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Text: We certainly appreciate your time today and your interest in Graham Corporation.
Joining me on the call are Dan Thoren, our president and CEO; and Jeff Glajch, our chief financial officer.
You should have a copy of the third quarter fiscal 2022 financial results, which just released a few minutes ago.
If not, you can access the release as well as the other slides that will accompany our conversation today at our website, grahammanufacturing.com, and I also want to point out that we also have now ir.
grahamcorp.com to access the investor information.
These documents can be found 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.
We have provided reconciliation of non-GAAP measures with comparable GAAP measures in the tables that accompany today's release and the slides for your information.
I am starting on Page 3.
As you might imagine, having just assumed the role of CEO in September, reporting this fiscal third year -- third quarter's results is a little bit rough.
Revenue has increased to $28.8 million, but we had a loss of $0.35 per share.
The loss was driven by Navy project cost overruns in our Batavia operations as a result of decisions we made during the quarter to ensure timely execution of our high-profile submarine and carrier projects.
The multiple decisions that led to the loss were for long-term gain over short-term pain and were not made lightly.
Our Navy business is very important for our future.
We had to protect this business and ensure our customers knew we were committed to hitting their need dates, even though we took a significant financial hit in the quarter and over our fiscal year 2022.
Jeff and I will provide more detail on subsequent slides.
As a result of the quarter loss, we were out of compliance on our financial covenants, which required suspending our dividend.
Jeff will talk more about the waiver we obtained and the coming amendment of our credit facility.
While this was a disappointing quarter and has been a very challenging year, we are deeply committed to our strategy to diversify beyond refining at petrochem with our defense work.
The pivot toward defense has been successful, as indicated by bookings and revenue.
Our defense revenue is now over half our total revenue.
We had a huge bookings quarter at $68 million.
Over half of these bookings were at Barber-Nichols.
Now that we have the bookings, we have to execute this work profitably.
Final point on this page is that Barber-Nichols' performance is exceeding our expectations.
They are building a larger backlog and delivering strong margins.
Jeff will provide more detail in the financial discussion.
But first, I'd like to provide more detail on our Navy challenges in Batavia.
We'll move to Slide 4.
So let me first address what led up to our third quarter performance.
To date, Graham manufacturing has been very successful in winning the trust and confidence of the U.S. Navy and its prime shipbuilders with its high-quality heat exchange and vacuum products used in the nuclear Navy power plants.
Navy orders and backlog continue to climb and have now significantly exceeded our commercial backlog and will soon exceed our commercial revenue.
As of December 31, 2021, our Navy backlog in Batavia was over $100 million.
Those orders come with big expectations.
As we have worked over the last two years to continue to win new business and meet those expectations, a perfect storm brewed in our third quarter.
There were several events that led to our need to readjust in Q3.
After getting started on Colombia, there was a Navy wide reset of quality requirements that caused delays with welder and quality recertification.
This was followed by the impact of COVID-19, the ongoing limited skilled workforce in the welding trades, and the sheer magnitude of work running through our shop combined with first article learning curve, all of these items caused us to get behind on our Navy jobs.
We do continue to have first article challenges.
This is quite typical with defense projects, and we would have expected this on the Columbia project.
We've reviewed this with you in the past.
Now while the CVN-80 work is not a true first article job for us, the lack of process documentation from the previous work combined with severe labor challenges and use of contract welders new to the equipment caused challenges on the carrier work as well.
Even as we work to catch up on hours, our equipment became the pacing item associated with our nation's most strategic ship and submarine build schedules.
The pressure to expedite was extreme.
Let's turn to Page 5.
The chart on Page 5 shows our labor plan with blue bars, our actual labor, application in gray bars, and the resulting deficit of hours caused by actual being less than our planned hourly expenditure.
The depth of our deficit occurred around May of 2021.
In past calls, we talked about redirecting commercial welders to Navy and hiring contract welders to address this deficit.
