Graham Corp (GHM) Q1 2022 Earnings Call Transcript

Greetings. Welcome to Graham Corporation's First Quarter Fiscal Year 2022 Financial Results. 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. At this time, I'll now turn the conference over to Deborah Pawlowski, Investor Relations for Graham Corporation. Ms. Pawlowski, you may now begin.

Thank you, Rob and good morning, everyone. We certainly appreciate your joining us today to discuss Graham's first quarter fiscal 2022 financial results. We announced those results earlier this morning and you should have a copy of that along with the slides that will accompany our conversation today. If you do not have the releases or the slides, you can find them on the company's website at www.graham-mfg.com. We also simultaneously this morning announced the planned retirement of Jim Lines, our Chief Executive Officer. He's on the call today with us and will be making some formal remarks. Also joining us are Jeff Glajch, our Chief Financial Officer; and Dan Thoren, our President and Chief Operating Officer, who has been named effective with Jim's retirement, our new Chief Executive Officer. Jim will start with his overview and then cover the brief results of the quarter. Jeff will then review details of the financial results and then we'll have Dan close out with his remarks. As you are aware, we may make some forward-looking statements during this discussion as well as during the Q&A session. These statements apply to future events and are subject to risks and uncertainties as well as other factors, which could cause actual results to differ materially from what is stated on the call today. These risks and uncertainties and other factors are provided in the releases and in the slide, as well as with other documents filed by the company with the Securities and Exchange Commission. These documents can be found on our website or at sec.gov. I’d like to point out that during today's call, we may also discuss some non-GAAP financial measures which we believe are useful in evaluating our performance. You should not consider the presentation of this additional information in isolation or as a substitute for the results prepared in accordance with GAAP. We have provided reconciliations of comparable GAAP with non-GAAP measures in the tables accompanying today's earnings release. With that, it's my pleasure to turn the call over to Jim Lines. Jim?

Thank you, Debbie and good morning, everyone. I will begin my remarks at Slide 3 and provide a brief review of the financial results, before discussing my planned retirement. Revenue in the quarter was $20.2 million, $16.7 million was organic and $3.5 million was due to the acquisition of Barber-Nichols that closed June 1. Defense revenue was 35% of total revenue in the quarter. We do expect that defense revenue will approach 50% of total quarterly revenue with Barber-Nichols fully in future quarters. This acquisition and the shift in revenue mix is a major transformation for Graham and measurably advanced our diversification strategy. On an organic basis, revenue was similar year-over-year. However, it was for different reasons. You might recall that our first quarter last year operated at nominally 50% capacity due to COVID-19, thus impacting revenue and profitability due to under-absorption. In the most recent quarter, our workforce utilization was at capacity. However, mix was very different. Orders from our crude oil refining and chemical – petrochemical markets were very low during the third and fourth quarters last fiscal year where non-Navy orders totaled $17.5 million for both quarters. Consequently, greater production resources were pulled into Navy backlog, which are lower margin due to first article work and also due to contract structure for a large order in backlog. Those headwinds work out of backlog across the next few quarters and largely behind us as we exit this current fiscal year. Organic revenue and profitability are expected to improve across the fiscal year. Orders in the first quarter were $20.9 million and were principally organic. Barber-Nichols orders were $200,000 for the month of June. Somewhat encouragingly, there were strong orders from our crude oil refining market in the quarter that totaled $11.5 million. We did have a significant win in the quarter for a domestic refinery revamping their facility to improve crude oil feedstock processing flexibility. That particular win was gratifying for me. I still remember losing the original order to a domestic competitor in the mid-1990s. And now, 25 years later, we won back the installation and replaced the original supplier with our own vacuum systems. Consolidated backlog at June 30 was $236 million, of which 80% is for defense. Importantly, as we work through the more challenging margin backlog, that impacts the current fiscal year, margin potential for our defense backlog improves measurably. Barber-Nichols acquisition provides additional market diversity to our profile, as it also adds backlog for new markets including space and advanced energy industries. While we put considerable cash toward acquiring Barber-Nichols to strengthen and diversify revenue along with earnings, our balance sheet remains strong and our opportunity to drive our return on assets improves. As announced earlier today, I am pleased to confirm that I will retire effective August 31 at the end of this month, and Dan Thoren will succeed me as President and CEO of the corporation. He will also join our Board of Directors at that time. It has been a tremendous honor for me to serve Graham shareholders and the corporation as its Principal Executive Officer since 2006. I believe I am leaving on a high note, as this is an incredibly exciting time for the company, particularly due to the strength of our organic defense strategy, having achieved preferred supplier status for many products provided to the US Navy, and in some cases, bidding on a sole-source basis. The credit goes to Alan Smith and his team for executing our defense strategy effectively. Secondly, we have made significant progress in innovating execution to succeed in price-focused international crude oil refining and petrochemical markets. Our sales team has demonstrated our ability to capture market share, and our operations team has shown that we can meet or exceed target margins. Thirdly, we have invested in IT tools, systems, and resources to leverage our installed base, which I believe will lead to benefits as crude oil refining and petrochemical customers invest in existing facilities with greater throughput before considering new capacity. We are ahead of competitors when it comes to commitment to the installed base. Lastly, the transformational acquisition of Barber-Nichols creates a strong growth platform for both organic and M&A expansion. Over nearly three years, I have had the opportunity to work with Dan through the acquisition process and most recently, the last two months as he was onboarded with the Graham team. I believe that Dan is equipped to lead Graham and has a terrific vision for the company's next growth phase. I am excited that this acquisition has proved to be as transformative as we had envisioned. Part of that transformation is strengthening our leadership team. In the last couple of months, it became clearer that this has provided for my succession plan as well. I'm glad the Board recognizes the potential in Dan that I have seen. As a Graham shareholder, I look forward to benefiting from the value of Dan's strategic direction. Congratulations, Dan. You have my full support through this transition and into the future. I would also like to thank our shareholders for the many conversations we've had over the years and for your ongoing support. Now, I will turn the call over to Jeff for his review of the financial results. Jeff?

