Prepared remarks
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. A question-and-answer session will follow the formal presentation. Please note, this conference is being recorded. I will now turn the conference over to Deborah Pawlowski, Investor Relations for Graham Corporation. Thank you. You may begin.
Thank you, Darryl, and good morning, everyone. We certainly appreciate your time today and your interest in Graham Corporation. Here with me on the call are Dan Thoren, 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.grahamcorp.com. You'll also find there the slides that will accompany today's discussion. If you will turn to Slide 2 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 the 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 ratio. They are operational measures in 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 3, 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 paydown during the quarter and strategic investments, both organic and inorganic. We highlight on Slide 4 a significant investment made during the quarter, which was the acquisition of P3 Technologies. This was a great bolt-on business, which brings highly complementary technology that enhances and expands our turbomachinery 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 Barber-Nichols turbomachinery business. In fact, in the short period that they have been with us, that business has already proven instrumental 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 turbomachinery 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. U.S. 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 6, 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 Barber-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 $0.22 per diluted share, up 183% from a year ago.
Similarly, you could 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 utilized 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 on 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 product 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 6 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 a nice order flow from our space customers of $6.1 million, which was up $4.5 million year-over-year and double the sequential quarter and remains a key growth driver in our diversified portfolio. Turning to Slide 9, 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 1 percentage point over our previous guidance. This includes costs associated with the supplemental performance bonus for our Barber-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 million to $16 million, up from our previous guidance of $11.5 million 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, Darryl, you can open the call for questions.
Questions and answers
Thank you. We will now be conducting a question-and-answer session. Our first question comes from the line of Theodore O'Neill with Litchfield Hills Research. Please proceed with your questions.
Thank you, and congratulations on the good quarter.
Thanks, Neill.
Okay. Great. Dan, in your prepared remarks, you mentioned a pipeline of high-growth opportunities that you acquired as part of the P3 acquisition. Could you provide us with more details on that?
They're primarily focused on the space sector, and I can't share too many details due to NDAs. However, P3 has been engaged in developing propulsion pumps and fluid management pumps for space applications, which nicely complements Barber-Nichols and strengthens our ties with the space community. I'm also excited about P3's work in new energy and waste heat power generation applications. Additionally, they develop cryogenic pumps for various medical applications. They possess some impressive intellectual property that we haven't fully explored yet in terms of bringing it to market, which we find very promising. One notable innovation is a multichannel diffuser designed to enhance the efficiency of any liquid pump. Overall, we're very enthusiastic about their cryogenic pump capabilities, which pair well with Barber-Nichols' centrifugal pumps, as P3 provides a positive displacement pump that complements our offerings. We're thrilled to have Phil and his team, who are exceptional engineers.
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. Over the past few years, our team has focused on implementing stronger discipline in capital management, including improving the collection of receivables and extending payment terms when possible. We had several large defense contracts with unfavorable payment terms that restricted our ability to bill until project completion after reaching 50% production. Some of these projects take several years, putting a strain on our cash flow. However, in the last three to four quarters, we successfully renegotiated some of those terms, allowing us to bill more frequently based on project milestones and percentage completion. This change has significantly boosted our cash generation in recent quarters. Additionally, with the $123 million in orders this quarter and a substantial amount in defense orders over the past year, we are receiving cash upfront for materials, although we will need to pay for the inventory as it arrives. As mentioned previously, we anticipate that our cash generation will be somewhat variable from quarter to quarter, but our team has effectively improved payment terms, enhancing our cash flow.
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?
Yes, definitely. As you know, we've guided for CapEx of $8 million to $10 million for this year, which is about 5% at the midpoint of the guidance. And we think that our CapEx spend is going to be in the 3% to 5% range over the next several years just to support that growth in the facility expansion that you just mentioned. So, yes, 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.
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 SG&A 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. As I outlined in my comments today, we had some unusual items in the quarter with regards to SG&A. We've been recording the Barber-Nichols earnout 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, the Barber-Nichols performance bonus is going to be with us for several years. 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 implement 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 $1 million 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 by the time we get to 2027, it should allow us to get to those low to mid-teen EBITDA margin percentages.
Thank you. Dan, is the strength in the aftermarket that you have observed over the past few quarters an indicator of what you might expect regarding capital budgets in refining and petrochemical? What are your thoughts on those end markets?
Yes. First of all, the aftermarket remains strong, and we continue to see elevated order levels. We are also hearing about some promising capital projects that our customers are planning for this year and we're beginning to bid on. This is encouraging. However, I don't think it will be the significant boom that Graham experienced in the past. We're pleased that the aftermarket is holding strong, and we're preparing for the possibility of a significant uptick. We've been working hard on training new employees and the supply chain challenges are starting to improve, becoming less of an issue. Therefore, I believe we will be in a good position if and when that uptick occurs.
