GRAHAM CORP quarterly report, Q2 FY2019

Graham Corporation — Form 10-Q Summary

Reporting period: Quarterly and six-month periods ended September 30, 2019, representing the second quarter and first six months of fiscal 2020. The supplied metadata identifies “2018 Q2,” but the filing itself is for September 30, 2019. The company designs and manufactures custom-engineered vacuum and heat-transfer equipment for energy, chemical and petrochemical, defense, and industrial markets.

Financial performance

Metric	Three months ended September 30, 2019	Three months ended September 30, 2018	Six months ended September 30, 2019	Six months ended September 30, 2018
Net sales	$21.643 million	$21.441 million	$42.236 million	$50.992 million
Gross profit	$4.948 million	$6.227 million	$9.662 million	$13.369 million
Gross margin	22.9%	29.0%	22.9%	26.2%
Net income	$1.205 million	$1.827 million	$1.287 million	$4.150 million
Diluted EPS	$0.12	$0.19	$0.13	$0.42

Second-quarter sales increased 1%, but six-month sales decreased 17%, primarily because the prior-year period included a large Canadian project and the commercial nuclear business that was subsequently sold.
Second-quarter operating profit was $1.101 million, or approximately 5.1% of sales, versus $1.449 million, or approximately 6.8%, in the prior-year quarter. Six-month operating profit was $0.725 million, or approximately 1.7%, versus $3.981 million, or approximately 7.8%.
Management attributed the gross-margin decline to lower volume and an unfavorable project mix. SG&A declined to $3.847 million in the quarter and $8.414 million year to date, partly due to the divestiture of Energy Steel.
Interest income increased to $0.363 million in the quarter and $0.762 million year to date, reflecting higher investment rates. Effective tax rates were 22% for both 2019 periods.

Cash flow, liquidity and capital structure

Six-month operating cash flow was negative $1.915 million, compared with positive $5.075 million in the prior-year period. The change primarily reflected lower earnings and reduced customer deposits, partly offset by collections of accounts receivable.
Cash and investments totaled $73.796 million at September 30, 2019, compared with $77.753 million at March 31, 2019. Cash and cash equivalents were $11.882 million and investments were $61.914 million.
Working capital was $79.414 million, with a 2.8 current ratio. Investments consisted primarily of certificates of deposit scheduled to mature by December 30, 2019.
The company had no borrowings under its credit facilities. Its JPMorgan facility provided $25 million of availability, expandable to $50 million, and its HSBC unsecured line was $5 million at September 30, 2019; HSBC increased that line to $10 million on October 8, 2019. Letters of credit outstanding were $11.265 million.
Six-month capital expenditures were $0.679 million, and fiscal 2020 capital expenditures were expected to be approximately $2.5 million to $2.8 million. Dividends paid were $2.075 million.
Lease adoption resulted in operating lease assets of $0.312 million and operating lease liabilities of $0.305 million at September 30, 2019. Finance lease obligations totaled $0.121 million.

Material changes versus the prior comparable period

Energy Steel & Supply Co., the commercial nuclear business, was sold on June 24, 2019 for proceeds of $0.602 million, subject to customary adjustments. The company recorded an $0.087 million disposal loss in the first quarter of fiscal 2020.
Excluding the divested business, adjusted six-month net income was $2.187 million, or $0.22 per diluted share, versus $5.112 million, or $0.52 per share, in the comparable prior-year period. Adjusted six-month operating margin was 4.5% versus 11.2%.
Six-month international sales fell 46%, primarily because the prior-year period included a large Canadian project. Domestic sales increased 6%.
Second-quarter orders were $32.552 million versus $34.416 million; excluding prior-year commercial nuclear orders, comparable orders increased $0.441 million. Six-month orders were $47.641 million versus $56.393 million.
Backlog was $127.765 million at September 30, 2019, up from $117.185 million at June 30, 2019 and down from $132.127 million at March 31, 2019. Excluding the divested business, backlog increased 3% from March 31.
The company adopted ASC 842 leases on April 1, 2019 and recognized a $0.080 million reduction to opening retained earnings.

Guidance, outlook and risks

Fiscal 2020 revenue guidance is approximately $100 million to $105 million, excluding the divested commercial nuclear business. Gross margin guidance is 24% to 26%, SG&A guidance is $17 million to $18 million, and the expected effective tax rate is approximately 20%.
Management expects fiscal 2020 cash flow to remain solid and believes cash, investments, operating cash flow and available credit capacity will meet near-term needs and support growth plans.
Management reported improving energy and petrochemical activity but cautioned that order levels are expected to remain variable and that the pace and durability of market improvement are uncertain.
At September 30, 2019, 48% of backlog related to U.S. Navy projects, 32% to refinery projects, 16% to chemical and petrochemical projects, and 4% to power and other industrial applications. Approximately 55% to 60% of backlog was expected to convert to revenue within one year.
Key risks include project execution and cancellation, customer timing and investment decisions, commodity and materials-price volatility, foreign currency, tariffs and trade relations, global economic weakness, dependence on U.S. Navy programs, and the timing of backlog conversion.
The company is a defendant in asbestos-related and other ordinary-course legal proceedings. Management cannot estimate a reasonably possible loss but does not believe the matters will materially affect financial condition, results or cash flows.
Disclosure controls were considered effective, and no material change in internal control over financial reporting was reported.

Investor verification points

Verify the fiscal 2020 revenue and margin guidance against subsequent filings and actual results.
Assess whether negative operating cash flow was temporary or reflects continued pressure from customer deposits, contract assets and working capital.
Monitor gross-margin recovery and project mix, particularly as backlog converts into revenue.
Track backlog quality, conversion timing and concentration in U.S. Navy and energy-related projects.
Review the financial and operational effects of the Energy Steel divestiture and confirm that comparisons properly exclude the sold business.
Evaluate exposure to asbestos litigation, project cancellation, materials costs, foreign markets and trade-policy changes.