GRAHAM CORP (GHM) FY 2023 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
(Amounts in thousands, except per share data)
Overview
We are a global leader in the design and manufacture of mission critical fluid, power, heat transfer and vacuum technologies for the defense, space, energy and process industries. We design and manufacture custom-engineered vacuum, heat transfer, pump and turbomachinery technologies. For the defense industry, our equipment is used in nuclear and non-nuclear propulsion, power, fluid transfer, and thermal management systems. For the space industry our equipment is used in propulsion, power and energy management systems and for life support systems. We supply equipment for vacuum, heat transfer and fluid transfer applications used in energy and new energy markets including oil refining, cogeneration, and multiple alternative and clean power applications including hydrogen. For the chemical and petrochemical industries, our heat transfer equipment is used in fertilizer, ethylene, methanol and downstream chemical facilities.
Our brands are built upon engineering expertise and close customer collaboration to design, develop, and produce mission critical equipment and systems that enable our customers to meet their economic and operational objectives. Continual improvement of our processes and systems to ensure qualified and compliant equipment are hallmarks of our brand. Our early engagement with customers and support until the end of service life are values upon which our brands are built.
Our corporate headquarters is located with our production facilities in Batavia, New York, where surface condensers and ejectors are designed, engineered, and manufactured. Our wholly-owned subsidiary, Barber-Nichols, LLC ("BN"), based in Arvada, Colorado, designs, develops and manufactures specialty turbomachinery products for the aerospace, cryogenic, defense and energy markets (see "Acquisition" below). We also have wholly-owned foreign subsidiaries, Graham Vacuum and Heat Transfer Technology Co., Ltd. ("GVHTT"), located in Suzhou, China and Graham India Private Limited ("GIPL"), located in Ahmedabad, India. GVHTT provides sales and engineering support for us in the People's Republic of China and management oversight throughout Southeast Asia. GIPL serves as a sales and market development office focusing on the refining, petrochemical and fertilizer markets in India and the Middle East.
This management's discussion and analysis of financial condition and results of operations omits a comparative discussion regarding the fiscal year ended March 31, 2022 versus the fiscal year ended March 31, 2021. Such information is located in Item 7 – Management's Discussion and Analysis of Financial Condition and Results of Operations of our Annual Report on Form 10-K for the fiscal year ended March 31, 2022.
Our fiscal year ends on March 31 of each year. We refer to our fiscal year, which ended March 31, 2023, as fiscal 2023. Likewise, we refer to our fiscal years that ended March 31, 2022 and March 31, 2021, as fiscal 2022 and fiscal 2021, respectively.
Acquisition
We completed the acquisition of BN on June 1, 2021, which changed the composition of our end market mix. For fiscal 2023, sales to the defense and space industries were 55% of our business compared with approximately 25% of sales prior to the acquisition. The remaining 45% of our fiscal 2023 sales came from the refining, chemical/petrochemical and other commercial markets. These markets represented approximately 75% of our sales prior to the acquisition.
The BN transaction was accounted for as a business combination, which requires that assets acquired and liabilities assumed be recognized at their fair value as of the acquisition date. The purchase price of $72,014 was comprised of 610 shares of common stock, representing a value of $8,964 at $14.69 per share, and cash consideration of $61,150. The cash consideration was funded through cash on-hand and debt proceeds (See Note 2 to the Consolidated Financial Statements included in Item 8 of Part II of this Annual Report on Form 10-K). The purchase agreement also included a contingent earn-out dependent upon certain financial measures of BN post-acquisition, pursuant to which the sellers were eligible to receive up to $14,000 in additional cash consideration. At June 30, 2021, a liability of $1,900 was recorded for the contingent earn-out. In the second quarter of the fiscal 2022, the earn-out agreement was terminated and the contingent liability was reversed into other operating (income) expense, net, on our Consolidated Statement of Operations. In connection with the termination of this earn-out agreement, we entered into a Performance Bonus Agreement (the "Bonus Agreement") to provide employees of BN with cash performance-based awards based on the achievement of BN performance objectives for fiscal years ending March 31, 2024, 2025, and 2026 and can range between $2,000 to $4,000 per year.
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Key Results
Key results for fiscal 2023 include the following:
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Net sales of $157,118 for fiscal 2023 increased $34,304 or 28% over the prior year period across our diversified revenue base. Approximately $8,900 of this increase was due to having two less months of BN results in fiscal 2022 compared to fiscal 2023. Net sales also benefitted from strong growth in aftermarket sales to the refining and petrochemical markets of approximately $5,000 in comparison to the prior year, as well as growth in our commercial space market, which was driven by newly awarded programs with several key industry players. Additionally, our defense market sales benefitted from improved execution and pricing in fiscal 2023 versus fiscal 2022.
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On April 4, 2023, Virgin Orbit Holdings, Inc. ("Virgin Orbit") commenced voluntary proceedings under Chapter 11 of the U.S. Bankruptcy Code ("Chapter 11 Bankruptcy"). As a result, we recorded reserves of approximately $2,500 for accounts receivable and inventory related to Virgin Orbit during fiscal 2023, net of associated performance-based compensation, and reversed approximately $4,000 of purchase orders. During fiscal 2023, approximately $5,300 of space revenue and $3,000 of space orders related to Virgin Orbit. As of March 31, 2023, we have $0 included in backlog related to Virgin Orbit. As of March 31, 2023, we estimate that we have approximately $1,000 to $2,000 of additional exposure related to Virgin Orbit depending on the outcome of the bankruptcy proceedings, but currently do not expect any material financial impact to fiscal 2024 results.
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Results for fiscal 2022 included the impact of first article U.S. Navy project labor and material cost overruns due to our strategic decision to take on additional costs in order to meet our customer's delivery schedules. We estimate that these strategic decisions for first article projects impacted our results in fiscal 2022 by over $10,000. In fiscal 2023, we completed four first article U.S. Navy projects, which were the source of many of the losses in fiscal 2022, and remain on schedule to complete the remaining two first article projects by the end of the second quarter of our fiscal year ended March 31, 2024 ("fiscal 2024").
