Q2 2023 Graham Corp Earnings Call
Greetings and welcome to the Graham Corporation second quarter fiscal year 2023 financial results Conference call.
At this time all participants are 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 turn the conference over to Deborah Pulaski Investor Relations. Mr. Lascar, you may now begin.
Thank you Rob and good morning, everyone. We certainly appreciate your time today and your interest in Graham Corporation. Joining me here are Dan store, and our president and CEO and Chris <unk>, Our Chief Financial Officer.
Should have a copy of the second quarter fiscal year 2023 financial results, which we released this morning before the market.
Also for your information and posted on our website slides that will accompany today's conversation as well as ace as supplemental information that provides greater detail regarding sales.
Kings and backlogs by industry and geography on our website those can be found at IR Dot Graham Corp Dot com.
I will first have Dan and Kriss do a formal presentation after which we will then open the lines for Q&A.
If you'll turn to slide two in that deck that I mentioned I'll review the safe Harbor statement.
You should be aware that we may make some forward looking statements during the formal discussions 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 with Securities and Exchange Commission.
These documents can be found on our website IR Dot Graham Corp, Dot com or at SEC Gov. During today's call. We will also make some non-GAAP financial measure disclosures. We believe these measures will be useful in evaluating our performance you should not consider the president the presentation of this additional information.
Nation isolation or the substitute for results prepared in accordance with GAAP.
We have provided a reconciliation of non-GAAP measures with comparable GAAP measures in the tables that accompany today's release and slides.
So with that if you would please advance to slide three I'll turn the call over to Dan to begin Dan.
Thank you Debbie and good morning, everyone.
I am pleased to report that we are tracking to plan. Our results are as we expected.
We are on track to achieve our fiscal year guidance.
Our second quarter was a big bookings quarter with over $90 million in new orders.
Approximately $70 million was attributed to our defense market and another 20 million to space and refinery petrochemical.
All of these newly booked orders have better margins than in the past.
We were able to increase pricing on both our navy and energy jobs.
We are seeing continued strong demand in our refinery petrochemical aftermarket business we.
We have not seen an increase in commercial capital equipment orders yet.
But our customers tell us they expect those orders to come in calendar 2023.
Execution is improving through continual improvement in the short term and with capital investments for the long term.
Both business units are working hard to improve manufacturing processes, and seeing improved cost and yields because of the effort.
This quarter, our board approved the acquisition of an automated welding machine.
New mill turn machining tool.
Our pump test rig and our facility expansion.
The automated welding machine will reduce cost and rework on some of our heat exchangers, we are making in Batavia.
The new mill turn machine tool will significantly reduce manufacturing time on production torpedo programs, while the facility expansion will enable a higher production delivery rate for these programs.
The pump test rig will be used to demonstrate lifecycle for high compliance production pumps that were making in arvada.
As we clear the low margin jobs through the year.
We expect profitability to continue improvement.
For the quarter, given the product mix GAAP loss was about $200000 and EBITDA was $1.5 million.
With that I'd like to hand, it over to Chris <unk> for a discussion of our financial performance.
Thank you Dan and good morning, everyone.
I will begin my presentation on slide four.
As Dan mentioned, our second quarter performance was in line with our expectations.
Sales were $38 1 million up 12% over last year's second quarter and 6% over the trailing first quarter.
I would like to point out that this growth was all organic as both periods included a full quarter from Barbara Nichols.
Year over year growth included $3 million from the space industry, where we are building relationships with many of the key commercial players.
In fact during the quarter, we were recognized by Virgin orbit as one of the.
Critical suppliers, which with which we believe is a testament to the value our solutions and engineering services bring to that industry.
During the quarter, we continued to see strong growth in the refining and petrochemical commercial aftermarket which was up 36%.
This is significant and that we view aftermarket sales as a leading indicator of future capital investments by our customers.
As Dan mentioned, we expect the next capital investment cycle to begin in calendar year 2023.
Offsetting these increases were sales to the defense market, which were down $5 million compared with the second quarter of last year, which is a record quarter for this business.
The change was all about project timing, reflecting the significant level of defense industry business, we have in our backlog.
As noted in our release today, we delivered an additional first article unit for a critical U S. Navy program and are on schedule to ship. The remaining first article units by the end of the first quarter and fiscal 2024.
For the quarter sales in the U S increased 16% to $30 3 million and represented 80% of our sales.
While international sales of $7 8 million accounted for 20% of total sales and were consistent with the prior year.
