Graham Corporation

Greetings. Welcome to the Graham Corporation third quarter fiscal year 2024 financial results call. At this time, all participants are in a listen-only mode. The 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. Please note this conference is being recorded. I will now turn the conference over to Deborah Pulaski, Investor Relations for Graham Corporation. Thank you. You may begin.

Thank you, Daryl, and good morning, everyone. We certainly appreciate your time today and your interest in Graham Corporation. Here with me on the call are Dan Soren, our president and CEO, and Chris Thome, our chief financial officer. Dan and Chris are going to provide their formal remarks, after which we will open the line for questions. You should have a copy of the third quarter fiscal 2024 financial results that were released this morning. And if not, you can access the release on our website at ir.gramcorp.com. You'll also find there the slides that will accompany today's discussion. If you will turn to slide two on that deck, I will 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 as a substitute for results prepared in accordance with GAAP. We have provided reconciliations of non-GAAP measures with comparable GAAP measures in the tables that accompany today's release 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 ratios. They are operational measures, and the company's methodology for calculating these numbers does not meet the definition of a non-GAAP measure, as that term is defined by the SEC. So as a result, 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, if you would please advance to slide three, I will turn it over to Dan to begin. Dan?

Thanks, Debbie, and good morning, everyone. Reflecting on the past few years, we firmly believe that our business is now in a significantly improved position due to the strategic actions that we've taken. This has been a great team effort, and I would like to thank our customers, our employees, and our service providers for their contribution to our turnaround. In the third quarter, our performance demonstrated robust strength underscoring the consistent execution of our strategic approach aimed at cultivating high-quality, top-line growth along with margin-accretive initiatives to enhance our future earnings potential. Notable highlights from the quarter include gross and adjusted EBITDA margin expansion, a substantial increase in bookings that led to a record backlog of nearly $400 million, And we refinanced our debt with a lower cost and more flexible credit facility, further solidifying our financial framework. Our bottom line was muted, however, given some atypical expenses that Chris will talk to. But on an adjusted basis, net income was up over 180% to $2.4 million. We generated strong cash from operations during the quarter, given recent working capital initiatives along with stronger financial discipline. This enabled significant debt pay down during the quarter and strategic investments, both organic and inorganic. We highlight on slide four a significant investment made during the quarter, which was the acquisition of P3 Technologies. This was a great bolt-on business. which brings highly complimentary technology that enhances and expands our turbo machinery solutions engineering and development team. Their patented technologies deepen our reach into existing space and new energy markets and create greater diversification with the addition of medical markets. From a financial perspective, P3 brings about $6 million of annual revenue accretive gross and adjusted EBITDA margins, and approximately $6 million of backlog. They also have what we feel is a lot of high-growth pipeline opportunities that are highly complementary to our Barbara Nichols Turbo Machinery business. In fact, in the short period that they have been with us, that business has already proven instrumental in in fortifying some of our solution offerings and has amplified our financial profile, including being accretive to earnings in the third quarter. It is important to note that given this quarter's robust cash generation, we were able to repay nearly all of the debt associated with the acquisition during the third quarter. Together, we believe we have a bright future as we aim to create opportunities for product and technology integration to provide more effective solutions across multiple markets. As we look forward, we are focused on advancing Graham by building a collaborative culture across our brands, leveraging best practices, and advancing employee development to reinforce our core capabilities of precision machining, of critical turbo machinery components and specialty welding for fabrication of critical equipment for large heat transfer and vacuum applications. Our confidence remains high in our ability to consistently execute our strategy and leverage the multitude of opportunities before us. With that, let me turn it over to Chris for the financial details. Chris?