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Net income and net income per diluted share for fiscal 2023 were $367 and $0.03 per share, respectively, compared with a loss of $8,773 and $0.83 per share, respectively, for fiscal 2022. This increase over the prior year was driven by our higher sales, an improved mix of sales related to higher margin projects (commercial space and aftermarket), improved execution, especially on our strategic U.S. Navy programs which resulted in losses in fiscal 2022, and strong cost discipline partially offset by the Virgin Orbit reserves discussed above.
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Adjusted net income and adjusted net income per diluted share for fiscal 2023 were $2,519 and $0.24 per share, respectively, compared with an adjusted loss and adjusted loss per diluted share of $6,582 and $0.62 per share, respectively, for fiscal 2022. See "Non-GAAP Measures" below for important information about these measures and a reconciliation of adjusted net income (loss) and adjusted net income (loss) per diluted share to the comparable GAAP amount.
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Orders booked in fiscal 2023 were $202,686 compared to $143,875 in fiscal 2022 and were 129% of sales during fiscal 2023. This increase was primarily due to a $53,499 increase in defense orders and was primarily from repeat orders in strategic U.S. Navy programs. We believe these repeat orders validate the investments we made, our position as a key supplier to the defense industry, and our customer’s confidence in our execution. Fiscal 2023 orders were also strong to the refining and petrochemical aftermarket, which increased 34% over the prior year, but were partially offset by lower large capital investment projects by our refining and petrochemical customers. Fiscal 2023 orders also benefitted from newly awarded programs with several key commercial space and new energy customers. For additional information see "Orders and Backlog" below.
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Backlog was $301,734 at March 31, 2023, compared with $256,537 at March 31, 2022. This 18% increase was primarily due to the growth in orders received during 2023 in the defense and new energy markets. Approximately 81% of our backlog at March 31, 2023 was to the defense industry, which we believe provides stability and visibility to our business. For additional information see "Orders and Backlog" below.
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Cash and cash equivalents at March 31, 2023 was $18,257, compared with $14,741 at March 31, 2022. This increase was primarily due to cash provided by operating activities of $13,914, partially offset by net repayment of debt of $6,000 and $3,749 of capital expenditures as we began to invest in longer-term growth opportunities. Cash provided by operating activities includes approximately $13,000 of customer deposits received for material purchases on a long-term U.S. Navy defense contracts that will be paid over the next twelve months as materials are received. These cash receipts were partially offset by an increase in working capital, in particular unbilled revenue, which is expected to generate positive cash flow in fiscal 2024.
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In fiscal 2023, we did not pay dividends to shareholders compared with $3,523 of dividends paid in fiscal 2022. In the fourth quarter of fiscal 2022, we suspended our dividend in accordance with the terms of our credit agreement with Bank of America. There can be no guarantee that we will pay dividends in the future, and any determination by our board of directors with respect to
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dividends will depend on a variety of factors, including our future financial performance, organic growth and acquisition opportunities, general economic conditions and other factors, many of which are beyond our control.
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At March 31, 2023, we had $0 outstanding on our line of credit and $10,016 available to be drawn under our line of credit subject to financial covenants under our credit facility. We believe cash flow from operations, availability under our line of credit, along with our cash balances, provide us adequate financial flexibility to meet our obligations. As of March 31, 2023, our bank leverage ratio calculated in accordance with our amended credit agreement was 2.1x and we were in compliance with all financial covenants of that agreement. For additional information see "Liquidity and Capital Resources" below.
Current Market Conditions
Demand for our equipment and systems for the defense industry is expected to remain strong and continue to expand, based on our significant backlog, improved execution, long-standing relationship with the U.S. Navy, the strategic programs we are qualified on, the projected procurement of submarines, aircraft carriers and undersea propulsion and power systems and the solutions we provide. In addition to U.S. Navy applications, we also provide specialty pumps, turbines, compressors and controllers for various fluid and thermal management systems used in Department of Defense radar, laser, electronics and power systems. We have built a leading position, and in some instances a sole source position, for certain systems and equipment for the defense industry.
Our traditional energy markets are undergoing significant transition. While we expect that fossil fuels will continue to be an important component in the global energy industry for many years to come, there are significant changes in the priorities for capital investments by our customers and the regions in which those investments are being made. We expect that the changes in the energy markets, which are influenced by conservation and the increasing use of alternative fuels, will lead to demand growth for fossil-based fuels that is less than the global growth rate. Currently, opportunities in the energy markets outside North America have been greater than opportunities inside of North America, but opportunities outside of North America are highly competitive and pricing is challenging. In those instances, we have been selective in the opportunities we have pursued in order to ensure we receive the proper returns. Over the long-term, we anticipate that future investment by refiners in renewable fuels (e.g., renewable diesel), in existing refineries (e.g., to expand feedstock processing flexibility and to improve conversion of oil to refined products) to gain greater throughput, or to build new capacity (e.g., integrated refineries with petrochemical products capabilities), will continue to drive demand for our products and services. The timing and catalyst for a recovery in these markets (crude oil refining and chemical/petrochemical) remains uncertain. Accordingly, we believe that in the near term the quantity of projects available for us to compete for will remain low and that new project pricing will remain challenging.
Of note, during fiscal 2023, we have experienced an increase in our aftermarket orders to the refining and petrochemical markets, primarily from the domestic market. Aftermarket orders have historically been a leading indicator of future capital investment by our customers in their facilities for upgrades and expansions. As such, we believe there is the possibility of a cyclical upturn following several years of reduced capital spending in a low oil price environment. Additionally, the financial performance of some of our larger energy customers improved during fiscal 2023, which may provide funding for capital spending. However, we do not expect the next cycle to be as robust as years past due to the factors discussed above.