In third quarter, we redirected even more commercial welders, outsourced more commercial work, hired more contract welders and even added some of our new welders that completed our training programs.
These actions help to reverse the Navy labor deficit, but they came at additional costs.
Outsourcing commercial work results in less margin.
We also realized less third quarter revenue as the outsourced suppliers were not able to ramp up quickly.
The contract welder costs were high, the specialized training required by the Navy took a long time and retention of the contract welders was poor.
Ultimately, we've been able to reduce our Navy program labor deficit by doubling our Navy workforce, mitigating the schedule slips and keeping our customer relationship strong.
The deficit should be erased in the first half of fiscal '23, but we expect to start reducing high-cost contract welders as we enter the next fiscal year.
In the end, the actions we took to stay on track in the last quarter resulted in revising estimates on labor hours and material, and we booked loss conversion costs that were recorded in the quarter and impacted our results as well.
Jeff will cover that detail in the financial briefing.
Certainly, we've learned a lot from this experience and have or will institute corrective and preventative actions to ensure that we continue to grow our Navy business and can deliver quality products in a timely fashion and earn a fair return for our efforts.
Our customers have been very appreciative of our efforts and we do not see any negative consequences if we hold current deliveries.
This equipment is built into the bowels of these ships, and they will never come out.
Thus, quality is paramount and Graham has not disappointed.
As we catch up on these programs and reduce our labor deficit, we can reclaim margins by eliminating contract welders, reassigning our commercial welders back to our commercial product and reduce the outsourcing that we're doing today.
Our people pipeline continues to be critical, and our welder training program will be continued.
Looking back, we could have done a better job in predicting and mitigating the situation with better developed FP&A, financial planning and analysis, and project management skills.
We are adding new talent with defense expertise in Batavia to better manage these processes.
In fact, we're adding a new position and Batavia will have a Navy business leader beginning February 28.
As we look forward, our processes need to advance to enable our ability to document and optimize all of our fabrication processes to prevent a recurrence of this first article issues that we've seen.
We see opportunities to increase future profits with investment in time-saving automated welding, and we're evaluating current contract margins and revisiting pricing on future production opportunities.
In summary, our Batavia defense business was hit by a perfect storm at a very inopportune time.
We made decisions to protect our strategic Navy business.
It cost us in the short term, but proved our dedication to our customers for the long term.
As Dan mentioned, our third quarter performance was quite disappointing.
Sales were $28.8 million, up $1.6 million over last year's third quarter.
Barber-Nichols contributed $12 million in sales in the quarter, helping to offset the weak sales quarter of our legacy Graham manufacturing business.
Our Batavia operations were impacted because of its need to focus on catching up and executing the two large Navy projects.
Those projects will both require more labor and material costs to complete that were projected at the start of the quarter.
The additional labor hours to complete the projects impacted the quarter's revenue since we did not move the projects as far along as expected.
The added labor and material costs, including the use of higher cost contract laborers required us to record increased reserves.
The sum of all these items impacted both revenue and gross margin.
The impact of the cost increases and required fully burdened contract costs in the quarter were $2 million.
In addition, the delayed revenue was approximately $6 million, and the delayed operating profit is approximately $750,000.
Furthermore, to get back on schedule with the Navy projects, we reallocated our commercial labor to Navy work, which resulted in increases in cost estimates for those jobs, which have now been outsourced.
All of the above items contributed to an adjusted EBITDA of negative $2.6 million in the quarter and an adjusted net loss of $0.27 per share.
On the positive front, with the addition of Barber-Nichols, we had 58% of our sales to the defense industry, as well as 5% or $1.5 million to the space industry.
If we can move on to Slide 7.
The impact of the third quarter results on top of a challenging first half of the year have yielded an unacceptable loss even as sales increased 16% or $11.3 million to $83.1 million.
There is a bright light within the results, and this has been the contributions of Barber-Nichols, which we acquired on June 1.