Thank you, Dan. And good morning, everyone. As Dan highlighted, our results for the quarter include approximately two months of operation from P3, which was acquired on November 9, 2023. On slide 5, you can see that we had a strong growth for our third quarter of fiscal 2024, with sales of $43.8 million. This was up 10% or $3.9 million over the prior year and included approximately $1 million of incremental sales from P3. Strong sales in the commercial aftermarket continued to help offset the cautious spending on capital projects in the refining and petrochemical industries. Aftermarket sales were $8.6 million in the quarter, up $3.2 million, or 59% over the third quarter of last year. Defense revenue was also solid, with an increase of $2.6 million, or 12%, reflecting higher price contracts as well as increased capacity in direct labor hours. We did see a decline in the space market, which had a lot to do with project timing, as we had strong order growth during the quarter that I will talk to in a few slides. We are still seeing the impact of the Virgin Orbit bankruptcy last year, but should finally cycle through that once we finish out fiscal 2024. P3 helped offset some of this decline, and we expect further lift from that acquisition within this industry mix, as well as a robust pipeline of other opportunities in the new energy, defense, and medical markets. US sales for the quarter were 84% of total revenue and continue to reflect the size and growth of our defense business. Looking to the chart on the right, Gross profit was another positive story with an increase of 3.5 million or 56% to 9.7 million in the third quarter. The 660 basis point expansion of gross margin reflected higher volume and the related improved absorption. Mix also played a role with higher margin commercial aftermarket sales as well as the margin accretive sales from P3. And lastly, we are benefiting from improved execution and pricing on defense contracts. Turning to slide six, you can see our bottom line and adjusted EBITDA results. As Dan mentioned, net income was impacted by a number of items this past quarter. SG&A excluding amortization was 8.4 million or 19% of sales, up from 13% of sales during last year's period. The increase reflects higher performance-based compensation, including a $1.3 million supplemental performance bonus for Barbara Nichols employees in connection with the 2021 acquisition. Also contributing to the increase in SG&A was P3 acquisition-related costs, increased professional fees largely related to our international operations, and initial ERP conversion costs. Separately, On the income statement, you will also see a line item for our costs associated with the debt extinguishment during the quarter, which amounted to $0.7 million. When excluding many of these atypical costs on a non-GAAP basis, adjusted net income was $2.4 million, or 22 cents per diluted share, up 183% from a year ago. Similarly, you can see the improvements in adjusted EBITDA. which grew 72% to $3.9 million, or 8.8% of sales, up 320 basis points. Turning to slide 7, you can see how a strong quarter of cash generation enabled us to further improve our balance sheet while still making strategic investments. At the beginning of the quarter, we refinanced all of our outstanding debt with a new five-year $50 million revolving credit facility that matures in 2028. This facility provides us with reduced borrowing costs and greater flexibility to fund our long-term strategic growth goals. Cash generated from operations in the third quarter was $7.6 million and $19.5 million for the year-to-date period of fiscal 2024. We utilize some of this cash to reduce our debt balance by $7.9 million to $3 million at quarter end. P3 was acquired with a combination of cash, stock, and contingent earn out based upon the future performance of P3. As Dan highlighted, most of the debt associated with the acquisition was paid off during the quarter. However, in January 2024, after the quarter ended, we paid off the remaining $3 million of debt, currently leaving us debt-free. Capital expenditures of $1.9 million in the quarter and $5.2 million year-to-date were focused on capacity expansion, productivity improvements, and the start of the ERP implementation at our Batavia facility. In total, we expect the ERP project to cost approximately $2 million in capital and $1 million in expense. with an anticipated go-live date of about a year from now. We decreased our expected fiscal 2024 capital expenditures to now be in the range of $8 million to $10 million, primarily due to the projected timing of cash flows. All projects continue to move forward at a steady and thoughtful pace. If you turn to slide 8, During the quarter, we had record orders of over $123 million, which were up six times over the prior year and resulted in a book-to-bill ratio of 2.8. These were largely follow-on orders for critical U.S. Navy programs, although aftermarket orders for the refining and petrochemical markets remained strong at $7.8 million. We also saw nice order flow from our space customers of 6.1 million, which was up 4.5 million year over year and doubled the sequential quarter and remains a key growth driver in our diversified portfolio. Turning to slide nine, you'll see that our backlog is nearly 400 million, also a record level, which provides several years of visibility given the long lead times of some of our defense contracts. The P3 acquisition added $6 million to our backlog. Approximately 40% of our backlog is expected to convert to sales in the next 12 months, and another 25% to 30% is expected to convert to sales over the next one to two years. The majority of our orders that convert beyond 12 months are for the defense industry, specifically the U.S. Navy. Turning to slide 10, we can review our guidance for fiscal 2024. Given our strong performance year to date and the addition of P3, we have raised our revenue expectations to be between $175 million and $185 million for fiscal 2024, up $5 million at the bottom and top end. This implies top line growth over fiscal 2023 of 15% at the midpoint of that range. From a margin perspective, our gross margin guidance is approximately 20%, up from the 18 to 19% we guided last quarter. Additionally, our expectations for SG&A, including amortization, to be between 16 to 17% of sales, up one percentage point over our previous guidance. This includes costs associated with the supplemental performance bonus for our Barbara Nichols employees the P3 acquisition costs, as well as ERP implementation expenses at our Batavia facility. We also raised our adjusted EBITDA guidance for fiscal 2024 to range between $15 to $16 million, up from our previous guidance of $11.5 to $13.5 million. The new range implies an adjusted EBITDA margin of about 9% at the midpoint. I should point out that our adjusted EBITDA guidance excludes the SG&A items I just mentioned and approximately $0.7 million of debt extinguishment charges. We are delivering continuous improvement and are on track to achieve our fiscal 2027 goals. We continue to expect 8 to 10% annualized organic growth per year, which implies $225 million to $240 million in revenue for fiscal 2027. And with margins improving steadily, we are on target to achieve our low to mid-teen adjusted EBITDA margin goal. With that, I will pass the call back to Dan.