The alternative and clean energy opportunities for our heat transfer, power production and fluid transfer systems are expected to continue to grow. We assist in designing, developing and producing equipment for hydrogen production, distribution and fueling systems, concentrated solar power and storage, geothermal power and lithium production, and small modular nuclear systems. We are positioning the Company to be a more significant contributor as these markets continue to develop.
We believe that chemical and petrochemical capital investment will continue to decouple from energy investment. Over the long-term, we expect that population growth, an expanding global middle class, and an increasing desire for improved quality of life and access to consumer products will drive increased demand for industrial goods within the plastics and resins value chain along with fertilizers and related products. As such, we expect investment in new global chemical and petrochemical capacity will improve and drive growth in demand for our products and services over the long-term.
Our turbomachinery, pumps, and cryogenic products and market access provide revenue and growth potential in the commercial space/aerospace markets. The commercial space market has grown and evolved rapidly, and we provide rocket engine turbopump systems and components to many of the key players in the industry. We expect that in the long-term, extended space exploration will become more prevalent, and we anticipate that our thermal/fluid management and environmental control and life support system turbomachinery will play important roles. We are also participating in future aerospace power and propulsion system development through supply of fluid and thermal management systems components. Small power dense systems are imperative for these applications, and we believe our technology and expertise will enable us to achieve sales growth in this market as well. For fiscal 2023, sales to the space industry represented 13% of our sales compared to 0% prior to the BN acquisition. Sales and orders to the space industry are variable in nature and many of our customers, who are key players in the industry, have yet to achieve profitability and may be unable
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to continue operations without additional funding similar to Virgin Orbit. Thus, future revenue and growth to this market can be uncertain and may negatively impact our business.
The chart below illustrates our strategy to increase our participation in the defense market. The defense market comprised 81% of our total backlog at March 31, 2023 and generally have longer conversion times than our other markets. We believe this strategy shift provides us more stability and visibility and is especially beneficial when our refining and petrochemical markets are weak.
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Results of Operations
For an understanding of the significant factors that influenced our performance, the following discussion should be read in conjunction with our consolidated financial statements and the notes to our consolidated financial statements included in Item 8 of Part II of this Annual Report on Form 10-K.
The following table summarizes our results of operations for the periods indicated:
| Year Ended March 31, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | |||||||
| Net sales | $ | 157,118 | $ | 122,814 | ||||
| Gross profit | $ | 25,408 | $ | 9,129 | ||||
| Gross profit margin | 16.2 | % | 7.4 | % | ||||
| SG&A expense (1) | $ | 24,158 | $ | 21,299 | ||||
| SG&A as a percent of sales | 15.4 | % | 17.3 | % | ||||
| Net income (loss) | $ | 367 | $ | (8,773 | ) | |||
| Diluted income (loss) per share | $ | 0.03 | $ | (0.83 | ) | |||
| Total assets | $ | 203,918 | $ | 183,691 |
(1)
Selling, general and administrative expense is referred to as "SG&A."
Fiscal 2023 Compared with Fiscal 2022
The following tables provides our net sales by product line and geographic region including the percentage of total sales and change in comparison to the prior year for each category and period presented:
| Year Ended | |||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| March 31, | Change | ||||||||||||||||||||
| Market | 2023 | % | 2022 | % | $ | % | |||||||||||||||
| Refining | $ | 27,270 | 17 | % | $ | 24,406 | 20 | % | $ | 2,864 | 12 | % | |||||||||
| Chemical/Petrochemical | 21,950 | 14 | % | 15,955 | 13 | % | 5,995 | 38 | % | ||||||||||||
| Space | 21,180 | 13 | % | 5,744 | 5 | % | 15,436 | 269 | % | ||||||||||||
| Defense | 65,327 | 42 | % | 62,189 | 51 | % | 3,138 | 5 | % | ||||||||||||
| Other | 21,391 | 14 | % | 14,520 | 12 | % | 6,871 | 47 | % | ||||||||||||
| Net sales | $ | 157,118 | 100 | % | $ | 122,814 | 100 | % | $ | 34,304 | 28 | % | |||||||||
| Geographic Region | |||||||||||||||||||||
| United States | $ | 127,519 | 81 | % | $ | 97,718 | 80 | % | $ | 29,801 | 30 | % | |||||||||
| International | 29,599 | 19 | % | 25,096 | 20 | % | 4,503 | 18 | % | ||||||||||||
| Net sales | $ | 157,118 | 100 | % | $ | 122,814 | 100 | % | $ | 34,304 | 28 | % |
Net sales for fiscal 2023 were $157,118, an increase of 28% from fiscal 2022 and was across our diversified revenue base. Approximately $8,900 of this increase was due to having two less months of BN results in fiscal 2022 compared to fiscal 2023. Net sales also benefitted from strong growth in aftermarket sales to the refining and petrochemical markets of approximately $5,000 in comparison to the prior year, as well as growth in our commercial space market which was driven by newly awarded programs. Additionally, our defense market sales benefitted from improved execution and pricing in fiscal 2023 versus fiscal 2022. See also "Current Market Conditions," above. For additional information on anticipated future sales and our markets, see "Orders and Backlog" below.
Our gross margin for fiscal 2023 was 16.2% compared with 7.4% for fiscal 2022. This increase was primarily due to an improved mix of sales related to higher margin projects (commercial space and aftermarket) and improved execution and pricing on defense contracts, partially offset by approximately $800 impact of Virgin Orbit reserves, net of applicable performance-based compensation, and higher overall incentive based compensation in comparison to the prior year. Results for fiscal 2022 included the impact of first article Navy project labor and material cost overruns. We estimate that the impact of these labor and material cost increases for first article Navy projects, was over $10,000 in fiscal 2022. In fiscal 2023, we completed four first article U.S. Navy projects, which were the source of many of the losses in fiscal 2022, and remain on schedule to complete the remaining two first article projects by the end of the second quarter of fiscal 2024. In addition to the above, fiscal 2023 included two additional months of operations from BN compared to fiscal 2022 which was acquired in June 2021.
