothermal power is a low-margin endeavor. It is tough to make money in geothermal power instead. coupling this lithium extraction with that process is really kind of nice from an economic perspective, but the process itself is a lot cleaner and more efficient than the standard, you know, put it all out into a lake bed and start to evaporate water. So it's pretty cool, and it's fun to be connected with that for a lot of different reasons.

Okay. You mentioned hydrogen, I think, three times in the presentation, but you really didn't expand on that. What kind of projects are you working on in hydrogen?

So hydrogen, as you know, can be pretty challenging. First of all, it's cold. in its liquid form. Then from a material perspective, there's a limited types of material that you can use in hydrogen. It ends up being some pretty specialty equipment that is used in hydrogen operations. Barbara Nichols is a turbo machinery house. And they have built cryogenic pumps for, gosh, over 40 years. And so Barbara Nichols has been involved in providing cryogenic pumps, liquid, argon, hydrogen, helium, all types of stuff. And with the major air products, players have supplied turbo machinery to those major air products types of players. So we see opportunities from them, and I can't name anything specific, but we see opportunities with them to provide turbo machinery. And then Graham has some unique heat exchange capability with their Heliflow heat exchanger that can handle some really extreme temperature ranges, and it's very applicable to hydrogen service. Again, we have been supplying these heat exchangers to various companies that are involved in the production, the transportation, the distribution, the fueling side of the hydrogen economy. And everybody's kind of working on their best solution to enabling the hydrogen economy. As you've seen, there's a lot of chatter in this market, and people are spending some big dollars to invest in it and develop the capability to support it. And so we're in there, and we're participating. It's still too early to say what will come out of it. But, again, a great place to be at this point in time.

Okay, great. Let me just ask a couple of bookkeeping questions. On the K, you said there remains approximately $1 to $2 million in potential additional exposure. We're talking about Virgin Orbit related to the space customer. Depending on the outcome of these proceedings and the asset sales, depending on the outcome of these proceedings and the asset sales, It says, however, at this time, the company does not expect any further impact in 24 or beyond. So does that mean that the $1 million to $2 million could be recaptured?

Yeah, I know it's a little bit confusing, Gary, so let me walk you through it. So during the quarter, we reserved $3.1 million for inventory and accounts receivable related to Virgin Orbit. That $3 million charge resulted in a $600,000 reduction in performance-based compensation since all our bonus programs are performance-based. So the net impact to the quarter and the year was $2.5 million. As you know, bankruptcy proceedings are complicated, and they take some time to work themselves out, you know. So we still have a little bit of exposure left on our balance sheet, which we feel very comfortable with what we reserve during the quarter. But again, these proceedings and us being able to capture value from what we have left on our balance sheet is uncertain. But we feel very comfortable with where we're reserved at at the end of the quarter and don't see any more impact for 2024. You know, never say never. So we wanted to at least put that qualifier out there.

Okay. So there's no recapture. You just don't expect any more reserve.

Yeah. So let's say the team is 100% focused on this. And, you know, if there is an ability to recapture, we're going to try to go after it and we're going to get it recaptured. But it's just too soon to tell. And, you know, we wanted to make sure that we were adequately reserved.

okay and then one last thing in the third quarter you know you were talking about your backlog and you said that of that backlog 40 to 50 percent should be converted in 12 months now this quarter you're saying that you want going from 40 to 50 percent to 50 to 55 percent what sped up the delivery schedule you know it's just the mix of um you know the contracts that we have out there as you recall in the third quarter

You know, we had some larger defense programs that we received, which we're not going to work on until, like, fiscal 24 through fiscal 26. So that extended it out a little bit. You know, but then in the current quarter, we received, you know, the Mark 48 modification. So that brought it back in a little bit. So those numbers typically won't shift too much over time, but, you know, but can vary a little bit. But typically we see around that 50% level that's going to convert. Okay.

Oh, and actually there is one other thing. They've been talking about the Artemis Moon program scheduled for 24 and then 25. Is Barbara Nichols involved in that in any way?

You stumped me on that one. I don't think so, but I don't know that for sure.

Okay. All right. Well, that's all I have. Thanks very much. Thanks, Gary.

We have no further questions at this time. I would like to turn the floor back over to management for closing comments.

Thank you. Thank you, everybody, for your time. I just want to reiterate the three key themes we hope you take away from our call. First, we are delivering on our promises. And while we have several years to achieve our fiscal 2027 goals, we are demonstrating our ability to get there. Second one is we have successfully diversified the business and have expanded our customer base. Even with the event, with our one space customer, we were able to absorb that and still deliver for the year. Third is we have a large opportunity set in front of us, and we have the strategy and team to continue to drive growth and improve profitability. I hope you all enjoy the rest of your day. Thank you very much.

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.