Thanks, Chris. Significant strides are being made within our organization, yet there remains a lot of work to be done. Our team is devoted to the ongoing pursuit of our strategy for sustained growth and I am grateful for their unwavering dedication, enthusiasm, and diligent efforts. Our record backlog and the acquisition of P3 add up to a bright future for Graham. Numerous opportunities lie ahead, and we anticipate that these will play a pivotal role in propelling our growth and bolstering our future earnings. With that, Daryl, you 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 key. One moment, please, while we poll for your questions. Our first questions come from the line of Theodore O'Neill with Litchfield Hills Research. Please proceed with your questions.

Thank you, and congratulations on the good quarter. Dan, in your prepared remarks, you mentioned that there was a pipeline of high-growth opportunities that you got as part of P3 acquisition. I was wondering if you could give us some more detail on that.

Yeah, they're mostly on the space side. And I probably won't be able to give you a whole lot of detail there just because of NDAs. But P3 has been working in propulsion pumps, fluid management pumps for space applications. So they're actually an awesome complement to Barbara Nichols from that perspective. And it really probably deepens our... engagement with the space community. The other thing I get excited about P3 is they're also involved in some of the new energy waste heat power gen types of applications. And then they do cryogenic pumps, which really get into some of the medical applications that they're trying to apply those to. And then they've got some very cool IP and that we believe we haven't scratched the surface on that yet as far as how and when we would like to take that to market. But that's definitely something we're pretty excited about. And one of those is what they call a multi-channel diffuser, which is a efficiency enhancement that can be applied to basically any pump. pumping liquids, and so we're pretty excited about that. And then their cryogenic pump capability really complements, again, Barbara Nichols, that it's mostly centrifugal types of pumps, and P3 brings a positive displacement pump that complements that. So lots of really cool things, and Phil and his team are top-notch engineers, and we're really, really excited to have them.

Okay. And Chris, in the press release, you say that the improved working capital was largely due to changes in payment terms related to large defense customer. Can you give us any more detail on that, what that means?

