Graham Corporation Form 10-Q Summary
Reporting period: Three and nine months ended December 31, 2017, representing fiscal 2018 through the third quarter. The request metadata identifies “2016 Q3,” but the filing itself is for December 31, 2017 and compares with December 31, 2016.
Business Context
Graham designs and manufactures custom-engineered vacuum, heat-transfer, condenser and nuclear-fabrication equipment for energy, defense, chemical and petrochemical markets. Operations include facilities in Batavia, New York; Energy Steel in Lapeer, Michigan; and a sales and engineering subsidiary in Suzhou, China.
Financial Results and Liquidity
| Metric | Q3 FY2018 | Q3 FY2017 | 9M FY2018 | 9M FY2017 |
|---|---|---|---|---|
| Net sales | $17.3 million | $22.7 million | $55.4 million | $66.1 million |
| Gross profit | $3.6 million | $6.3 million | $12.3 million | $15.4 million |
| Gross margin | 21% | 28% | 22% | 23% |
| Net income (loss) | $(11.6) million | $1.8 million | $(10.7) million | $3.2 million |
| Diluted EPS | $(1.19) | $0.19 | $(1.09) | $0.33 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $3.9 million | $10.7 million |
- Reported operating margin was negative 89% in the quarter and negative 26% for the nine-month period, primarily because of the $14.8 million goodwill and intangible-asset impairment charge. Excluding the impairment and related items, quarterly operating margin was negative 1%.
- Q3 SG&A was $4.1 million, or 24% of sales, versus $3.8 million, or 17%, in the prior-year quarter. The increase included a $234,000 bad-debt charge associated with the commercial nuclear market.
- At December 31, 2017, cash and cash equivalents were $36.2 million and short-term investments were $38.0 million, for total cash and investments of $74.2 million. Working capital was $78.4 million, with a 3.3 current ratio.
- The company had no borrowings under its credit facilities. It had $7.4 million of outstanding letters of credit, approximately $25.2 million of availability under the JPMorgan Chase and HSBC facilities, and total revolving capacity of up to $50 million under the JPMorgan Chase arrangement, subject to terms.
- Nine-month capital expenditures were $543,000, dividends paid were $2.6 million, and cash decreased by $3.3 million from March 31, 2017 to $36.2 million.
Material Changes Versus the Prior Comparable Period
- Q3 sales declined 24%; nine-month sales declined 16%. Domestic sales were the principal weakness, while international sales increased 15% in the quarter and 7% year to date.
- Gross profit declined 43% in Q3 and 20% year to date because of lower volume, weaker project mix and lower production-cost absorption.
- The company recorded a $14.8 million pre-tax impairment charge: $8.6 million for permits, $500,000 for the Energy Steel tradename and $5.7 million for goodwill. The impairment reduced the carrying value of related assets by approximately $14.8 million.
- The impairment reflected reduced U.S. commercial nuclear investment, competitive pressure affecting Energy Steel and the bankruptcy of Westinghouse Electric Company, which halted work at the Summer, South Carolina nuclear facility.
- The company also recorded a $46,000 revenue reversal and a $234,000 bad-debt charge related to the Westinghouse-related disruption.
- Restructuring charges were $316,000 in the first nine months of fiscal 2018 versus $630,000 in the prior-year period. Workforce reductions were approximately 6% of the global workforce, with expected annual savings of approximately $1.5 million.
- Orders increased 129% in Q3 to $40.5 million and 20% year to date to $68.7 million. Backlog increased to $96.2 million at December 31, 2017, from $82.6 million at March 31, 2017.
Outlook, Risks and Unusual Items
- Management expects fiscal 2018 revenue of approximately $75 million, gross margin of 21% to 22%, SG&A of $15 million to $15.5 million, and an effective tax rate of 24% to 26% excluding the impairment and one-time Tax Act effects.
- Management expects fiscal 2018 operating cash flow to be lower than fiscal 2017 and forecasts capital expenditures of approximately $1.5 million to $2.5 million.
- Management expects energy-market weakness, lower pricing and under-utilized production facilities to continue pressuring fourth-quarter gross margins. It describes nuclear-market conditions as weak and unpredictable.
- Approximately 55% to 60% of backlog is expected to convert to sales within one year. Backlog at December 31, 2017 was 51% U.S. Navy, 35% refinery, 6% power, 4% chemical and petrochemical, and 4% other industrial applications.
- The Tax Cuts and Jobs Act produced a provisional $1.575 million deferred-tax remeasurement benefit and a $137,000 transition-tax expense. The company had not completed its accounting for the Tax Act, so these amounts could change.
- The company faces asbestos-related lawsuits and other ordinary-course claims. Management cannot estimate a reasonably possible loss range but does not believe the matters will materially affect operations, financial position or cash flows.
- Revenue is substantially recognized using percentage-of-completion or shipment-based methods, requiring estimates of labor, milestones, contract value and costs to complete. The company expects to adopt the new revenue standard using the modified retrospective approach in fiscal 2019 and believes timing of revenue recognition may be the most significant effect.
- The company reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Key Facts for Investors to Verify
- Whether the sharp increase in orders and backlog converts into sales and cash flow as projected, particularly given management’s expectation that only 55% to 60% of backlog will ship within one year.
- The sustainability of the refining, petrochemical and U.S. Navy demand that is offsetting weakness in commercial nuclear markets.
- The final accounting impact of the Tax Act, including deferred-tax remeasurement and the foreign earnings transition tax.
- Whether quarterly gross margins stabilize within management’s 21% to 22% fiscal-year range despite under-absorption and lower pricing.
- Future cash generation, dividend funding and capital spending relative to the company’s reduced operating cash flow.
- Potential additional losses, customer-payment issues or contract impacts associated with Westinghouse and the commercial nuclear business.
- Developments in asbestos litigation and other contingencies, for which the filing provides no estimable loss range.