GRAHAM CORP annual report, FY2019

Graham Corporation — Fiscal 2020 Form 10-K Summary

Reporting period: Fiscal year ended March 31, 2020. The request metadata references “2018 Q4,” but the supplied filing is Graham Corporation’s fiscal 2020 Form 10-K, filed June 15, 2020.

Business Context

Graham designs and manufactures engineered vacuum and heat-transfer equipment for energy, defense, chemical and petrochemical applications. Its products serve petroleum refining, chemical processing, power generation and the U.S. Navy’s nuclear propulsion programs. Operations are based in Batavia, New York, with wholly owned subsidiaries in China and India.

Energy Steel, the commercial nuclear utility subsidiary, was sold on June 24, 2019 for proceeds of $602.
The Company had 337 employees at March 31, 2020 and operates as one reportable segment.
U.S. Navy projects represented 52% of backlog at year-end, including 24% for Columbia-class submarines, 16% for nuclear carriers and 12% for Virginia-class submarines.

Financial and Operating Metrics

Metric	Fiscal 2020	Fiscal 2019	Change
Net sales	$90.604 million	$91.831 million	Down 1%
Gross profit	$18.148 million	$21.909 million	Down 17%
Gross margin	20.0%	23.9%	Down 3.9 percentage points
Operating margin	0.7%	(2.6%)	Improved
Net income	$1.872 million	$(0.308) million	Improved
Diluted EPS	$0.19	$(0.03)	Improved
Operating cash flow	$1.239 million	$7.917 million	Down $6.678 million
Capital expenditures	$2.417 million	$2.138 million	Up $0.279 million
Cash, cash equivalents and investments	$73.003 million	$77.753 million	Down $4.750 million
Backlog	$112.389 million	$132.127 million	Down 15%

Domestic sales were $58.042 million, or 64% of revenue, while international sales were $32.562 million, or 36%. Sales mix shifted toward chemical and petrochemical markets and defense, while refining and power-market sales declined.

SG&A expense declined to $16.879 million from $17.878 million. Interest income was $1.324 million, and interest expense was $12 thousand. The effective tax rate was 19% in fiscal 2020.

Liquidity remained strong. Working capital was $77.443 million, the current ratio was 2.6, and the Company reported no bank borrowings. Finance lease obligations totaled $95 thousand. Credit facilities provided aggregate capacity of up to $60 million, including the JPMorgan facility and HSBC letter-of-credit facility. Outstanding letters of credit totaled $13.328 million.

Quarterly cash dividends totaled $0.43 per share, consisting of $0.10 in the first quarter and $0.11 in each subsequent quarter. Total dividends paid were $4.250 million.

Material Changes Versus Fiscal 2019

Revenue was broadly stable after including the divested Energy Steel business, which contributed $1.276 million in fiscal 2020 versus $8.336 million in fiscal 2019.
Gross margin contracted because production costs increased as the Company had expanded its cost structure for anticipated growth that was subsequently weakened by market conditions.
Net income improved from a loss to a profit, primarily because fiscal 2019 included a $6.449 million pre-tax impairment charge related to Energy Steel.
Fiscal 2020 included a $617 thousand loss on the Energy Steel sale, a $98 thousand bad-debt charge and a $338 thousand inventory write-down related to Westinghouse Electric Company’s bankruptcy.
Orders declined 21% to $80.034 million from $101.241 million. Domestic orders fell 31% and international orders fell 5%.
Backlog declined 15%, although the fiscal 2019 balance included $8.039 million attributable to Energy Steel. Approximately 70% to 75% of backlog was expected to convert to revenue within one year.
Operating cash flow declined substantially, driven primarily by cash usage from unbilled revenue and customer deposits.

Guidance, Outlook and Management Commentary

Management did not provide quantitative revenue guidance because of uncertainty from COVID-19 and oil-market volatility.
COVID-19 adversely affected estimated fiscal 2020 revenue by approximately $7 million, including $5 million related to a project fabricated in China and $2 million related to reduced Batavia production.
Batavia production was limited for approximately three weeks beginning in late March 2020. Management expected fiscal 2021 production to operate at approximately one-third capacity during the first two months of the first quarter and approximately 50% of normal capacity for the quarter overall, followed by a return toward normal capacity during the remaining nine months.
Management expected a weak first quarter of fiscal 2021 and anticipated that 70% to 75% of the March 31, 2020 backlog would convert to fiscal 2021 revenue.
Three projects totaling $4.118 million were delayed beyond fiscal 2021 as of June 2020. Two projects totaling $3.165 million were cancelled during fiscal 2020, and two projects totaling $562 thousand were on hold at year-end.
Navy programs in backlog were expected to generate approximately $20 million to $25 million of annual revenue in fiscal 2021 and beyond, although timing may vary based on government funding and project releases.
Fiscal 2021 capital expenditures were expected to be approximately $2.0 million to $2.5 million.
Management continued to pursue expansion in U.S. Navy markets, commercial markets and potential acquisitions, while emphasizing operational efficiency, engineering capacity and flexible manufacturing.

Risks, Contingencies and Unusual Items

COVID-19 could cause further production interruptions, supply-chain disruptions, customer delays, project cancellations, additional costs and reduced demand.
Energy and petrochemical markets are cyclical and sensitive to oil and natural-gas prices, capital spending and geopolitical supply-demand conditions.
Customer concentration is material: the top ten customers represented 48% of fiscal 2020 sales, and one customer represented 13% of sales.
U.S. Navy contracts are long-term, fixed-price projects that may take three to seven years from order to shipment and are subject to annual government funding, cost overruns, delays and potential liabilities beyond insurance coverage.
The Company relies on estimates of labor hours and operational milestones for over-time revenue recognition on approximately 70% of fiscal 2020 revenue. Changes in estimates can create significant period-to-period volatility.
Fixed-price contracts expose the Company to supplier failures, cost inflation, estimating errors, customer disputes and potential losses.
The Company faces foreign currency, tariff, China and India operating, cybersecurity, intellectual-property, product-liability and skilled-labor risks.
Graham is a defendant in asbestos-related lawsuits and other ordinary-course legal proceedings. Management stated that losses cannot be estimated for most claims but does not currently expect a material adverse effect.
Letters of credit totaled $13.328 million at March 31, 2020. The filing also disclosed contractual obligations of $1.183 million, excluding amounts that could not be estimated for certain postretirement obligations.

Facts Investors Should Verify

Whether fiscal 2021 production recovered to normal capacity and how COVID-19 affected revenue, margins, cash flow and backlog conversion.
The timing, funding and profitability of the large U.S. Navy backlog, including the concentration in Columbia-class, Virginia-class and carrier programs.
Whether the $4.118 million of delayed projects and the $562 thousand of projects on hold were ultimately resumed, cancelled or re-priced.
Whether gross margins recovered after the Company’s fiscal 2020 production-cost increases.
Changes in unbilled revenue, customer deposits and operating cash flow, particularly under ASC 606 over-time revenue recognition.
Potential effects of asbestos litigation, product claims, fixed-price contract losses and customer credit deterioration.
Compliance with credit-facility covenants and the availability of borrowing capacity after considering letters of credit.
The sustainability of quarterly dividends given weak near-term cash flow and cyclical end markets.