Graham Corporation — Form 10-Q Summary
Reporting period: Three and nine months ended December 31, 2018, representing the third quarter and first nine months of fiscal 2019, which ends March 31, 2019. The supplied metadata identifies “2017 Q3,” but the filing itself is for December 31, 2018.
Business Context
Graham designs and manufactures custom-engineered vacuum and heat-transfer equipment for energy, defense, chemical and petrochemical markets. Its products serve refining, power, nuclear, U.S. Navy, fertilizer, chemical and other industrial applications. Operations are based in New York and Michigan, with subsidiaries in China and newly established India operations.
Financial Performance and Liquidity
| Metric | Three months ended December 31, 2018 | Three months ended December 31, 2017 | Nine months ended December 31, 2018 | Nine months ended December 31, 2017 |
|---|---|---|---|---|
| Net sales | $17.2 million | $17.3 million | $68.2 million | $55.4 million |
| Gross profit | $3.7 million | $3.5 million | $17.1 million | $12.0 million |
| Gross margin | 22% | 20% | 25% | 22% |
| Net income (loss) | $0.1 million | $(11.6) million | $4.2 million | $(10.7) million |
| Diluted EPS | $0.01 | $(1.19) | $0.43 | $(1.09) |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $8.5 million | $3.9 million |
- SG&A: $4.3 million in the quarter and $13.7 million year to date, compared with $4.1 million and $11.5 million, respectively, in the prior-year periods.
- Cash and investments: $80.4 million at December 31, 2018, including $16.7 million of cash and $63.7 million of short-term investments, versus $76.5 million at March 31, 2018.
- Working capital: $78.7 million, with a current ratio of 2.6. Working capital excluding cash and investments was $(1.7) million.
- Debt and credit: No borrowings were outstanding under credit facilities. The company had $7.2 million of letters of credit, a $25 million revolving facility expandable to $50 million, and a separate $5 million unsecured line of credit.
- Capital spending and dividends: Year-to-date capital expenditures were $1.5 million and dividends paid were $2.9 million. Fiscal 2019 capital expenditures are expected to be approximately $2.0 million to $2.5 million.
Material Changes Versus the Prior Comparable Period
- Year-to-date sales increased 23%, driven by higher volume and stronger international sales; quarterly sales were essentially flat because international sales declined 52%, partially offset by a 27% increase in domestic sales.
- Gross margin improved to 25% year to date from 22%, reflecting higher volume and improved pricing, partly offset by increased production costs and under-absorbed capacity costs.
- The company returned to profitability. The prior-year results included a $14.8 million goodwill and intangible-asset impairment charge, a $0.3 million restructuring charge, and tax effects associated with the Tax Cuts and Jobs Act.
- Excluding those prior-year unusual items, management reported fiscal 2018 nine-month net income of approximately $1.2 million, or $0.12 per diluted share, compared with $4.2 million, or $0.43 per diluted share, in the current period.
- Year-to-date orders increased 16% to $79.6 million, although third-quarter orders declined 43% to $23.2 million due largely to a large specialized-materials order in the prior-year quarter.
- Backlog reached a record $133.7 million at December 31, 2018, up from $117.9 million at March 31, 2018. Approximately 50% of backlog related to U.S. Navy projects.
- Customer deposits increased to $32.6 million from $13.2 million at March 31, 2018, while inventories increased to $22.5 million from $11.6 million. These balances were significantly affected by adoption of ASC 606.
Guidance, Outlook, Risks and Unusual Items
- Fiscal 2019 guidance: Revenue of approximately $90 million to $95 million; gross margin of 25% to 27%; SG&A of $18.25 million to $18.75 million; effective tax rate of approximately 20%; and strong full-year cash flow.
- Management expects 50% to 55% of current backlog to convert to sales within twelve months. Remaining backlog may convert over longer periods, including U.S. Navy projects with conversion cycles of up to five years.
- Energy and petrochemical activity has improved, but order levels are expected to remain variable. Commercial nuclear markets remain weak, while naval nuclear demand is tied to U.S. Navy shipbuilding schedules.
- Key risks include project timing and cancellation, contract-cost estimates for over-time revenue recognition, tariffs and trade restrictions, foreign currency exposure, competition and pricing pressure, dependence on U.S. Navy programs, and government shutdown-related export and inspection delays.
- The company faces asbestos-related lawsuits and other ordinary-course claims. Management cannot estimate a reasonably possible loss but does not believe the matters will have a material effect on results, financial position or cash flows.
- Graham adopted ASC 606 using the modified retrospective method on April 1, 2018, recording a $1.0 million reduction to opening retained earnings. The filing states that the new lease standard may materially increase balance-sheet assets and liabilities when adopted.
- Disclosure controls and procedures were effective, and no material change in internal control over financial reporting was identified during the quarter.
Investor Verification Items
- Verify the timing and profitability of converting the $133.7 million backlog, particularly the concentration in U.S. Navy projects.
- Assess whether the fiscal 2019 revenue and gross-margin guidance remains achievable given variable orders and weak commercial nuclear demand.
- Monitor customer deposits, inventory, unbilled revenue and contract-cost estimates under ASC 606 for potential effects on cash flow and earnings.
- Evaluate the effect of tariffs, steel and other input costs, and under-absorbed production capacity on future margins.
- Review the impact and implementation status of the new lease accounting standard on reported assets, liabilities and leverage.
- Track asbestos litigation, government shutdown effects, trade restrictions and other contingent exposures.