I think Chris mentioned some increased professional fees in your international operations. Does that reflect some of these early capital project discussions, or is that something else?
Yes, I can address that. As we mentioned in our 10-Q today, earlier this year, our audit committee received a whistleblower complaint from our India subsidiary. This prompted an investigation, which involved hiring outside legal counsel and forensic professionals. The investigation confirmed the whistleblower complaint, leading to a broader inquiry that uncovered additional misconduct, primarily related to improper expense reimbursements. As noted in the 10-Q, the financial impact was relatively minor, totaling around $150,000 over four years. However, this did result in an increase in professional services fees, amounting to approximately $750,000 incurred year-to-date for the investigation.
Okay. So, 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 mention bringing scale to the story, is that broadening the end markets? Or is there a possibility to get deeper into the space business when you combine efforts?
Yes, we view it as both. P3 has access to markets that Barber-Nichols doesn’t necessarily cover, and they have a strong engineering team. They are contributing valuable engineering expertise to Barber-Nichols. We see this as an opportunity to expand with P3. While P3 does not have the same production capabilities as Barber-Nichols, we will be able to meet P3's customer needs in production going forward. I see this as a real win-win, as it broadens and deepens the technology that P3 brings.
Great. Thank you.
Yeah.
Thank you. 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 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, from a demand side, I would say, not too surprising just because we're not adding a bunch of new capacity here in this country, and you got to keep the existing assets running at top performance. So…
Okay. It's really picked up a lot in the last year, and I know you have an aftermarket sales force that you started. How have they become so successful in closing orders? Are the orders just there or is it the way you're doing it?
I believe it's a combination of factors. Demand has certainly increased due to high refinery output sustained over time. We have also been investing in our aftermarket team by adding more engineers and making some changes to the leadership in that area, which has had a positive impact. We're still working on this and looking at our international installed base to explore additional opportunities. Our sales offices are collaborating on communication strategies related to component life and service intervals. This proactive approach aims to continue growing our aftermarket business, and I think we still have significant potential for improvement. We're optimistic about maintaining momentum in the aftermarket sector, so we will see how it develops.
Is most of it installed base or is all of it installed base?
Yeah. Pretty much all of it is installed base, yes.
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?
We have an initiative starting this week with a kickoff meeting focused on automating our approach to the aftermarket. While I wouldn't say we're using AI yet, we are looking to automate our outreach based on our installed base database, which tracks when components were installed and their typical lifespan. We're determined to enhance our efforts and are actively pursuing ways to engage more effectively with our installed base customers.
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. It's definitely related to the refining and petrochemical markets. So, 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?
Sure.
Thanks a lot and congratulations again.
Thanks, Gary.
Thank you. Our next questions come from the line of John Bair with Ascend Wealth Advisors. Please proceed with your question.
Thank you. Good morning. Congratulations, Dan and Chris.
Thanks, John.
It's great to see the debt reduced. I have two quick questions. One is about the possibility of reinstating a dividend within the next year. The second question relates to aftermarket sales; could you provide a rough breakdown between traditional refining and marketing upgrades and biodiesel, which you've mentioned is part of the mix?
Yes, John. Let me address the first question regarding a dividend. As we discussed earlier, we have significant capital expenditures that we need to undertake in the coming years. We also have numerous organic growth opportunities that offer more than a 20% return on investment. These areas are our primary focus, in addition to expanding our pipeline for mergers and acquisitions, with P3 being a clear example of the types of opportunities we want to pursue. Thus, for the next several years, our emphasis will be on organic growth, M&A, and reducing any debt that may arise from M&A activities. Currently, the Board has not made a decision to reinstate the dividend at this time.
That makes sense.
In response to your question about the aftermarket for traditional versus biodiesel, we have observed an increase in the use of biodiesel applications as some refineries are being converted. However, I don't have specific details about the aftermarket. The installed base is currently quite small compared to that of refineries, which leads me to believe that the aftermarket is also relatively small. Unfortunately, I can't provide a precise figure, but it is minor in comparison to the refinery aftermarket.
What does the aftermarket look like in the international market where you have an established base of past business?
Very various…
Are they on the same cycle, I guess, is what I'm getting at? Is our industry here running hard? Is that a similar situation internationally?
Yeah. It’s – 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 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. And as we build that installed base, we have plans to be much more aggressive in going after that. So, as I have 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.
Well, great. Keep up the good work, it’s 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 Thoren 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 22 and then the Sidoti conference on March 14. 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.