SG&A expense including amortization for fiscal 2023 was $24,447, up $3,148 compared with $21,299 for fiscal 2022. Approximately $1,400 of this increase was due to having two less months of BN results in fiscal 2022 compared to fiscal 2023, approximately $1,700 impact of Virgin Orbit reserves net of applicable performance-based compensation, as well as higher overall
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incentive compensation. These increases were partially offset by cost savings and deferred initiatives, which included reducing the use of outside sales agents, cost management, and delayed hiring of non-critical positions. Additionally, SG&A expense for fiscal 2022 included $562 of acquisition and integration costs incurred in connection with the BN acquisition. As a result, SG&A expense as a percentage of sales for fiscal 2023 was 15.4% of sales compared with 17.3% of sales in the prior year period.
During fiscal 2022, we terminated the BN contingent earn-out agreement and the contingent liability of $1,900 was reversed into other operating (income) expense, net, on our Consolidated Statement of Operations. In connection with the termination of this earn-out agreement, we entered into a Bonus Agreement to provide employees of BN with cash performance-based awards based on results of BN for fiscal years ending March 31, 2024, 2025, and 2026. Additionally, in fiscal 2022 we incurred $1,073 of severance costs related to the departure of our former Chief Executive Officer and former Chief Financial Officer, which was also recorded in other operating (income) expense, net.
Net interest expense for fiscal 2023 was $939 compared to $400 in fiscal 2022 primarily due to borrowings related to the BN acquisition, as well as increased interest rates since the time of the acquisition.
Our effective tax rate for fiscal 2023 was 35%, compared with 22% for fiscal 2022. This increase was primarily due to discrete tax expense recognized in fiscal 2023 related to the vesting of restricted stock awards, as well as a higher mix of income in higher tax rate foreign jurisdictions. Our expected effective tax rate for fiscal 2024 is approximately 22% to 23%.
The net result of the above is that net income and net income per diluted share for fiscal 2023 were $367 and $0.03 per share, respectively, compared with a loss of $8,773 and $0.83 per share, respectively, for fiscal 2022. Adjusted net income and adjusted net income per diluted share for fiscal 2023 were $2,519 and $0.24 per share, respectively, compared with a loss of $6,582 and $0.62 per share, respectively, for fiscal 2022. See "Non-GAAP Measures" below for important information about these measures and a reconciliation of adjusted net income (loss) and adjusted net income (loss) per diluted share to the comparable GAAP amount.
Non-GAAP Measures
Adjusted net income (loss) before net interest expense, income taxes, depreciation and amortization ("EBITDA"), adjusted net income (loss), and adjusted net income (loss) per diluted share are provided for information purposes only and are not measures of financial performance under accounting principles generally accepted in the U.S. ("GAAP"). Management believes the presentation of these financial measures reflecting non-GAAP adjustments provides important supplemental information to investors and other users of our financial statements in evaluating the operating results of the Company. In particular, those charges and credits that are not directly related to operating performance, and that are not a helpful measure of the performance of our underlying business particularly in light of their unpredictable nature. These non-GAAP disclosures have limitations as analytical tools, should not be viewed as a substitute for net income (loss) or net income (loss) per diluted share determined in accordance with GAAP, and should not be considered in isolation or as a substitute for analysis of our results as reported under GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies. In addition, supplemental presentation should not be construed as an inference that our future results will be unaffected by similar adjustments to net income (loss) or net income (loss) per diluted share determined in accordance with GAAP. Adjusted EBITDA, adjusted net income (loss) and adjusted net income (loss) per diluted share are key metrics used by management and our board of directors to assess the Company’s financial and operating performance and adjusted EBITDA is a basis for a portion of management's performance-based compensation.
Adjusted EBITDA excludes charges for depreciation, amortization, net interest expense, taxes, acquisition related expenses, and other unusual/nonrecurring expenses. Adjusted net income (loss) and adjusted net income (loss) per diluted share exclude intangible amortization, acquisition related expenses, other unusual/nonrecurring expenses and the related tax impacts of those adjustments.
A reconciliation of adjusted EBITDA, adjusted net income (loss), and adjusted net income (loss) per diluted share to net income (loss) in accordance with GAAP is as follows:
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| Year Ended | |||||||
|---|---|---|---|---|---|---|---|
| March 31, | |||||||
| 2023 | 2022 | ||||||
| Net income (loss) | $ | 367 | $ | (8,773 | ) | ||
| Acquisition related inventory step-up expense | - | 95 | |||||
| Acquisition & integration costs | 54 | 562 | |||||
| Change in fair value of contingent consideration | - | (1,900 | ) | ||||
| CEO and CFO transition costs | - | 1,182 | |||||
| Debt amendment costs | 194 | 278 | |||||
| Net interest expense | 939 | 400 | |||||
| Income taxes | 194 | (2,443 | ) | ||||
| Depreciation & amortization | 5,987 | 5,599 | |||||
| Adjusted EBITDA | $ | 7,735 | $ | (5,000 | ) | ||
| Adjusted EBITDA as a % of revenue | 4.9 | % | (4.1 | %) |
| Year Ended | |||||||
|---|---|---|---|---|---|---|---|
| March 31, | |||||||
| 2023 | 2022 | ||||||
| Net income (loss) | $ | 367 | $ | (8,773 | ) | ||
| Acquisition related inventory step-up expense | - | 95 | |||||
| Acquisition & integration costs | 54 | 562 | |||||
| Amortization of intangible assets | 2,476 | 2,522 | |||||
| Change in fair value of contingent consideration | - | (1,900 | ) | ||||
| CEO and CFO transition costs | - | 1,182 | |||||
| Debt amendment costs | 194 | 278 | |||||
| Normalize tax rate(1) | (572 | ) | (548 | ) | |||
| Adjusted net income (loss) | $ | 2,519 | $ | (6,582 | ) | ||
| GAAP diluted net income (loss) per share | $ | 0.03 | $ | (0.83 | ) | ||
| Adjusted diluted net income (loss) per share | $ | 0.24 | $ | (0.62 | ) | ||
| Diluted weighted average common shares outstanding | 10,654 | 10,541 | |||||
| (1) Applies a normalized tax rate to non-GAAP adjustments, which are pre-tax, based upon the statutory tax rate of 21%. |
Liquidity and Capital Resources
The following discussion should be read in conjunction with our consolidated statements of cash flows and consolidated balance sheets appearing in Item 8 of Part II of this Annual Report on Form 10-K:
| March 31, | |||||||
|---|---|---|---|---|---|---|---|
| 2023 | 2022 | ||||||
| Cash and cash equivalents | $ | 18,257 | $ | 14,741 | |||
| Working capital(1) | 23,904 | 27,796 | |||||
| Working capital ratio(2) | 1.3 | 1.5 |
(1)
Working capital equals current assets minus current liabilities.