The mix of U S to international sales has shifted over the last couple of years given the growth in our Navy business as well as the addition of Barbara Nichols, which sells primarily into the U S.
Gross profit and margin improved over the prior year period on a better mix of higher margin projects, namely space commercial aftermarket and new energy.
As well as better execution and pricing.
The decline sequentially was as expected and was due to COVID-19 on projects made in the first quarter to keep production moving that resulted in that quarter benefiting from a better mix of business.
SG&A expense for the second quarter was $5 3 million consistent with the prior year.
However, as a percentage of sales.
SG&A expense improved to 14% compared to 50% in the prior year as we maintained strong cost discipline, while growing our top line.
The net result was near breakeven net income for the quarter.
Adjusted earnings per share of <unk> <unk> and.
And adjusted EBITDA of $1 5 million.
Turning to slide five you can see our capitalization.
Net debt at quarter end was $5 million up slightly from $4 2 million at the end of the trailing first quarter.
Due to the timing of milestone payments.
We have instituted strong cash management discipline throughout the organization, which includes actively managing working capital and operating expenses, while increasing oversight of capital expenditures to ensure proper returns.
As a result capital expenditures in the quarter were <unk> 9 million and we have reduced our guidance for capex spend for fiscal 2023 to be approximately 3 million to $4 million.
The investments that we're making that Dan highlighted earlier total approximately $4 million and will occur over the next four quarters with each project, having a greater than 20% IRR.
Turning to slide six as previously.
We announced we had record orders during the quarter of $91 5 million.
Driven by repeat orders for critical U S Navy programs.
We believe these repeat orders validate the investments we made over the last year.
And our customers confidence in our execution.
We also expect these repeat orders will be at higher margins through increased pricing and better execution.
In addition to strong defense sales.
We had $13 million in refining and petrochemical orders, which related to continued strong commercial aftermarket demand and $4 million of orders each from space and other commercial which is comprised primarily of new energy.
The orders for the quarter, resulting in a book to Bill ratio of 2.4 times and reflects the breadth and diversity of our customer base.
If you turn to slide seven you can see that these orders drove a 20% increase in backlog from the sequential first quarter.
And now sits at a record $313 million.
We believe 40% to 45% of this backlog will convert within the next 12 months.
Most of the backlog expected to convert beyond 12 months is for the defense industry, primarily to the U S. Navy.
Defense now comprises 79% of our backlog and is significant in that it provides greater visibility and stability to our business.
Slide eight provides our guidance for fiscal 2023.
Our first half results were in line with our expectation and gives us confidence we will be able to achieve our full year guidance.
As such we are reaffirming our expectations of revenue and adjusted EBITDA growth for the year.
Revenue is expected to be between $135 million to $150 million, which implies top line growth at the midpoint of 16%.
From a margin perspective, we are looking for a gross margin of 16% to 17%.
And expect SG&A to be 15% to 16% of sales.
The net result is that we expect adjusted EBITDA to be in the range of six five to $9 5 million.
Which equates to an adjusted EBITDA margin of 5% to 6%.
As discussed year to date fiscal 2023 results were impacted by our larger lower margin first article U S Navy projects.
We believe this negative impact will continue through the first quarter of 2024 when the last of these larger first article projects are expected to be completed.
I should also point out that the company's third quarter is typically impacted by lower labor hours due to the holidays.
With that.
Operator, please open the phone lines and Dan and I will be happy to take your questions.
Thank you well now be conducting a question and answer session.
If you'd like to ask a question today. Please press star one from your telephone keypad and a confirmation tone will indicate your line is in the question queue.
You May press Star two if you like to remove your question from the queue.
For participants using speaker equipment may be necessary to pick up your handset before pressing the star keys.
One of them, so we pull for questions and once again Thats star one thank you.
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 beating the estimates for the quarter.
Thanks Leo.
So in your opening remarks, you talked about some new equipment that you're that you're ordering what kind of lead time, so you're looking at for that or is it already on its way in.
Yes lead times for those machine tools typically are around a year.
So as Chris had mentioned, we're kind of expecting that capital expenditure to go over the next four years, So we put money down.
Our fourth quarters. Thank you.
So we put money down at the beginning to get the order going and then pay for it when it's delivered so yes. There is there are some things that are relatively quick and then and then most of that capital equipment ends up being kind of a year long.
Right.
Can you talk about whether or not oh.
What youre seeing in terms of inflation or supply chain issues and in your business.
Yes, certainly and inflation.
Inflation, we are seeing.
Increased prices from our suppliers.