In the seven months since the acquisition, BN has contributed $31.9 million in sales, offsetting significant declines in refining and petrochemical markets.
In fact, our diversification into defense, which is less cyclical than our commercial business, has resulted in 52% of our year-to-date revenue coming from that industry.
The shortfall in commercial sales in the first nine months of the fiscal year reflects the very low order levels, which we saw in the second half of fiscal 2021.
The two Navy projects in our Batavia operations will continue to convert over the next three quarters, and we expect this to be behind us by mid fiscal 2023.
As of December 31, we recorded all known expected costs on these large projects.
We are also implementing expanded processes within our project management group to better review all of Batavia's major projects.
The year-to-date impact of increased cost on these two jobs is approximately $4.5 million.
In addition, the delayed revenue was approximately $12 million and the delayed operating profit is an additional $1.5 million.
These latter amounts will be recognized over the next three quarters as the jobs are completed.
We've had to outsource more commercial work and have also had cost challenges on a couple of projects.
This, too, has impacted financial results.
The increased cost of outsourcing and higher costs has impacted the commercial business by $3 million.
All of the above items contributed to an adjusted EBITDA of negative $5.4 million year-to-date, and a year-to-date net loss of $0.70 a share and an adjusted loss of $0.60 per share.
Barber-Nichols again, is a strong positive in the first three quarters.
In the seven months since the acquisition, BN sales are on track at $31.9 million, and EBITDA margins are well ahead of expectations.
I have noted in previous calls, that we were expecting $45 million to $48 million in sales and low double-digit EBITDA margins.
The sales number is on target, and we are now seeing mid-teen EBITDA.
In fact, through seven months since the acquisition, BN has achieved our targeted EBITDA for the full fiscal year.
So its Q4 EBITDA will represent overachievement compared with our expectation.
Moving on to Slide 8.
And given the weak financial performance in the first three quarters, we have failed to meet our debt covenant related to debt-to-EBITDA and fixed cost charges.
This miss was due to the EBITDA loss.
We were given a waiver by our lender for Q3 and are proactively in negotiations to amend our existing bank agreement.
Because of the covenant misses, it was necessary to suspend our dividend.
And as part of the waiver agreement, we have agreed not to utilize more than $15 million of our revolver.
I want to be clear that the issues we are seeing are P&L profit issues and not liquidity issues.
We have sufficient liquidity from cash we are generating from operations to work through our challenges.
In fact, in January alone, lowered our revolver debt from $9.75 million to $6 million.
We expect to lower it further between now and the end of March.
Conversations with our lender have been very positive.
I've been pleased with the bank's willingness to understand the details and not overreact to the numbers.
They understand the near-term challenges are primarily related to profitability and delayed revenue.
While there are certainly some significant cost -- cash cost increases, the costs booked in Q3 and the elongation of project revenue and profit recognition into future quarters have doubled down the impact on our year-to-date P&L.
The bank and I both expect the lending amendment to be completed by the end of Q4.
Onto Slide 9, some very good news on the order front.
As Dan noted, orders in Q3 were $68 million.
Just over half of this came from Barber-Nichols, which most of their orders coming from key defense projects.
They also continue to bring in a nice level and variety of space orders.
On the commercial side, Graham manufacturing saw another strong quarter of aftermarket and short-cycle orders.
Those are promising since historically, an increase in those areas has often been a precursor to a recovery in capital investment by our customers.
We also booked a significant refinery order in China.
Our backlog at the end of Q3 is a record $272.6 million, with both Barber-Nichols and the legacy Graham business having a nice step-up in their respective backlogs during the quarter.
Defense represents 77% of total backlog.
This defense backlog extends over the next 6 years, though much of it converts in the next three to four years.
Additionally, we are seeing growth in our commercial backlog.
The commercial backlog was quite low entering the fiscal year.
It has grown from $33 million at the end of March to $63 million now.
About one-fourth of that increase occurred when we added BN, the rest was due to orders received in the first nine months of the year.