Thank you, Jim, and good morning everyone. If you can move to Slide 4. As Jim mentioned, we had a very rough first quarter. As I discuss that first quarter, I would like to keep in mind that our full year guidance is unchanged. Therefore, we expect to see improvements as the year goes on and we expect sequential quarterly improvement across each quarter for the rest of fiscal 2022. Sales in the quarter improved by $3.5 million, which was due to the one month that we owned Barber-Nichols. The comparable quarter last year was early on during the COVID pandemic. And as Jim mentioned, we ran the company at half capacity during that quarter. However, in that quarter, we did have a $5 million project which was recognized on a completed contract basis, and because of COVID, had shifted from fiscal 2020 into Q1 of 2021. Gross profit and EPS were dramatically affected by a very poor mix of projects and some timing and some cost items. Namely, we had some liquidated damages due to COVID in the quarter and some timing of expenses which were pulled into Q1. We also had a small amount of acquisition expenses about $169,000 pretax and the first month of purchase price accounting related costs for Barber-Nichols. To clarify the latter, the purchase accounting amortization costs were $225,000 before taxes in June. Before we move on, I want to mention that we expect approximately $2.7 million pretax and $2.15 million after tax related to acquisition purchase accounting. 90% of this is amortization costs, with the rest being a step-up in depreciation and inventory. We will be filing an 8-K later this week with much more detail on the purchase accounting and pro forma income statements. We expect the amount of amortization will be similar in fiscal 2023 as fiscal 2022, since we will have 12 rather than 10 months of amortization in fiscal 2023. It will decrease in future years and level off at approximately $1.1 million pretax. On to slide five. With the acquisition of Barber-Nichols, we have moved from a very inefficient to a much more efficient balance sheet. We have added $20 million of low-cost term debt as part of the acquisition and we have access to a much larger revolving line of credit. This term loan and the line of credit will provide ongoing flexibility. We expect the acquisition of Barber-Nichols to be accretive in fiscal 2022, even with the $2.15 million, or approximately $0.20 a share in added amortization costs. We will continue to look for both organic and M&A-related growth opportunities and believe we have the financial strength to invest in both areas. With the addition of Barber-Nichols, we believe there are some excellent opportunities in both arenas. On to slide six. Orders in the commercial markets picked up in Q1 off a very low base in the previous two quarters. With a $236 million backlog, we are well positioned for long-term growth. 80% of that backlog is in the defense market, which provides an excellent baseline for our business, not just this year, but in upcoming years as well. We expect approximately 50% of our forward-looking business to come from the defense market, and with the opportunities for growth in the space market and recovery in the energy markets, we are excited about the future. Before I pass it over to Dan, I would be remiss if I didn't recognize Jim for his 37 years of service at Graham, the last 15 years being as leader. He has transitioned Graham from a company which was capacity limited and had minimal growth engines to a much broader organization with strong footprints in defense and the Asian energy markets to couple with our long history in the United States and Middle East. Look nearly anywhere in the world and you will see Graham equipment in many world-class refining and petrochemical facilities. You will also see Graham equipment playing a key role on US Navy vessels which support our country's national defense. I also want to welcome Dan. I've known Dan for the past three years, including negotiating the acquisition with or perhaps against him during part of that time. Dan is a very high character leader with a great history of Barber-Nichols and I expect him to do the same at Graham. Over the past many months when the Board members have asked for my view as Dan, as a potential CEO, I was and continue to be unequivocal in my belief that Dan is the right CEO, to take Graham forward. Now that I've set the bar high, Dan, I'll pass the call over to you.