(2)
Working capital ratio equals current assets divided by current liabilities.
We use the above ratios to assess our liquidity and overall financial strength.
Net cash provided by operating activities for fiscal 2023 was $13,914 compared with $2,219 of cash used by operating activities for fiscal 2022. This increase was primarily due to higher cash net income during fiscal 2023 than the comparable prior year period, partially offset by lower cash flow from net working capital. Results for fiscal 2022 included the impact of our strategic decision to take on additional costs in order to meet our U.S. Navy customers delivery schedules. We believe the increased level of repeat defense orders received during fiscal 2023 validates the investments we made, our position as a key supplier to the defense industry and our customer’s confidence in our execution. In fiscal 2023 we collected approximately $13,000 of customer deposits related to material purchases for
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a large U.S. Navy order that will be paid over the next nine months as materials are received. This increase in customer deposits was more than offset by increases in inventories and unbilled revenue due to growth and the timing of billing milestones. Net repayment of debt for fiscal 2023 was $6,000 compared to a net borrowing of $18,500 for fiscal 2022 primarily due to the cash used for the acquisition of BN of $60,282.
Dividend payments and capital expenditures in fiscal 2023 were $0 and $3,749, respectively, compared with $3,523 and $2,324, respectively, for fiscal 2022. In the fourth quarter of fiscal 2022, we suspended our dividend in accordance with the terms of our credit agreement with Bank of America. There can be no guarantee that we will pay dividends in the future and any determination by our board of directors with respect to dividends will depend on a variety of factors, including our future financial performance, organic growth and acquisition opportunities, general economic conditions and other factors, many of which are beyond our control. Capital expenditures for fiscal 2024 are expected to be approximately $5,500 to $7,000. Our fiscal 2024 capital expenditures are expected to be primarily for machinery and equipment, as well as for buildings and leasehold improvements to fund our growth and productivity improvement initiatives. The majority of our planned capital expenditures are discretionary. We estimate that our maintenance capital spend is approximately $2,000 per year.
Cash and cash equivalents were $18,257 at March 31, 2023 compared with $14,741 at March 31, 2022, as cash provided by operating activities was used to fund capital expenditures and repayment of debt. At March 31, 2023, approximately $6,968 of our cash and cash equivalents was used to secure our letters of credit and $2,618 of our cash was held by our subsidiaries in China and India.
On June 1, 2021, we entered into a $20,000 five-year loan with Bank of America. The term loan requires monthly principal payments of $167 through June 1, 2026, with the remaining principal amount plus all interest due on the maturity date. The interest rate on the term loan is the applicable Bloomberg Short-Term Bank Yield Index ("BSBY"), plus 1.50%, subject to a 0.00% floor.
On June 1, 2021, we entered into a five-year revolving credit facility with Bank of America that provided a $30,000 line of credit, including letters of credit and bank guarantees, expandable at our option and the bank's approval at any time up to $40,000. As of March 31, 2023, there was $0 outstanding on the line of credit. Amounts outstanding under the facility agreement bear interest at a rate equal to BSBY plus 1.50%, subject to a 0.00% floor. As of March 31, 2023, the BSBY rate was 4.92%. As of March 31, 2023, there was $5,874 letters of credit outstanding with Bank of America.
Under the original term loan agreement and revolving credit facility, we covenanted to maintain a maximum total leverage ratio, as defined in such agreements, of 3.0 to 1.0, with an allowable increase to 3.25 to 1.0 for a period of twelve months following the closing of an acquisition. In addition, we covenanted to maintain a minimum fixed charge coverage ratio, as defined in such agreements, of 1.2 to 1.0 and minimum margined assets, as defined in such agreements, of 100% of total amounts outstanding on the revolving credit facility, including letters of credit. At December 31, 2021, we were out of compliance with our bank agreement covenants and were granted a waiver for noncompliance by Bank of America.
We entered into amendment agreements with Bank of America since origination. Under the amended agreements, we were not required to comply with the maximum total leverage ratio and the minimum fixed charge coverage ratio covenants contained in the original term loan agreement for the periods ending December 31, 2021 and March 31, June 30 and September 30, 2022. The principal balance outstanding on the line of credit may not exceed $15,000, unless letters of credit exceed $11,500, in which case the limit is $17,000, until the compliance date. The compliance date is defined as the date on which Bank of America has received all required financial information with respect to us for the fiscal year ending March 31, 2023 and no event of default exists. In addition, on or before September 1, 2023 and at all times thereafter, all of our deposit accounts, except certain accounts, will be either subject to a deposit account control agreement or maintained with Bank of America. We covenanted to maintain EBITDA, as defined in such amendment, of at least ($700) for the twelve-month period ending June 30, 2022 and $1,800 for the twelve-month period ending September 30, 2022; maintain a total maximum leverage ratio of 4.0 to 1.0 for the twelve-month period ending December 31, 2022 and 3.0 to 1.0 for the period ending March 31, 2023; and maintain liquidity, as defined in such amendment, of at least $10,000 prior to the occurrence of the compliance date and $20,000 from and after the occurrence of the compliance date. As of March 31, 2023, we were in compliance with the amended financial covenants of our loan agreement and our leverage ratio as calculated in accordance with the terms of the credit facility was 2.1x. At March 31, 2023, the amount available under the revolving credit facility was $10,016 subject to the above liquidity and leverage covenants.