And we're able to build those into our bids fairly well.
Suppliers are continuing to kind of hold the short.
<unk> dates for their for the material and we're just passing those on to our customers.
I'm thinking that pretty much all customers know exactly where we are with supply chain and we haven't got any pushback for for needing to.
Revisit material pricing for instance, when we accept orders so it.
Maybe a little bit better, but our supply chain is still a little bit challenged.
Okay, and I noticed that the under their product lines sales space segment was up strongly this year over last is there or is that a market share gain or is that probably just getting bigger.
I, probably a little bit of both.
We're we're seeing.
Some activity continuing at launch.
Type activities and then we're also seeing.
Some more.
Orders in the thermal management systems for communication satellites.
Both of those continue to grow.
As a market and we're able to participate in those.
Okay. Thanks very much.
Yep.
Thank you. Our next question is from the line of Andrew Shapiro with long tail capital. Please proceed with your questions.
Hi, Thank you so a few questions here.
Guarding right now the low profitability or breakeven first article units. These are the units for the sub programs right.
Correct. We have we have won for this sub program and then one for the carrier program.
And.
Are both of those are suffering presently from low margins. Because these are the first article units.
Yes, yes.
Sure.
And when you refer to the first start up the units will be done in their delivery to Q1 fiscal 'twenty four I think that's a correct me if I'm wrong is the June 2020.
Three.
Quarter is that right yeah, that's correct Andrew.
And they're in the and this is first article for both the carriers and the subs in terms of that kind of the quarterly.
Completion yep.
Yep exactly.
Okay.
Now the low margin on those.
Find me I think I ask just one or two quarters ago, when I first got it.
Interested in the company.
These are fixed fee contracts and that you bid on and of course, even though you you learn from experience and that's why there'll be better margins for next time.
Were these some type of R&D with costs.
Cost plus in them.
No. They they are firm fixed price contracts.
That our bid.
Competitively upfront.
Then you go through all of the learning.
And.
And then when you bid them again, you basically get to bid what your actual hours were.
Expanded in the first article.
And so your pricing actually improves for the second one.
Got it and then the automated welding equipment to be installed and activated in Batavia.
Which I think is where youre doing much of the first article work.
And the second article work.
When is that equipment expected to be installed and activated.
That has like a year lead time to to get it and get it installed and get it operational. So we would expect probably fall of next year is the time frame that we'll be able to bring that online in our production process.
Okay. So when you bid out.
That will call it the second articles or the second wave of contracts that have now gone into the backlog.
Was that on any assumption of the productivity enhancement. This.
New equipment would provide or that will be an added.
Benefiting bonus.
If we're successful with the implementation of the automated welding equipment it won't reduce.
Bob.
Both labor hours that we put into the jobs as well as re work hours that that we would have with a manual process. So it should improve margins from from that from where we bid those jobs.
Awesome alright, thank you.
Yes, Thanks, Andrew.
Our next question is from the line of Brett Kearney with Gabelli funds. Please proceed with your questions.
Hey, guys. Good morning, Thanks for taking my question and congrats on the continued execution.
Thanks, Brett Thanks, Brett.
Two quick ones, great to see growth I mean, really all areas of the business, but particularly on the new energy side curious.
There's so much happening in some of these spaces.
Whoa.
The opportunities you're seeing in your brand and Barbara Nickels are best suited for those primarily fall kind of within the U S geographically or how you're thinking about kind of the global opportunity set across some of those areas.
Yes, very much right now theyre all domestic so we're seeing biodiesel.
Applications, both new and.
Existing.
There is there is some good activity on the hydrogen side.
And the hydrogen production.
<unk> and distribution fueling.
Type of area and then there is continued to be some good activity.
On the small modular nuclear side, so that ends up being very much R&D, where the other two are more on the.
Production side, but but.
But yes, some some pretty interesting opportunities.
Again, all domestic at this point.
Great and then.
Sounds like you've identified some really attractive internal investment opportunities are that are moving forward I was wondering just as part of kind of the.
Process Overhauls you put in place at the organization. If you could talk about you know how these investments.
Investments kind of bubbled up and kind of how you guys are looking at.
Identifying and going after some of these attractive internal investment opportunities in the future.
Yeah pretty much all of the really good ideas come from the floor.
Yeah. So so people that are struggling with a particular process or challenged with a piece of equipment to that.
They can see that there's a better way.
We get some really good ideas from folks that are on the production floor, just just kind of dealing with it every day.
Certainly theres some theres, some manufacturing engineering and design engineering type ideas that that come through too.