Thank you, Jim. Thank you, Jeff, very kind words, very kind introduction. Good morning, everyone. I'd like to start by thanking the Board of Directors and Jim Lines, specifically for placing their confidence in me to lead Graham Corporation. I've spent 2.5 years getting to know Graham, their leadership and at a high level their business. Indirectly I've learned a little about their culture, their people, their customers and their Board. Over the last two months, I've met with the executive team, managers, employees, customers and the Board to understand the company in more depth. These interactions have helped me understand the proud engineering and manufacturing heritage at Graham, the importance of the company in the community of Batavia, New York and how they have become a trusted partner to their customers across the world in the critical process industries that they serve. As I go through my slides, I'll give you an idea of how we are developing our strategy to build upon our strong legacies while leveraging our opportunities in the defense and space industries. Specifically, we'll be working to generate sustainable earnings growth, reduce that earnings volatility, improve operating performance, generate strong cash flows to reinvest in our business and provide a dividend to stockholders. The ultimate goals are to provide an acceptable return to our stockholders and provide benefit to all of our stakeholders. Now let's focus on Slide 7. With Graham Corporation acquiring Barber-Nichols, we recognize that the two businesses have individual strengths, serving their respective markets that we do not want to disrupt. Our strategy is to leverage the strengths of each as platforms that provide potential for both organic and inorganic growth. As such Graham operations and BN operations both operate under the Graham Corporation umbrella. As we consider future capital investments, our plan is to add new companies and technologies with related engineered product that can stand alone yet collaborate to win bigger business. Leverage best practices between subject matter experts in the companies, share services across the organizations and provide career paths for key employees. When we do these things each member company can remain focused and agile while accomplishing more than they could alone. As you look at Slide 7, this depicts our two platforms for expansion. Barber-Nichols is currently in space and defense predominantly. Graham manufacturing is currently in Defense, Energy and Petrochemical. For the space industry, we believe there are acquisition opportunities in this expanding market as it gains more interest in private investment. We will be looking for small acquisitions that we can tuck in, as well as medium acquisitions that can stand on their own and are complementary to our current businesses. We are also focused on internal investments to develop new products and technologies in that space industry. Both Graham and Barber-Nichols are well engaged in the defense industries. We'll be looking for new areas to provide value, as well as internal investments and acquisitions that can help us grow into new and more sophisticated product. Graham has been a world leader, in vacuum and heat transfer products for energy and chemical petrochemical applications. As Jim and Jeff had discussed over many years, the domestic market is flat and the international markets have room for growth. We intend to focus on our domestic installed base and provide customers the support they need to keep those plants running at an optimized level. We'll continue to invest in international markets and grow our presence around the world through our successful shared margin strategy. More recently both companies are seeing opportunities to engage in the alternative and clean energy markets through turbomachinery and heat transfer products. Clean energy is actually an area where synergy between companies is possible. Strategically, we plan to both service and grow our legacy business while having the engineering and new product capability to participate in these new alternative and clean energy markets. Now each one of these markets that I have gone over have their own risk and reward profiles. Having teams focused in each area is paramount and we are well along with the organizational changes needed to successfully execute our strategies in each of the markets. Let's move to Slide 8. As Jim and Jeff discussed earlier, we look at fiscal '22 as a transition year with a tough start getting better sequentially by quarter. Meanwhile, we are seeing a stronger pipeline with more inquiries and new orders in the second quarter. Graham manufacturing second quarter orders are $9.5 million to-date, while Barber-Nichols has booked $9.1 million. Based on the timing of customers' projects, we are holding our revenue guidance at $130 million to $140 million of which Barber-Nichols is expected to contribute between $45 million and $48 million. Combined the Defense segment is expected to account for almost half of the revenue and EBITDA is expected to be in the $7 million to $9 million range. Let's go to Slide 9. As alluded to in my initial remarks, we are transforming Graham Corporation. Barber-Nichols was the initial transformational acquisition. We will be looking to solidify the Barber-Nichols investment through further investment on its platform to enable growth in the defense and space industries as well as other industries as opportunities arise. Coincident with the acquisition, we believe we are at or near the bottom of the energy and petrochemical cycle. We have been preparing for an up-cycle expansion that we believe will start in FY 2023. Our welder training program has been very successful in refilling our pipeline of future employees. We are qualifying additions to our supply base to enable additional capacity with the expectation of a potential up cycle. Our plans include expanding our international offices with sales, quality and project management personnel. Both Barber-Nichols and Graham have leading market positions and strong brand recognition. We believe that strong engineering working hand-in-hand with customers on challenging applications and delivering high-quality products on time will enable us to maintain those brand strength and market leadership positions. As we advance our transformation, we will be improving our market presence with linked and updated websites and social media. We believe that this will expand our exposure to a broader audience that doesn't yet recognize our growth and earnings potential. Personally, I have a strong interest in being a great corporate citizen and working with all of our stakeholders to build a better stronger business for us all. With the BN acquisition Graham puts its large cash reserves to work and created a more efficient balance sheet. As we continue to improve our business and further our strong cash-generating capabilities, we'll intend to make smart choices to allocate that capital for further growth with a keen focus on returns. We are very optimistic about this new combination in the future it presents for all of us. When you have a talented team of people that can see problems for your customers, work with them to design and build solutions to those problems and then shift when the markets change you will be successful. At Graham Corporation, we have that ability and we will be looking to add more. With that, operator, we are ready to open the call for questions.

Thank you. At this time we will 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 question.

Yeah. Thanks very much. So first question, in your slide presentation you used an image of the Blue Origin New Shepard reusable launch vehicle. Can you give us a little more detail on Graham's opportunity in space development programs?