We did not have any off-balance sheet arrangements as of March 31, 2023 other than letters of credit incurred in the ordinary course of business.
We believe that cash generated from operations, combined with the liquidity provided by available financing capacity under our credit facility, will be adequate to meet our cash needs for the immediate future.
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Stockholders' Equity
The following discussion should be read in conjunction with our consolidated statements of changes in stockholders' equity that can be found in Item 8 of Part II of this Annual Report on Form 10-K. The following table shows the balance of stockholders' equity on the dates indicated:
| March 31, 2023 | March 31, 2022 | ||||
|---|---|---|---|---|---|
| $ | 96,933 | $ | 96,494 |
Orders and Backlog
In addition to the non-GAAP measures discussed above, management uses the following key performance metrics to analyze and measure the Company’s financial performance and results of operations: orders, backlog, and book-to-bill ratio. Management uses orders and backlog as measures of current and future business and financial performance and these may not be comparable with measures provided by other companies. Orders represent written communications received from customers requesting the Company to provide products and/or services. Backlog is defined as the total dollar value of net orders received for which revenue has not yet been recognized. Management believes tracking orders and backlog are useful as it often times is a leading indicator of future performance. In accordance with industry practice, contracts may include provisions for cancellation, termination, or suspension at the discretion of the customer.
The book-to-bill ratio is an operational measure that management uses to track the growth prospects of the Company. The Company calculates the book-to-bill ratio for a given period as net orders divided by net sales.
Given that each of orders, backlog and book-to-bill ratio is an operational measure and that the Company's methodology for calculating orders, backlog and book-to-bill ratio does not meet the definition of a non-GAAP measure, as that term is defined by the U.S. Securities and Exchange Commission, a quantitative reconciliation for each is not required or provided.
The following table provides our orders by market and geographic region including the percentage of total orders and change in comparison to the prior year for each category and period presented:
| Year Ended | |||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| March 31, | Change | ||||||||||||||||||||
| Market | 2023 | % | 2022 | % | $ | % | |||||||||||||||
| Refining | $ | 29,276 | 14 | % | $ | 28,411 | 20 | % | $ | 865 | 3 | % | |||||||||
| Chemical/Petrochemical | 15,306 | 8 | % | 22,241 | 15 | % | (6,935 | ) | -31 | % | |||||||||||
| Space | 15,160 | 7 | % | 10,733 | 7 | % | 4,427 | 41 | % | ||||||||||||
| Defense | 116,714 | 58 | % | 63,215 | 44 | % | 53,499 | 85 | % | ||||||||||||
| Other | 26,230 | 13 | % | 19,275 | 13 | % | 6,955 | 36 | % | ||||||||||||
| Total orders | $ | 202,686 | 100 | % | $ | 143,875 | 100 | % | $ | 58,811 | 41 | % | |||||||||
| Geographic Region | |||||||||||||||||||||
| United States | $ | 167,984 | 83 | % | $ | 117,106 | 81 | % | $ | 50,878 | 43 | % | |||||||||
| International | 34,702 | 17 | % | 26,769 | 19 | % | 7,933 | 30 | % | ||||||||||||
| Total orders | $ | 202,686 | 100 | % | $ | 143,875 | 100 | % | $ | 58,811 | 41 | % |
Orders booked in fiscal 2023 were $202,686 compared to $143,875 in fiscal 2022. This increase was primarily driven by growth in defense, refining and petrochemical aftermarket, space, and new energy customers. Noteworthy orders during fiscal 2023 included the following:
•
$116,714 from the defense industry driven by repeat orders for critical U.S. Navy programs including a $23,000 follow-on order to support the MK48 Mod 7 Heavyweight Torpedo program;
•
$40,566 from the refining and petrochemical aftermarket;
•
$15,160 of orders for highly engineered pumps and turbo pumps for a variety of applications and customers in the commercial space industry (of which approximately $3,000 were to Virgin Orbit);
•
Increased orders to the new energy market including hydrogen, solar, and geothermal with lithium extraction including a $5,000 order for a vacuum system for the Hell’s Kitchen Stage 1 Project in the Imperial Valley of California; and
•
$7.0 million for a vacuum system for a refinery in India.
For fiscal 2023, our book-to-bill ratio was 1.3x. We believe the increased level of repeat U.S. Navy orders received during the fiscal year validates the investments we made, our position as a key supplier to the defense industry and our customer’s confidence
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in our execution. Additionally, we believe the strong aftermarket orders are significant because they historically have been a leading indicator of a cyclical upturn in capital project orders. However, we do not expect the next cycle to be as robust as years past due to the factors discussed above under "Current Market Conditions." The increase in space orders for fiscal 2023 over fiscal 2022 was due to newly awarded programs, as well as having an additional two months of BN operations included in the results for fiscal 2023.
Orders to the U.S. represented 83% of total orders for fiscal 2023 and is relatively consistent with the prior year. These orders were primarily to the defense and space markets, which represented 58% and 7% of orders, respectively, and are U.S. based.