Sure. So for the last couple years, the team has actively been working on putting in stronger discipline with regards to capital management you know, basic blocking and tackling, you know, collecting receivables sooner, pushing out payment terms where possible. And several of our large defense contracts had really unfavorable payment terms where basically once you got past 50% production, you couldn't bill anymore until project completion. Well, as you know, some of these projects can go on for several years. So that was really putting a cash restraint on our business. And over the past, I would say three to four quarters, we were able to renegotiate some of the payment terms where we're now billing more milestones and more on a percentage complete basis. So that really provided a significant uplift to the cash generation over the last couple quarters. Additionally, as you know, with the $123 million of orders that we had this quarter, and then a large amount of defense orders over the last year, a lot of those pay for the materials up front. So we've been able to collect that cash up front, but we'll have to pay for that inventory as it comes in. So as we've discussed in the past, we fully expect our cash generation from quarter to quarter to be pretty lumpy. But the team's done an excellent job really improving some of the payment terms and helping that cash flow along.

Okay. And given the growth that you're experiencing there, are there any potential CapEx expenditures that you'll need to make or have to make investments in skilled employees to keep up with it all?

Yeah, definitely. As you know, you know, we've guided for CapEx of 8% to 10%. million for this year, which is about 5% at the midpoint of the guidance. You know, when we think that, you know, our CapEx spend is going to be in the 3% to 5% range over the next several years just to support, you know, that growth and the facility expansion, you know, that you just mentioned. So, yeah, we certainly expect capital expenditures to remain elevated for a few years here.

Okay. Thanks very much.

Thank you. Our next questions come from the line of Dick Ryan with Oak Ridge Financial. Please proceed with your questions.

Thank you. Congratulations also on the great quarter, guys. Thanks, Dick. Chris, looking at the OPEX, your leverage gets a little obscured with all the puts and takes in this quarter. You still guide to that 16, 17-ish range for this year. I know you're not providing guidance for 25 yet, but is there any reason to think that kind of the SGA level at this percent of sales changes materially with your aspirational goals going into 27, or will we start seeing the leverage kind of kick in over the next few quarters?

Sure. Well, thanks for the question, Dick. You know, as You know, I outlined in my comments today we had some unusual items in the quarter with regards to SG&A. We've been recording the Barbara Nichols earn-out bonus for the last several quarters. We also had some elevated acquisition costs as a result of the P3 acquisition. Professional fees were a little bit elevated related to our foreign subsidiaries. And then, as you know, we've kicked off the ERP implementation. So talking to those items, you know, the Barbara Nichols performance bonus is going to be with us for several years. You know, as we've discussed on other calls, it's a three-year program for fiscal 24, 25, and 26. So that's going to be around for a while here. The ERP implementation really just kicked off in the current quarter. In earnest, so as I mentioned in my prepared remarks today, we expect that to be about a million dollars of expense over the next year. So I would expect SG&A to be a little bit elevated for the next year here as we work through these things. But then, yes, you're certainly right. The leverage should kick in and, you know, by the time we get to 2027, it should allow us to get to those, you know, low to mid-teen EBITDA margin percentages.

Okay, thank you. Say, Dan, the strength you've seen in aftermarket over the last few quarters, is that still kind of a potential precursor of what you might see on capital budgets and refining and petrochemical? Or what's your view of those end markets?

Yeah, so I guess, first of all, the aftermarket is remaining strong. So we're still seeing that elevated order level continuing on. We are seeing and hearing about some nice capital projects that our customers are planning for this year and we're starting to bid on. So we're encouraged. But again, it will not be the big boom, I think, like Graham has seen in the past. So we're encouraged. We're happy that the the aftermarket continues on strong and we're getting ready to, you know, if there is a significant uptick, we've been working pretty hard as far as, you know, training new employees at our businesses and the supply chain challenges are starting to work out and less of an issue there. So I think that we're going to be in a pretty decent position if and when that does take off.