Yeah. Barber-Nichols is involved in quite a few different new space as well as existing space applications. And so historically, we've been involved in the propulsion side. So rocket engine turbo pumps, the pumps that basically take the fuel out of the tanks and supply it to the combustion chamber to provide propulsion. We're seeing more-and-more applications for the next journey in space. So you worry about launch first. And then, you worry about or think about living in space or operating in space second. And so, we're starting to get more opportunities for turbomachinery, fluid and power systems for space-based vehicles. And so I won't talk about specific customers or very specific applications. But think about launch and then, think about living and operating in space as kind of the follow-on to that. And that's where Barber-Nichols has been involved and has future opportunities.

Okay. In the prepared remarks, you say that margins were impacted by your aggressive strategies to enter the naval nuclear propulsion program, which clearly was successful. Does it mean you underprice the project to get the business?

Theo, this is Jeff. We did price aggressively to secure the business. Some of these projects are the first in a specific vessel, which comes with operational challenges. We understood that these would be tough jobs, but we successfully secured them and executed well from a customer perspective. Importantly, we've shifted the business so that a significant portion of our current backlog is sole sourced. If you look at the backlog today, particularly on the historic Graham side and not including Barber-Nichols, most of what has come into backlog over the past couple of years has been sole-sourced.

Great. Thanks very much.

The next question is from the line of Dick Ryan of Colliers. Please proceed with your question.

Thank you. On the margin question again, can you give us the impact? And which vessel programs those were tied to? And then maybe, looking down the road, with being a sole-sourced, what kind of margins should we consider going forward?

Dick, I can't provide much detail on your first question, but it involves multiple boats. As we look ahead, especially entering fiscal 2023 and beyond, we anticipate a significant increase, not just a couple of hundred basis points, but much more towards a normal level of profitability. While I cannot specify a margin number, I can assure you it is considerably more than a couple of hundred basis points.

Okay. Thank you. On your commercial side, the increased business coming through there, how does that margin profile stack up? I thought, you said, it was more domestic business. And I know, the Chinese and Indian markets are probably more price sensitive. So can you kind of handicap that going forward?

Dick, as Jim mentioned, we had the one order in the first quarter, I believe he was speaking of on the domestic side. But we've also had some orders of – some of the ones that Dan mentioned, were in the international markets. Even the ones that are in the international markets are not at a poor margin level they're actually at a pretty decent margin level. So the orders that have come in – in the first quarter and the ones so far in the second quarter that Dan talked about are all at a better margin level than what we've been pulling out of backlog over the past – this past quarter. Again, a lot of that was due to a really low order level in the second half of fiscal 2021.

Yeah. I know, you haven't published your target model, but when you get into 2023 and 2024 with the rebound in energy and defense kicking in. Can you give us a range of where do you think gross margin should be coming in when kind of both sides the commercial and the defense market are operating more efficiently?

Dick, at this point, we've not provided anything in the future looking at gross margins. I will talk a little bit about EBITDA margins. And those we do expect – if you look at this year's EBITDA margins relative to our guidance, you'd see that they would be kind of in the 5% to 6% range. We expect those to noticeably step up as we get into fiscal 2023.

Okay. Thank you.

You’re welcome, Dick.

The next question is from the line of Andrew Shapiro with Lawndale Capital. Please proceed with your question.

Hi. Thank you. Sorry to pile on, on this the issue, but margins are I think the main focus here. Maybe, I could throw out the question in a different way. If you could help clarify or maybe bridge the steps to achieving the normalized range of margin? And can you at least identify, what kind of range of margin would be appropriate? And when I'm asking about the clarification of bridging us from our current below expected margins to a normalized margin, this is independent of the overhead absorption of revenue growth. I want to get to that in a follow-up question.

Okay. Andrew, this is Jeff again. As we – a couple of things. First off, if you look at the first quarter results and we talked about that – of the $20 million in revenue, about $3.5 million was Barber-Nichols, the rest being the historic Graham business. Most of the challenges that we had from a margin standpoint, and I'll talk EBITDA margin, if that's okay. We're on the Graham – historic Graham side. Those will start to work their way out in the second half of the year, and we would expect those to turn positive in the second half of the year. Some of it will be due to the transition from the mix of – away from the mix of some of the lower profit projects that we had that will run through the first quarter and we'll be running throughout the year, but will be a lesser percentage of our business going forward, and we'll be through with most of that as we get through the end of the year. So some of it is a mix of projects on the Graham side, and again, we'll move that toward a positive profitability level. In the first quarter, Barber-Nichols contributed only one month of revenue, which was lower than anticipated for the year. Dan indicated that our guidance for Barber-Nichols is between $45 million and $48 million for the full year. With only 10 months remaining, this translates to a monthly revenue expectation of $4.5 million to $4.8 million, while the actual revenue in the June quarter was only $3.5 million, reflecting a lower performance than usual. This also led to reduced profit margins. However, as we move into the current quarter and proceed through the third and fourth quarters, we anticipate Barber-Nichols will achieve higher revenue levels, positively impacting profitability. Overall, we expect the historic Graham business to progress towards achieving positive EBITDA, particularly in the third and fourth quarters. The Barber-Nichols business, based on the guidance provided on the June 1 call, is expected to achieve low double-digit EBITDA levels in the second, third, and fourth quarters. While there may be fluctuations between quarters, we anticipate that throughout the next nine months, EBITDA will improve from the low performance seen in the first quarter. Our revenue expectation for the last three quarters is between $37 million and $40 million per quarter, along with a positive EBITDA margin. We expect revenue to grow sequentially from the second quarter into the third and fourth quarters. I want to elaborate on one point related to your question and also to Dick Ryan's question from a few minutes ago. If we look at the EBITDA margins this year, they're at 5% to 6%. If you exclude the first quarter, we achieve high single-digit EBITDA margins. While I don't want to give extensive guidance for fiscal 2023, I anticipate that we will transition into at least low double-digit EBITDA margins as we enter the year. I hope this clarifies Dick's question and provides insight into the anticipated growth of our EBITDA margins. Please let me know if this helps.