The following table provides our backlog by market, including the percentage of total backlog, for each category and period presented:
| March 31, | March 31, | Change | |||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Market | 2023 | % | 2022 | % | $ | % | |||||||||||||||
| Refining | $ | 26,142 | 9 | % | $ | 25,402 | 10 | % | $ | 740 | 3 | % | |||||||||
| Chemical/Petrochemical | 7,842 | 3 | % | 13,647 | 5 | % | (5,805 | ) | -43 | % | |||||||||||
| Space | 8,242 | 3 | % | 11,283 | 4 | % | (3,041 | ) | -27 | % | |||||||||||
| Defense | 243,628 | 81 | % | 194,758 | 76 | % | 48,870 | 25 | % | ||||||||||||
| Other | 15,880 | 5 | % | 11,447 | 4 | % | 4,433 | 39 | % | ||||||||||||
| Total backlog | $ | 301,734 | 100 | % | $ | 256,537 | 100 | % | $ | 45,197 | 18 | % |
Backlog was $301,734 at March 31, 2023, an increase of 18% compared with $256,537 at March 31, 2022. Approximately 50% to 55% of orders currently in our backlog are expected to be converted to sales within one year and 25% to 30% after one year but within two years. The majority of the orders that are expected to convert beyond twelve months are for the defense industry, specifically the U.S. Navy that have a long conversion cycle (up to six years).
Outlook
We are providing the following fiscal 2024 outlook:
| Net Sales | $165 million to $175 million | |
|---|---|---|
| Gross Profit | 17% to 18% of sales | |
| SG&A Expenses(1) | 15% to 16% of sales | |
| Tax Rate | 22% to 23% | |
| Adjusted EBITDA(2) | $10.5 million to $12.5 million | |
| (1) Includes approximately $2 million to $3 million of BN performance bonus and approximately $0.5 million to $1.0 million of ERP conversion costs. | ||
| (2) Excludes approximately $2 million to $3 million of BN performance bonus and approximately $0.5 million to $1.0 million of ERP conversion costs. |
See "Cautionary Note Regarding Forward-Looking Statements" and "Non-GAAP Measures" above for additional information about forward-looking statements and non-GAAP measures. We have not reconciled non-GAAP forward-looking Adjusted EBITDA to its most directly comparable GAAP measure, as permitted by Item 10(e)(1)(i)(B) of Regulation S-K. Such reconciliation would require unreasonable efforts to estimate and quantify various necessary GAAP components largely because forecasting or predicting our future operating results is subject to many factors out of our control or not readily predictable.
We have made significant progress with the advancements in our business, which puts us ahead of schedule in achieving our fiscal 2027 goals. As a result, we now believe that we can achieve greater than $200 million in revenue (8% to 10% average annualized revenue growth) and adjusted EBITDA margins in the low to mid-teens in fiscal 2027.
Our expectations for sales and profitability assume that we will be able to operate our production facilities at planned capacity, have access to our global supply chain including our subcontractors, do not experience significant global health related disruptions, and assumes no further impact from Virgin Orbit or any other unforeseen events.
Contingencies and Commitments
We have been named as a defendant in lawsuits alleging personal injury from exposure to asbestos allegedly contained in or accompanying our products. We are a co-defendant with numerous other defendants in these lawsuits and intend to vigorously defend ourselves against these claims. The claims in our current lawsuits are similar to those made in previous asbestos lawsuits that named us as a defendant. Such previous lawsuits either were dismissed when it was shown that we had not supplied products to the plaintiffs’ places of work, or were settled by us for immaterial amounts.
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As of March 31, 2023, we are subject to the claims noted above, as well as other legal proceedings and potential claims that have arisen in the ordinary course of business. Although the outcome of the lawsuits, legal proceedings or potential claims to which we are or may become a party cannot be determined and an estimate of the reasonably possible loss or range of loss cannot be made for the majority of the claims, we do not believe that the outcomes, either individually or in the aggregate, will have a material adverse effect on our results of operations, financial position or cash flows.
Critical Accounting Policies
The discussion and analysis of our financial condition and results of operations are based upon the consolidated financial statements and the notes to consolidated financial statements included in Item 8 of Part II of this Annual Report on Form 10-K, which have been prepared in accordance with GAAP.
Critical accounting policies are defined as those that reflect significant judgments and uncertainties and could potentially result in materially different results under different assumptions and conditions.
Revenue Recognition. The Company accounts for revenue in accordance with Accounting Standard Codification 606, "Revenue from Contracts with Customers" ("ASC 606").
We recognize revenue on all contracts when control of the product is transferred to the customer. Control is generally transferred when products are shipped, title is transferred, significant risks of ownership have transferred, we have rights to payment, and rewards of ownership pass to the customer. Customer acceptance may also be a factor in determining whether control of the product has transferred. Although revenue on the majority of our contracts, as measured by number of contracts, is recognized upon shipment to the customer, revenue on larger contracts, which are fewer in number but generally represent the majority of revenue, is recognized over time as these contracts meet specific criteria in ASC 606. Revenue from contracts that is recognized upon shipment accounted for approximately 26% of revenue in fiscal 2023. Revenue from contracts that is recognized over time accounted for approximately 74% of revenue in fiscal 2023. We recognize revenue over time when contract performance results in the creation of a product for which we do not have an alternative use and the contract includes an enforceable right to payment in an amount that corresponds directly with the value of the performance completed. To measure progress towards completion on performance obligations for which revenue is recognized over time the Company utilizes an input method based upon a ratio of direct labor hours incurred to date to management’s estimate of the total labor hours to be incurred on each contract, or cost incurred to date to management's estimate of the total cost to be incurred on each contract, or an output method based upon completion of operational milestones, depending upon the nature of the contract.
Business Combinations and Intangible Assets. Assets and liabilities acquired in a business combination are recorded at their estimated fair values at the acquisition date. The fair value of identifiable intangible assets is based upon detailed valuations that use various assumptions made by management. Goodwill is recorded when the purchase price exceeds the estimated fair value of the net identifiable tangible and intangible assets acquired. Definite lived intangible assets are amortized over their estimated useful lives and are assessed for impairment if certain indicators are present. Goodwill and intangible assets deemed to have indefinite lives are not amortized but are subject to impairment testing annually or earlier if an event or change in circumstances indicates that the fair value of a reporting unit or the indefinite lived asset may have been reduced below its carrying value.