I think Chris mentioned some increased professional fees in your international operations. Does that reflect, you said, maybe some of these early capital project discussions or is that something else?

Yeah, I could take that one, Dick. You know, as we disclosed in our 10Q today, you know, earlier in the year, our audit committee received a whistleblower complaint from our India subsidiary. And as a result of that, they launched an investigation which included hiring outside legal counsel and some forensic professionals. That investigation did confirm the whistleblower complaint, which led to a broader investigation where other misconduct was identified, mostly with regards to improper expense reimbursement expense reimbursements. As we disclosed in the 10Q, the impact was relatively minor. It was about $150,000 in total over four years, but that did result in an increase in professional services fees, probably about $750,000 year-to-date that we've incurred in that investigation.

Okay. Okay. Dan, one of the arguments for P3 was Graham can bring this scope to really expand the potential of both companies. You talked a lot about entering some new market opportunities with P3. When you talk bringing scale to the story, is that broadening the end markets, or is there potential to get deeper into the space business, let's say, when you guys are combining efforts?

Yeah, we see it as both, Dick. So P3 has connections to markets that Barbara Nichols doesn't necessarily have. And they're a really strong engineering group. And so they're actually bringing some strength on the engineering side to Barbara Nichols also. So we see... you know, probably some breadth that comes with P3. You know, P3 doesn't necessarily have the production capabilities that Barbara Nichols has. So we're actually going to be able to satisfy, you know, P3's customers on the production side also going forward. So I see it as a real win-win in that it is broadening And it's a deepening with some of the technology that P3 brings to the table.

Great. Thank you.

Yep. Thank you. As a reminder, if you would like to ask a question, please press star 1 on your telephone keypad. Our next questions come from the line of Gary Schwab with Valley Forge Capital Management. Please proceed with your questions.

Yeah. Hi, guys. And I'd just like to – Say congratulations. Great quarter.

Thanks, Gary. Thanks, Gary.

Have you been surprised following up on Dick's question on aftermarket? Have you been surprised by how strong the aftermarket sales have been in the past year?

To some level. Now, I don't have a lot of history with the company, so I couldn't tell you what it was like 10 and 15 years ago. But we do know that especially in the U.S., where the majority of our aftermarket comes from, that these refineries have been running hard. And so they've got to continue to invest in them and keep them properly serviced to be able to keep that high level of output. going. And so, you know, from a demand side, I would say, you know, not too surprising, just because we're not adding, you know, a bunch of new capacity here in this country, and you got to keep the existing assets running at top performance.

Okay, because it's really picked up a lot in the last year. And I know you have an aftermarket sales force that you've How have they become so successful in closing orders? Are the orders just there or is it the way you're doing it?

Well, I think it's both. So certainly the demand is up just because of the refinery output has been so high for a long time. The other part of it, we have been investing in our aftermarket team, adding more engineers, readjusted some of the leadership associated with aftermarket, and I think that's been positive. We're not done yet. As we kind of think about our installed base internationally, we're trying to figure out how to go after that, too. We've got initiatives with both of our sales offices to figure out the communication strategies relative to life of components and service intervals and things like that. It has been a proactive approach to continue to grow that business. Honestly, I think that we still have quite a bit of room to improve. So we're encouraged in the aftermarket business that we can keep it going. So we'll see.

Is most of it installed base or is all of it installed base?

Yeah, pretty much all of it is installed base, yeah.

So the fact that these are all customers of yours that you've delivered product to before – And you talked last quarter about really not having much visibility. Is there a way that you can increase visibility, almost like setting up a subscription business for replacement parts based on predicted wear rates or predicted failure dates?