Yes, it was quite beneficial for follow-up. Regarding the remainder of this fiscal year and the beginning of next year, can you clarify whether the revenue streams refer to the existing backlog of orders, or if they also encompass projected revenue growth beyond the current booked business?

Sure. The vast majority of it includes things that are already in our backlog and I will include our backlog to include some of the orders that Dan mentioned that came in during the month of July.

Okay. That's fine. Let me elaborate a bit here because I believe it will be helpful. If you consider our guidance of $130 million to $140 million, I'll simplify the math and use the midpoint of $135 million. Looking at Barber-Nichols, which is forecasted to be $45 million to $48 million, I'll take the midpoint of $46.5 million. Subtracting that from the total, we end up with about $88.5 million for the historic Graham business. The first quarter showed a growth of around 16.5%, leaving approximately $72 million for the remainder of the year. This indicates that the average revenue for the historic Graham business over the next three quarters should be around $24 million each quarter, which is an increase of about 50% from the first quarter. However, I don't anticipate that it will be exactly $24 million for each of those quarters; rather, I expect it to grow throughout the year. The second quarter will likely be lower than $24 million, but we expect the third and fourth quarters to meet or exceed that figure. Therefore, part of the ramp-up to enhance your confidence in profitability includes significant growth in the historic Graham business along with increases in the Barber-Nichols business. I hope this additional information has been valuable. Yes. Regarding the shortfall or disappointment in the margins of the legacy Graham business, I assume these are fixed-price contracts. Did they face unexpected challenges? Were the bids too tight, resulting in low margins? What issues arose in these projects that impacted this quarter and may lead to a decline in arbitrage in the upcoming quarters?

Sure. Much of what you mentioned was bid aggressively. We knew when we placed those bids that these projects wouldn't be outstanding, but they also wouldn't be terrible. Our team has performed well, especially considering that the first project for a certain vessel can pose operational challenges. I believe our team has done an excellent job addressing those challenges, but there are costs associated, which usually means additional labor to complete the tasks. Additionally, we've received some short-term material orders that ultimately became part of a larger order. Unfortunately, due to how the profit was allocated, we ended up making a bit more profit on the material aspect of the order, which has made the execution portion less profitable. All these factors combined have had an impact. As we talk about the projects going forward, again, what's come into backlog that are sole-sourced are at a better position, because they're not aggressively competitively bid. They're certainly not projects that we're going to make an enormous amount of percentage margin on, but they will be much fairer to both the customer and to Graham as the vendor.

Understood. Please proceed.

Barber-Nichols has experienced similar challenges with some of our DOD and Navy projects, which is common in the industry. When entering a new area, we tend to be quite competitive and bid aggressively, but not excessively. Our initial articles involve a significant learning process, during which we develop our processes and invest in engineering. This initial investment is not repeated in subsequent articles, leading to a steep learning curve. The first article certainly presents challenges, but as we recognize revenue over time and progress through additional units, we see continuous improvement. Jeff and Jim highlighted that the initial articles can be a burden, but once we move past them, the subsequent articles tend to improve. Looking ahead, we anticipate that this trend of improvement will continue on a quarter-by-quarter basis, which aligns with typical new Navy project development.

So, these projects that contributed to the disappointment in this quarter and then are going to be worked off, if you could clarify. The bulk of these are on products or programs that are not like working themselves off and they're done. These are like the first round of whether it's going to be successive orders and successive similar products for which you will have obviously developed production efficiencies and workarounds, et cetera. Is that correct?

Andrew, that is correct. And not only are they projects, they're programs that we are continuing to be in, but in most cases we already have those in our backlog for the next article.

Okay. And then moving on to go on Dan.

I would say Andrew that this is good business and we'll continue to chase additional Navy opportunities where we will do first articles and the first articles will be a challenge to get through, and then subsequent ones will get better and better. So this will be a recurring theme. And we've seen it in Barber-Nichols too where when you first get into it they're tough.