Pension and Postretirement Benefits. Defined benefit pension and other postretirement benefit costs and obligations are dependent on actuarial assumptions used in calculating such amounts. These assumptions are reviewed annually and include the discount rate, long-term expected rate of return on plan assets, salary growth, healthcare cost trend rate and other economic and demographic factors. We base the discount rate assumption for our plans on the FTSE Pension Liability Above-Median AA-Index. The long-term expected rate of return on plan assets is based on the plan’s asset allocation, historical returns and expectations as to future returns that are expected to be realized over the estimated remaining life of the plan liabilities that will be funded with the plan assets. The salary growth assumptions are determined based on long-term actual experience and future and near-term outlook. The healthcare cost trend rate assumptions are based on historical cost and payment data, the near-term outlook, and an assessment of likely long-term trends.
Critical Accounting Estimates and Judgments
We have evaluated the accounting policies used in the preparation of the consolidated financial statements and the notes to consolidated financial statements included in Item 8 of Part II of this Annual Report on Form 10-K and believe those policies to be reasonable and appropriate.
We believe that the most critical accounting estimates used in the preparation of our consolidated financial statements relate to labor hour estimates, total cost, and establishment of operational milestones which are used to recognize revenue over time, accounting
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for contingencies, under which we accrue a loss when it is probable that a liability has been incurred and the amount can be reasonably estimated, accounting for business combinations and intangible assets, and accounting for pensions and other postretirement benefits.
As discussed above under the heading "Critical Accounting Policies", we recognize a majority of our revenue using an over-time recognition method. The key estimate for the over-time recognition model is total labor, total cost and operational milestones to be incurred on each contract and to the extent that these estimates change, it may significantly impact revenue recognized in each period.
Contingencies, by their nature, relate to uncertainties that require us to exercise judgment both in assessing the likelihood that a liability has been incurred as well as in estimating the amount of potential loss. For more information on these matters, see the notes to consolidated financial statements included in Item 8 of Part II of this Annual Report on Form 10-K.
As discussed above under the heading "Critical Accounting Policies", we allocate the purchase price of an acquired company, including when applicable, the acquisition date fair value of contingent consideration between tangible and intangible assets acquired and liabilities assumed from the acquired business based on their estimated fair values, with the residual of the purchase price recorded as goodwill. Third party appraisal firms and other consultants are engaged to assist management in determining the fair values of certain assets acquired and liabilities assumed. Estimating fair values requires significant judgments, estimates and assumptions, including but not limited to discount rates, future cash flows and the economic lives of trade names, technology, customer relationships, and property, plant and equipment. These estimates are based on historical experience and information obtained from the management of the acquired company and are inherently uncertain.
During fiscal 2022, we completed the acquisition of BN for an aggregate purchase price of $72,014. We identified and assigned value to identifiable intangible assets of customer relationships, technology and technical know-how, backlog and trade name, and estimated the useful lives over which these intangible assets would be amortized. The estimates of fair values of these identifiable intangible assets were based upon discounted cash flow models, which include assumptions such as forecasted cash flows, customer attrition rates, discount rates, and royalty rates. The fair value estimates resulted in identifiable intangible assets, in the aggregate, of $32,500. The resulting goodwill, in the aggregate, from this acquisition was $23,523. For more information on these matters, see the notes to consolidated financial statements included in Item 8 of Part II of this Annual Report on Form 10-K.
Accounting for pensions and other postretirement benefits involves estimating the cost of benefits to be provided well into the future and attributing that cost over the time period each employee works. To accomplish this, assumptions are made about inflation, investment returns, mortality, turnover, medical costs and discount rates. These assumptions are reviewed annually.
The discount rate used in accounting for pensions and other postretirement benefits expense (income) is determined in conjunction with our actuary by reference to a current yield curve and by considering the timing and amount of projected future benefit payments. The discount rate assumption for fiscal 2023 was 3.66% for our defined benefit pension plans and 3.32% for our other postretirement benefit plan. A reduction in the discount rate of 50 basis points, with all other assumptions held constant, would have increased fiscal 2023 net periodic benefit expense for our defined benefit pension plans and other postretirement benefit plan by approximately $290 and $0.2, respectively.
The expected return on plan assets assumption of 5.50% used in accounting for our pension plan is determined by evaluating the mix of investments that comprise plan assets and external forecasts of future long-term investment returns. A reduction in the rate of return of 50 basis points, with other assumptions held constant, would have increased fiscal 2023 net periodic pension expense by approximately $197.
During fiscal 2023 and fiscal 2022, the pension plan extinguished liabilities for vested benefits of certain participants through the purchase of nonparticipating annuity contracts with a third-party insurance company. As a result of these transactions, in fiscal 2023 and fiscal 2022, the projected benefit obligation and plan assets each decreased $1,383 and $1,279, respectively.
As part of our ongoing financial reporting process, a collaborative effort is undertaken involving our managers with functional responsibilities for financial, credit, tax, engineering, manufacturing and benefit matters, and outside advisors such as lawyers, consultants and actuaries. We believe that the results of this effort provide management with the necessary information on which to base their judgments and to develop the estimates and assumptions used to prepare the financial statements.
We believe that the amounts recorded in the consolidated financial statements included in Item 8 of Part II of this Annual Report on Form 10-K related to revenue, contingencies, pensions, other postretirement benefits and other matters requiring the use of estimates and judgments are reasonable, although actual outcomes could differ materially from our estimates.
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New Accounting Pronouncements
In the normal course of business, management evaluates all new accounting pronouncements issued by the Financial Accounting Standards Board, the Securities and Exchange Commission, the Emerging Issues Task Force, the American Institute of Certified Public Accountants or any other authoritative accounting body to determine the potential impact they may have on our consolidated financial statements. For discussion of the newly issued accounting pronouncements see ''Accounting and reporting changes'' in Note 1 to the Consolidated Financial Statements included in Item 8 of Part II of this Annual Report on Form 10-K.