Yeah, we've actually got an initiative that's starting this week. We've got a kickoff meeting. to figure out how to automate. Using AI is a little bit of a stretch, I would say, but automate our approach to aftermarket that uses this installed database, understanding exactly when these things got installed and the typical life associated with the components and starting to automate our market outreach to those installed-based customers. So, again, I said I think that there's quite a bit more we can do, and so we're not resting on our laurels here. We're out there being aggressive and trying to figure out how to go get more.

Okay, and just one last question for Chris. Is this worth putting a line item on You have space sales, chemical sales, refinery sales, defense sales, adding aftermarket sales as a line?

So, certainly something we can think about internally here. You know, it's definitely related to the, you know, refining a petrochemical market. So, you know, it's kind of all-encompassing, and our disclosure really is by market, which the aftermarket is related to. If anything else, we'd probably in the future look to break out new energy because that's becoming a higher growth and more important part of our business.

Okay. Because it is the biggest gross margin product that you carry.

True.

Okay. Well, thanks a lot. And congratulations again.

Thanks, Gary. Thanks, Gary. Thank you. Our next questions come from the line of John Baer with Ascend Wealth Advisors. Please proceed with your questions.

Thank you. Good morning. Congratulations, Dan and Chris.

Thanks, John.

Very good to see you. I'm real pleased to see the debt out of there. And so I've got two questions, quick questions. One is contemplation perhaps within the next year or – 12 months beyond reinstituting a dividend. And the second question would be with regards to the aftermarket sales, what percentage or roughly what's the breakout between the traditional refining and marketing upgrades versus biodiesel, which you've said has been in the mix here.

Yeah, John, so let me take the first one with regards to a dividend. As we've already been talking here on the call, we have quite a bit of CapEx that needs to get spent over the next several years. And we have a lot of organic growth opportunities that are in front of us that are well in excess of 20% ROI. So those are really our main focus. And then as well as we've really started to try to build out the pipeline with regards to M&A as well. And P3 is a great example of the types of opportunities that we'd like to take advantage of. So really, for the next several years, we're going to be focused on organic growth in M&A and paying down any kind of debt that might come with M&A. So right now, the board has not made any decision to reinstate that dividend at this point. That makes sense. Yep.

And then your question about aftermarket traditional versus biodiesel. Certainly, we've seen an uptick in applications using biodiesel where some of these refineries are getting converted over. I would guess, you know, I don't have that detail as far as, you know, what the aftermarket looks like. The installed base is relatively small at this point compared to refineries, so I would suspect that the aftermarket is relatively small also. But I couldn't quantify that for you other than small in relationship to the refinery aftermarket.

And what does that aftermarket look like as far as the international market where you have an established base of past business?

Yeah, very, very.

Are they on the same cycle, I guess is what I'm getting at? Our industry here has been running hard. Is that a similar situation internationally?

You know, internationally we're seeing new capacity being brought on. So there's been quite a bit of new capacity in China and India, for instance. And Middle East seems to also be planning on new capacity. And so, you know, that continues to grow on the new side. The aftermarket... in the installed base internationally has not been a big piece of our business in the past. As we build that installed base, we have plans to be much more aggressive in going after that. As I had said earlier, we've got initiatives in our sales offices internationally. to figure out what that installed base is, where it is, and how we go after it in a concerted effort with the Batavia effort here.

Great. Keep up the good work. Very encouraging. Thank you.

Thanks, John.

Thanks, John. Thank you. We have reached the end of our question and answer session. I would now like to turn the floor back over to Dan Thorne for any closing remarks.

Thank you all for joining us today. I hope that you can sense the excitement we have here at Graham about our future. We will be participating virtually in two upcoming conferences, the Gabelli Pump, Valve, and Water Symposium on February 22nd, and then the Sedoti Conference on March 14th. As always, please feel free to reach out to us at any time, and we look forward to talking with you again

after our fourth quarter fiscal 2024 results enjoy your day thank you this does conclude today's teleconference we appreciate your participation you may disconnect your lines at this time enjoy the rest of your day