Okay. And, moving on to one last other topic here was your discussion on future growth deploying capital, capital allocation opportunities. And one of those things you described was it seems like then there was greater language of this than in the past maybe is an acquisition focus. And so I was wondering on acquisitions is where is your focus? Is it just in space? As you mentioned there are some opportunities. Is there already a pipeline of acquisitions you're evaluating? And I know Barber-Nichols acquisition was three years in the making. Do you have somewhat of timing thought process on all of this? Is there a certain amount of absorption swallowing integration to go on with Barber-Nichols before the next acquisition is compelling and teed up for the Board and for you to present to our shareholders?

So Andrew, this is Jeff. I'll begin and then I’d like Dan to share his insights as well. You're right that the Barber-Nichols acquisition took three years, and I might jokingly blame Dan for the negotiations, but that’s not really the case. To answer your question regarding integration, given how our businesses operate and the leadership in place, we don't expect much of a challenge with integration. It won't take us a significant amount of time, nor will it hinder our acquisition process. Currently, we are assessing our organization, examining our capabilities in the various markets, and trying to determine which markets we should pursue more aggressively and prioritize. We aim to focus our efforts rather than attempting to target everything at once. Over the next few quarters, part of our focus will be identifying market opportunities, and we're having the Barber-Nichols team collaborate with the historic Graham team to pinpoint the right opportunities for us to pursue. Is space an opportunity? Absolutely. Is defense an opportunity? Absolutely. Is energy an opportunity? Perhaps to some extent, but not to the same level as the other two. We want to carefully evaluate the markets and determine how we should position ourselves within them. Instead of rushing to pursue a large number of companies, I would prefer to take our time until we have a clearer understanding of our focus. There are promising opportunities available, and I'm not concerned about the quantity of targets. My focus is on ensuring that we concentrate our efforts on the right ones. Now, I’ll turn it over to Dan for any additional comments he may have.

That's actually very well said. The prioritization is going to be probably our biggest internal challenge. We feel like we've got lots of different opportunities that we can go chase. And ultimately from a direction standpoint what we're looking for is these smaller companies that we can either tuck in to one of our existing companies or a company that can stand on its own and is complementary to our other businesses. We like to think about companies that are complementary and can join together to go after larger business. That engineered product is really key. That complementary piece is very key that enables us to go after larger more sophisticated systems. So the challenge will be again where do we prioritize? And we're definitely deep into that process right now.

And is the focus primarily defense, or if you - or would you be looking for something in petrochemical or something like that as well?

We're very open. We're evaluating space defense. There's fluid systems in general that we're looking at that you can kind of apply fluid systems across a bunch of different kits. So yes, we're pretty open at this point and trying to understand where the best opportunity is earliest that would provide the focus that we want to go chase for our next acquisition.

Hey, Andrew, this is Jeff. I'll go first and then let Dan add his thoughts. From my viewpoint, our acquisition team at Graham is quite small, mainly consisting of myself and Chris Johnston, our Head of Business Development. We've consistently focused on exploring external opportunities and will continue to do so. I'm particularly excited about the Barber-Nichols team because they have conducted extensive work analyzing the platforms within their business. They are considering not just which other companies they want to pursue for growth, but which technologies, areas, and products they want to develop. This approach has been more market-oriented rather than centered on specific companies, and now we're bringing our two groups together. In fact, we're actively working on this today. There are meetings today with Chris Johnston and his team, along with the Barber-Nichols team. I'm excited about leveraging the expertise from Barber-Nichols and having them collaborate with the corporate acquisition team, which consists of Chris and me. Dan has extensive knowledge of the Barber-Nichols markets and is providing significant guidance to our team as we plan for the future. Barber-Nichols has been less focused on acquisitions but has conducted a thorough analysis of their markets to identify expansion opportunities, whether organic or inorganic. We intend to leverage that insight as a company to explore both organic growth and M&A opportunities.

As Barber-Nichols examines our markets, we essentially supply a pump for transferring fluid between two points. There are numerous components that might be involved in this process, such as control valves, plumbing, a skid for support, and heat exchangers, among others. When considering fluid systems, we look at the entire system and all its components. We've made significant progress in identifying our gaps. Prior to the acquisition, our focus was primarily on organic growth and identifying the next component we needed to elevate our position and deliver a more advanced system or subsystem. Therefore, while we are not concentrating on specific companies, we have a clear vision of the elements required to enhance our offerings.

Our next question is from the line of William Bremer with Vanquish Capital Partners. Please proceed with your question.

Can you hear me?

Yes.

First thing Jim, it's been a pleasure all these years. Congrats on the retirement. Daniel welcome. I look forward to meeting with you. And Jeff, you did a great job just now in that clarity not just on the financials but in end market. My question is specifically on – you just touched on this on the fluid handling systems. I'd like you to go into your opportunity primarily in hydrogen and what you're seeing there. And educate us a little bit on if you – if these projects that – they're dicey they're bit lumpy. I understand that a little bit on the permitting issues that you may be seeing and how long it takes but more importantly, your exposure and potential margins there? Thanks.

