Graham Corporation — Form 10-Q Summary
Reporting period: Three months ended June 30, 2017, representing the first quarter of fiscal 2018. The request metadata identifies “2016 Q1,” but the filing itself is for June 30, 2017.
Business Context
Graham designs and manufactures custom-engineered vacuum, heat-transfer, nuclear, defense, energy, chemical and petrochemical equipment. Operations include facilities in Batavia, New York; Lapeer, Michigan; and Suzhou, China. The company serves energy, defense, power, chemical and other industrial markets, including the U.S. Navy.
Financial Performance and Liquidity
| Metric | Q1 FY2018 | Q1 FY2017 | Change |
|---|---|---|---|
| Net sales | $20.851 million | $22.365 million | Down 7% |
| Gross profit | $4.866 million | $4.111 million | Up 18% |
| Gross margin | 23% | 18% | Up 5 percentage points |
| Net income | $935 thousand | $85 thousand | Up $850 thousand |
| Diluted EPS | $0.10 | $0.01 | Up $0.09 |
| Operating cash flow | $2.876 million | $3.814 million | Down $938 thousand |
- SG&A was $3.681 million, or 18% of sales, compared with $3.656 million, or 16%, in the prior-year quarter.
- Operating margin was 6%, compared with approximately 0% in the prior-year quarter.
- The prior-year quarter included a $555 thousand restructuring charge, or $383 thousand after tax. Excluding that charge, prior-year net income was $468 thousand and diluted EPS was $0.05.
- Cash and investments totaled $75.260 million at June 30, 2017, compared with $73.474 million at March 31, 2017. Cash and cash equivalents were $25.260 million and short-term investments were $50.000 million.
- Working capital was $79.150 million and the current ratio was 3.9 at June 30, 2017.
- The company had no borrowings under its credit facilities. Its principal revolving facility provided total potential availability of up to $50 million, subject to terms, and an additional $5 million unsecured HSBC line was available. Letters of credit outstanding totaled $9.603 million.
- Total liabilities were $33.328 million and stockholders’ equity was $114.203 million at June 30, 2017.
- Cash flow from operations was reduced by timing of customer deposits, accounts payable and inventory. Investing cash use was $16.117 million, primarily from net purchases of certificates of deposit. Financing cash use was $1.022 million, including $879 thousand of dividends.
- Capital expenditures were $117 thousand during the quarter; fiscal 2018 capital expenditures were expected to be approximately $2.5 million to $3.0 million.
Material Changes Versus the Prior Comparable Period
- Sales declined 7%, with domestic sales down 9% and international sales down 1%. Market mix shifted toward chemical and petrochemical work and away from refining and power markets.
- Gross profit and gross margin improved because of project mix and the timing of overhead costs, despite lower sales.
- Net income increased substantially, primarily because the prior-year period included a restructuring charge and a favorable $100 thousand tax adjustment. The current-quarter effective tax rate was 30%.
- Orders booked declined 24% to $11.064 million from $14.601 million.
- Backlog declined 12% to $72.908 million at June 30, 2017, from $82.590 million at March 31, 2017. Approximately 45% to 55% of backlog was expected to convert to sales within one year.
- Backlog composition was 64% U.S. Navy, 18% refinery, 9% chemical and petrochemical, 6% power including nuclear, and 3% other industrial applications.
- Product warranty expense benefited from a $160 thousand reversal of prior provisions, reflecting lower claims experience. Warranty liability declined to $291 thousand from $694 thousand at June 30, 2016.
Guidance, Outlook, Risks and Unusual Items
- Management expects fiscal 2018 revenue of approximately $80 million to $90 million, gross margin of 22% to 24%, SG&A of $16 million to $17 million, and an effective tax rate of 30% to 32%.
- Management expects fiscal 2018 cash flow to be more moderate than fiscal 2017 because the prior year benefited from continued growth in customer deposits.
- Energy markets remain weak because of low and volatile oil and natural gas prices, reduced customer capital spending, pricing pressure and underutilized production capacity. Management expects near-term order levels to remain volatile.
- Management expects long-term growth from diversification into U.S. Navy and power markets and expects growth in naval nuclear propulsion work, but notes that Navy contracts can have conversion cycles of up to five years.
- Revenue is recognized primarily using percentage-of-completion accounting for longer manufacturing contracts. Estimates of labor hours, milestones, contract value and costs to complete can affect reported revenue and earnings.
- The company is evaluating adoption of the new revenue recognition standard and expected to adopt using the modified retrospective approach in the first quarter of fiscal 2019. Management expects the most significant potential effect to be timing of revenue recognition.
- The company faces asbestos-related lawsuits and other ordinary-course legal proceedings. Management cannot estimate a reasonably possible loss range but does not believe the matters will have a material effect on results, financial position or cash flows.
- The company had no projects on hold at June 30, 2017 and reported no material off-balance-sheet arrangements other than operating leases and letters of credit.
- Disclosure controls and procedures were assessed as effective, with no material change in internal control over financial reporting during the quarter.
Important Facts for Investors to Verify
- Whether the fiscal 2018 revenue forecast of $80 million to $90 million remains achievable given declining orders and backlog.
- The conversion timing and cancellation risk of the $72.908 million backlog, particularly the large U.S. Navy component.
- Whether gross margins remain within the 22% to 24% guidance range amid pricing pressure and production underutilization.
- The sustainability of operating cash flow as customer deposits and working-capital timing normalize.
- The eventual effect of the new revenue recognition standard on revenue timing, backlog conversion and reported earnings.
- Potential exposure from asbestos litigation, other contingencies, letters of credit and future lease-related liabilities.