Yes, we're pretty excited.
And that's really kind of why I wanted to highlight those in my opening statement and that we're able to see some of those opportunities start investing in them today don't expect immediate return.
But but pretty quick return.
On the next couple of years that really well.
Improve our efficiency and throughput.
And enable us to accelerate on the.
On the revenue side, so so pretty excited about all of them and.
And it's just that continual improvement mindset.
Both businesses have that's starting to come through.
I think I would add to that Brian is that one of the project is capacity expansion as well one of our defense programs, which is seeing some really nice growth.
We needed to take on additional space and purchased some new equipment as well to accommodate their request for volume.
Terrific. Thanks, so much guys.
Yeah. Thank you Brett.
Thank you.
The next question is from the line of John Bair with ascend wealth management wealth Advisors. Please proceed with your question.
Thanks, Good morning.
Hey, John morning, Jon.
It appears that your cost of goods sold rate of change is starting to slow down am I reading that right and is that.
Something that you think is going to continue.
So if you recall from last last quarter, John We expected we entered the first quarter benefited from a really good mix.
And we did expect that gross profit percentage to come down in the in the current quarter.
So I would say the margin for this quarter.
Within line with our expectation, we still continue to see some impact from these first article jobs in the second half of the year, but as those jobs to make their way through our backlog, we would expect our margin to improve after that.
Okay.
One other another question was.
So as you move through these these projects and get into the second tier if you will.
Going forward or looking out over a couple of years.
What do you think the mix.
Could be on.
Winning new.
Project orders as well.
You know winning first bid to where the.
The order backlog as it grows and becomes more of a.
More mix of repeat business, if you will for existing projects.
That as opposed to you know maybe getting new new.
New bid wins that would require this first article.
Learning curve.
Sure. So if we if we kind of focus on the defense for now.
We are building up some nice backlog of repeat work and so.
Necessarily we would we would expect that that repeat work as a higher percentage of any new first articles, we will be bidding.
Additional new first article jobs in the future, because that's where that's where the.
The growth in out years really comes but as a percentage of our overall business it should be a smaller percentage going forward.
Okay.
Very good thank you very much.
Yes, Thanks John .
As a reminder to ask a question today, you mean first star one from your telephone keypad.
The next question is from the line of Gary Schwab with Valley Forge Capital Management. Please proceed with your question Yeah, Hi, Thanks for taking my call.
Nice to nice defense orders.
Was there any first article new business included in this big Defense order that you just got else corner no. It was I'll repeat.
Okay.
And as far as cutting back on Capex for the year, you said three to four I think last quarter, you were saying four to five and a half.
What in your plans are being deferred.
If anything yes, so I would say at this point.
With just the discretionary spend we've been trying to be prudent.
As we were.
Work our way.
Through these projects, we are trying to be prudent with the spend given the you know the cash flow that we're generating.
But we expect the capex to pick pickup as our cash flow expense. So basically we're only spending what we're generating from a cash flow perspective.
But certainly not putting these projects behind in any way these are little bit larger projects.
That had to go through a full financial evaluation and I think we said at the beginning of the year that we thought they would be in the second half more towards the second half of the year. So those are right on schedule.
Okay. So your planned expansion at Barbara Nichols, and the new equipment that you mentioned that that's all in this three to four.
Or that Hasnt, even been paid for yet.
A portion of it because as we said it's going to go through the next four quarters.
But a portion of it is built into that three to four yes. Okay.
Can you give us an update on archon flame I think you said that for November youre going to have a big graduation months and what about your next class and have you been able to attract.
Any more experienced well there since the last call.
Yeah. So you have it right on there Gary.
Next.
Graduating classes in November .
We have been seeing an uptick with some experienced hires.
But it is a continual battle for share and you know we're not we're not out of the woods yet we've made some good progress we're able to kind of maintain a level of workforce right now and we do expect a bump up once that that class graduates in November .
But it's still it's still remains a daily battle.
And then the next archon flame class will start in January if I remember right.
Yep Yep.
Okay.
Are you are you graduating the full class are you getting drop out sooner.
What's happening I would say through the normal we've had a few drop off but thats. We go through some rigorous testing some some don't quite make it through unfortunately.
But we've retained I think we started with 11 and we're down to 10 now so we are not too bad okay. So you're keeping the bulk anyway.
In June you were running a full first shift, but only a small second shift.
Has that improved much and.
Do you have any idea when the second shift would Phil.
Yeah, it's actually improved quite a bit and essentially what happened is.