Yes. So it's – the hydrogen economy is very old and it's very new. So Barber-Nichols played in the hydrogen economy very early. We had a lot of the automotive companies we're looking at hydrogen-powered fuel cells. And so – gosh, 15 years ago some of the larger automotive companies were starting to look at that and we were providing anode cathode blowers for their R&D types of systems. Kind of fast forward to today and hydrogen economy is still a discussion, I think the position that Graham and Barber-Nichols play there is really on the component side and less on the system side. We are – both companies are talking to various potential customers and customers about what they are doing with the hydrogen, how do you make hydrogen, how you distribute hydrogen how you fuel different vehicles with hydrogen. And so we're involved in all of those discussions boy it's way too premature to talk about exactly what our play will be there, as well as what our margins will be, but you can be sure that we are engaged in that and having some very great conversations with customers that – we hope to be able to talk a lot about in the future but right now too premature.

No. Completely agree, fair. Would you be selling this potentially direct or through distributors?

I would guess it's going to be direct, yes. I don't see it really getting to the point where it's commercial off the shelf for quite a while. So it would be going direct to the OEMs that are building the larger systems.

Yes, hi. In your fourth quarter conference call, one of the priorities was to speed up your backlog conversion by growing your workforce capacity. I think Jim said, he wanted to grow up by 20%. He also said that Batavia currently has the infrastructure to handle the workforce expansion. Can you just talk us through that growth plan and its timing? I know that you said that the welder pipeline is picking up.

Gary, this is Jeff. We are looking to – continue looking to grow. Obviously it's – as many companies are finding it's challenging to bring on new employees. So what we're doing – Dan talked about part of it with the welder training that we have in-house. We also have engaged with a third-party to provide additional wells, really to source additional individuals and provide additional welder training for us. And then – and some of these folks come in fairly fresh with minimal capabilities on the welding side. But they're being taught – what we need them to have those capabilities to ultimately join our organization. So I don't have a great time line on you just because the uncontrollable variable is the number of individuals that are available or they're making themselves available. And certainly, we've seen as many other companies have seen challenges in hiring, but we're trying to bring on, kind of, five or six a quarter if we can possibly do that as we go forward.

Yes. And, I guess, I'd add on to that. From Barber-Nichols' perspective as we've grown you can grow too fast. The people that were looking to train and develop have to have very consistent skills the ability to produce our equipment our fabrications in a very, very consistent high-quality manner. And so you can absolutely grow too fast. I don't think that we're quite there with Graham. We're still kind of bottlenecked on the training piece. But absolutely Alan and his team have done a great job of developing curriculum and being very proactive in priming our pipeline. And I think we're seeing benefits from that. So I can't quantify it real well right now but we're definitely headed in the right direction.

Okay. When you mention accelerating backlog conversion, do you have set delivery schedules? If you speed up the conversion, can you manage that, or does it depend on your delivery rates and schedules?

Yes, we have long-term contracts with specific delivery dates aligned with the shipbuilders to ensure timely arrivals. While we can expedite deliveries to some extent, pushing too hard may result in the shipyards refusing to accept them. There’s a balance to maintain. We have various programs, and in some instances, the shipyards are looking to accelerate our deliveries, while in others, lower demand could mean they don’t require the deliveries as quickly as scheduled. Therefore, we have the operational flexibility to adjust our delivery pace as needed.

Okay. And then I just have one more. I have a housekeeping question. The acquisition of BNI is now 2.5 months old. But when you go onto the Graham website you still have your old website up. And if you look at the Graham's corporate profile, it doesn't say anything about defense. If you do a financial search on Yahoo or Wall Street Journal it says Graham's an industrial machinery company. So anybody who's doing a search for defense companies Graham doesn't even show up. When will that be updated?

Hi, Gary, this is Jeff. And I appreciate you bringing this up and you and I have talked about this one-on-one. We are working on updating our website both with Graham website and the interaction with the Barber-Nichols website. We recognize that if there's one area we've let slip through the cracks. That's clearly been it. But we are working on improving our website and we should hopefully be seeing some impact to that soon and then over time much greater impact. Barber-Nichols has done a great job over the last year focusing on their website and improving it. And we're looking to do the same for the Graham website and linking the two. So I appreciate your frustration. I have it also but that's on us and we need to get that to work.

Can't you at least change the wording on your profile and send out contact information to different financial companies saying that you're now a new company please change our profile don't put us in industrial machinery anymore?

Yes, we are doing that. We are actually working on that Gary.

We do have one more, I'm sorry. But we have one more in the queue if you'd like to take that call right now.

Sure. My apologies. So that's one of Andrew Shapiro with Lawndale Capital.

Thanks for the follow-up. This is actually related to Gary's comments. In addition to updating the website and changing the wording, what are your upcoming investor outreach or engagement events? I know you're participating in Seaport Global and may have some Midwest ideas. What planned Investor Relations events are you considering to ensure the company engages with defense sell-side analysts, rather than just those focusing on industrial machinery? Currently, there are only a few sell-side analysts covering the company, and I believe there could be more in the defense sector.