Another positive feature of the commercial backlog and its growth is that it has a much shorter conversion cycle than the defense backlog generally 12 to 18 months.
We've had a rough fiscal 2022, but the future looks far better.
Moving on to Slide 10.
We have lowered our guidance for fiscal 2022.
Our revenue guidance is now $120 million to $125 million, which implies $37 million to $42 million in Q4.
We expect a breakeven adjusted EBITDA in Q4.
While this is below our prior expectations, it's far better than Q3 results, and we believe we have turned the corner on many of the challenges we have faced this fiscal year.
I will now pass the call back to Dan to talk about our strategy going forward.
We are now on Slide 11.
At a high level, we have been talking about a strategic pivot toward defense for many years, and we have been making good progress.
The long-term visibility of strategic naval programs provide stability and an ability to invest intelligently in our business, and it offsets the cyclicality and challenges of our refining and petrochemical markets.
The acquisition of Barber-Nichols strengthened the strategy and brought additional market experience to our company.
As with any new venture, we have had some lessons learned and opportunities to further strengthen our strategy.
I'd now like to give you some insight on how our strategy is evolving going forward.
Let's turn to Page 12.
Graham Corporation is a related group of mission-critical engineered product companies that win on superior quality, performance and customer trust.
Our corporate role is to strengthen our member companies with best practices, leader rotation and board expertise while providing value-enhancing services and core in any collaboration to win large programs.
In fact, we are filling out critical leadership positions in upgrading talent for what the future of Graham Corporation requires.
Our board took on this requirement themselves last year after the BN acquisition, and they began a search for director candidates with strong defense experience.
Our Batavia operations, which we are referring to as Graham manufacturing, will continue to serve the Navy refining and petrochem markets with high-quality, highly engineered heat transfer and vacuum systems.
It is expanding into new energy and we'll now put more focus on aftermarket opportunities to be a life cycle partner with our customers.
Internally, we are restructuring for significant Navy growth and we'll be leveraging our large installed base for growth capital.
Our strengths will help us realize our goals.
In Batavia, we want to realize strong margin in all of our markets, improve our operational effectiveness and develop capabilities to provide more value to our customers.
We need to establish roles and responsibilities to align with the structure designed to be responsive analytical and forward thinking.
And we need to create an organization that is accountable and that can diagnose problems, evaluate alternatives, improve, develop, reshape and quickly redirect as required.
Importantly, we need to make sure our people are provided the tools, materials and information they need to do their jobs well.
Barber-Nichols continues on its path of intelligent full life cycle turbomachinery systems in identified high-growth potential markets.
BN has structured people, technology and customer relationships mostly in place.
They are moving to the next level in teams, processes and improvement to optimize business performance, while working even closer with customers developing new product to ensure year-over-year growth.
Our future opportunities will be the result of proper execution of our plans that will get us beyond these short-term issues.
We believe this is the inflection point.
We have no doubt hit bottom.
So I am confident we can go up from here.
I realize that we have to prove to you that we can drive earnings and generate cash.
As Jeff noted, we already have in the first month of 2022 -- in the first month of 2022, I'm sorry.
As we look to our future, we see the BN acquisition as a model that we will look to repeat.
There were several novel approaches utilized that we believe can entice the best and the brightest, small independent companies to join us.
We are an organization in the midst of dynamic change.
We serve great markets.
We have the confidence of the customer.
We have the orders and the backlog to prove it.
We have been challenged on execution, but have identified the issues and put corrective actions in place.
We have a plan for growth.
We believe we have a strong business model with excellent earnings, power and cash generation.
While we have several quarters of work to get these projects out the door, we are on the upward trend of the curve.
And then Jeff and I will answer questions from the audience.

user
compname reports q3 loss per share $0.35.
q3 loss per share $0.35.
sees q4 revenue $37 million to $42 million.
qtrly revenue of $28.8 million, up 6% over prior-year period.

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