Again lesson to employees about what what they want and and we floated the idea of a.
410 kind of arrangements, where they could get their 40 hours and four days.
And then have a longer weekend.
And we rolled that out on second shift.
And it turns out that that people really like that.
So we are we got a lot more people onto onto a second shift then than we had before so it's getting close to.
To being a full second shift and that we've got availability on first ship two to hire and fill their too so.
Good good progress.
Bala.
Balancing the shifts at this point.
Okay, that's good to hear.
And then finally I just.
With the recent political conflicts between the U S and China is it having any deleterious effects on your China business outlook.
We haven't seen anything to date.
You know that China business.
Can run in.
5% to $12 million range. It has been a little bit lower recently.
But we haven't seen any any bad effects.
From from that conflict, thus far certainly are.
Keeping our eyes and ears open.
And trying to understand whats going to happen there.
It ends up being a relatively small piece of our overall business.
And so.
I'm not too concerned about it, but but certainly watching it for sure.
Okay, and then I just have one last one.
You said last quarter that there was going to be some low margin business that didn't come in in Q1, and it was going to.
Well, what you thought it was going to eventually come into did that all come in and did that go out in Q2.
Yeah, we had a we had some lower margin business that was.
And for the India market.
That.
Cleared probably 90% of it cleared in the second quarter. So so we felt like that would be a little bit of a drag in and it was for the second quarter, but that appears to have cleared I think the last I'd.
Items shipped like the first or second week of November .
Okay. So that was the biggest reason for your lower.
Margin in the second quarter.
I don't know that I'd characterize it is the biggest but not the biggest but yeah yeah yeah.
Okay, alright, thanks very much.
Yeah. Thanks, Gary.
Our next question is from the line of John <unk> with Pinnacle. Please proceed with your questions. Good.
Good morning, everyone.
Hey, Joe I was happy to see the backlog up so significantly.
Want to make sure I understand.
The nature of that backlog does that backlog I think you said, 80% was defense oriented which is about $250 million.
Does any of that is any of that $250 million of defense backlog does that include.
Any new first article projects.
Oh no.
Okay.
Does it include any second article projects.
Yes, certainly there is.
And our backlog there.
The first articles that we've been talking through that arent complete that ship.
Through.
June of 2023.
And some second articles that also where in that in that timeframe. So yes. It does include lower margin stuff and that's what we had talked about earlier in the call right that part is clear but what.
What would be a rough percentage of the backlog that is going to be the higher margin second article projects.
Right.
So John we announced them the $70 million in Oregon, or the $90 million in orders that we got which was a record order level.
70 million was related to defense.
That's the.
Second article that's I'll repeat orders yes.
That's the higher margin better pricing.
Orders that are in our backlog and that's what caused the backlog to step up okay. Alright. So thanks.
Sorry go ahead.
No I was just thanking Debbie I didn't understand the question and she she helped me answer it there. Okay got Ww is good at that.
So $70 million.
Is the total of the second article projects embedded in the backlog.
Now there's more than that because there's a there's a.
Carrier program also.
Then we will have better better margins.
Yes, I wouldn't I wouldn't characterize it as just the 70 and the backlog is more than that and then that backlog also includes quite a bit from Barbara Nichols right. So there is there is in the neighborhood of $100 million.
For Barbara Nichols, and a big portion of that is.
Production on.
On some of their programs also so.
We're actually very happy about the backlog that we've got and we're encouraged that.
That is that it's good margin and that we can continue to improve.
And better that going forward, okay great.
And when does the second article.
Backlog start to become produced.
We're actually yes, we're actually producing.
And <unk>.
The second article equipment now.
On the carrier side, we've ordered material for some of the submarine.
Programs and then Barbara Nichols is absolutely in the.
And the production of of.
Following one quarters that have <unk>.
Good margins associated with them.
Right now.
So think about it as kind of clearing.
<unk>.
The lower margin jobs through through June of next year, and then what we have in backlog there is actually pretty good stuff.
Okay.
Oh, great. That's helpful. Thank you.
Thank you at this time, if we see end of the question and answer session I'll turn the call over to management for closing remarks.
Thank you very much in closing I'll, just say that we're very excited about the future Graham.
I am, especially grateful to the entire Graham Corporation team for their commitment their resiliency and their contributions to deliberate on the quarter.
To driving our future potential thanks for your interest in our company and hope you have a great day and look forward to talking to you again.
This will conclude today's conference you may disconnect. Your lines at this time. Thank you for your participation.