Andrew this is Jeff. Thank you for that question. You are correct that the two conferences at the latter part of August I believe the last Wednesday and Thursday of August which would be the 25 and 26 we have those. Colliers is having a virtual conference the second week of September. Don't put me on the date but I believe it at 9.

At 9.

Thank you, Debbie. Sidoti has a virtual conference in late September that we are attending. We are also planning to attend the Southwest New IDEAS Conference in mid-November, which is currently scheduled to take place in person in Dallas. In addition to that, we are having calls and video meetings with investors, and I would be very open to in-person meetings if investors want to meet. Dan and I met with a few investors in person here in Denver back in June, but we are more than willing to travel to meet people if they are comfortable with it, considering the ongoing COVID concerns. We are also exploring opportunities in the defense sector right now, with assistance from Debbie Pawlowski and her team at Kei Advisors, looking into areas where we can expand while still maintaining our focus as an industrial company, particularly in defense and aerospace. We are actively trying to communicate our message, and I find it quite frustrating that it's challenging to do so in person these days.

Yes, if you can get into some of the databases and then you'll show up in the relative comp tables that will be a start?

Absolutely.

And I think you'll see when you see our next 10-Q that we are advancing the discussion regarding being a defense company in those disclosures.

Great.

At this time I'll hand the floor back to Dan Thoren for closing remarks.

We do have one more, I'm sorry. But we have one more in the queue if you'd like to take that call right now.

Sure. My apologies. So that's one of Andrew Shapiro with Lawndale Capital.

Hi, thanks for taking my question. First of all, I'd like to congratulate Jim. It's been a pleasure working with you. I appreciate all the assistance you've provided over the years and helping us better understand Graham. So we wish you well in your retirement.

Thank you very much, John. I enjoyed working with you and everyone else that was on the call and other investors over the years.

Good luck. I have two questions. First, regarding the margins, what was the liquidated damages amount that you highlighted?

Sure, John. I can't disclose that, but I can say it did have a noticeable percentage of the impact on the quarter, even though it wasn't a large percentage of the overall impact.

Can you frame it, somewhat for us?

Yes, it's a few hundred basis points.

A few hundred basis points impact on gross margin?

Yes, a couple of hundred basis points on gross margin and also on EBIT or EBITDA margins.

Good. That's helpful. And I'd like to welcome, Dan. My question to you Dan is, perhaps I would guess you have an employment agreement. And I would be curious hopefully, a large percentage of your comp is incentive-based. And I'd be curious, how that's structured? I presume it might be disclosed in an 8-K or we're certainly going to see it when the proxy comes out. But I'd be curious as to, what's your incentive compensation is tied to, specifically?

John this is Jeff. I'm going to jump in for one second and then let Dan jump in. The 8-K on the employment agreement will be filed over the next couple of days. It does not delineate the specifics of Dan's, variable comp. It does talk a little bit about it but it does not very delineate the specifics. But I can assure you that his variable component is a very large percentage of his total compensation. And I'll let Dan jump in and talk about what areas he is focused on to meet those goals.

Yes. The conversation I had with the comp committee really pushed towards a less fixed and more variable. I am a person, that is long-term driven. And I wanted to make the statement that I'm invested in this long term. And so, I think you'll see that my compensation tends to head in that direction. Coming from a private company, I am really driven by planning and building the organization to execute the plan. And so a chunk of my compensation will be tied to my ability to get a strategic plan in place for the Board that meets their expectations. Another piece as a private company leader has been that I don't have experience with Investor Relations, and a lot of this quarterly earnings call and investor conferences and all of that. And so again one of my areas of learning and need, to help Graham going forward is, absolutely in this Investor Relations piece. And so I've got several different things that I'm doing there to get up to speed quickly, so I can be a more effective leader there.

John, one last piece for me. This is Jeff, again. Across our long-term incentive program while half of it are time vested shares, the other half are performance vested and the performance vested now all going forward not just for Dan, but for all the executives are completely tied to relative total shareholder return. So we think it's important and Dan is very strong on this. He and I have spoken about it a couple of times that we want to align our interests with the interest of the shareholders. And the long-term incentives are tied that way. The shorter-term incentives are more focused on the next one- or two-year performance but ultimately all of our focus is on total shareholder return. And quite frankly Dan, when Graham bought Barber-Nichols, took a meaningful portion of his proceeds from the sale in Graham stock. And so he is absolutely tied into the return to the shareholders.

Okay. Great. And in terms of those short-term metrics, I mean is it growth driven? Is it EBITDA driven? What are the key metrics there?

Historically, our proxy from last year serves as a good reference, showing that there are typically three components. One component relates to financial performance for the year, which was 40% last year and remains at 40% for this year in the short-term incentive plan. Another 40% is connected to our bookings, which, while it slightly affects this year, has a more significant impact on the following years. The final 20% is based on personal goals, which Dan has discussed with you.

Great. Okay. Thanks very much.

Thanks, John.

Thank you all for your questions and your interest in Graham Corporation. We'll look forward to updating you again in late October.

Thank you. This concludes today's conference. You may disconnect your lines at this time we thank you for your participation.