Graham Corporation — Form 10-Q Summary
Reporting period: Three months ended June 30, 2016, the first quarter of fiscal 2017. The request metadata identifies “2015 Q1,” but the filing text clearly covers June 30, 2016 and compares it with June 30, 2015. Amounts are in thousands except per-share data.
Business Context
Graham designs and manufactures custom-engineered ejectors, vacuum pumping systems, surface condensers, vacuum systems, and nuclear fabrication and machining products for the energy, defense, chemical and petrochemical industries. Its operations include facilities in New York, Michigan, and China. The U.S. Navy represented approximately 50% of backlog at June 30, 2016.
Key Financial Metrics
| Metric | Q1 FY2017 | Q1 FY2016 | Change |
|---|---|---|---|
| Net sales | $22,365 | $27,617 | Down 19% |
| Gross profit | $4,111 | $8,037 | Down 49% |
| Gross margin | 18% | 29% | Down 11 percentage points |
| SG&A, including amortization | $3,656 | $4,638 | Down 21% |
| Restructuring charge | $555 | — | New charge |
| Net income | $85 | $2,361 | Down 96% |
| Diluted earnings per share | $0.01 | $0.23 | Down $0.22 |
| Operating cash flow | $3,814 | $3,331 | Up 15% |
Excluding the restructuring charge, management reported adjusted net income of $468 and adjusted diluted EPS of $0.05. The filing does not present these adjusted measures as GAAP results.
At June 30, 2016, cash and cash equivalents were $26,705, investments were $41,000, and total cash and investments were $67,705. Working capital was $74,734, with a current ratio of 3.2. Total assets were $148,043 and stockholders’ equity was $108,667.
Debt was minimal: capital lease obligations totaled $201, and there were no borrowings under the company’s credit facilities. Credit availability was $25,887 under the JP Morgan Chase and HSBC facilities, with $10,506 of letters of credit outstanding. The JP Morgan Chase facility provides a $25,000 line, expandable by another $25,000, and the company also has a $5,000 unsecured HSBC line.
Investing cash flow was a use of $129, principally for capital expenditures. Financing cash flow was a use of $938, including $866 of dividends and $30 of treasury-stock purchases. Fiscal 2017 capital expenditures are expected to be approximately $2,000 to $2,500.
Material Changes Versus the Prior Comparable Period
- Sales declined primarily because of lower volume across most markets, particularly chemicals and petrochemicals, and lower international sales to the Middle East.
- International sales fell to 27% of sales from 36%; domestic sales declined 8% and international sales declined 39% year over year.
- Gross margin contracted to 18% from 29% because of lower-margin backlog orders, fewer short-cycle sales, lower production volume, and under-absorption of overhead.
- SG&A declined $982, principally due to lower compensation costs, lower volume and cost-reduction actions.
- Orders declined 39% to $14,601 from $23,976. Backlog declined 8% from $107,963 at March 31, 2016 to $99,863.
- Operating cash flow increased despite lower earnings, aided by higher customer deposits and lower inventory, partly offset by higher accounts receivable and unbilled revenue.
- Cash and investments increased 4% from $65,072 at March 31, 2016 to $67,705.
Guidance, Outlook, Risks and Unusual Items
Management expects fiscal 2017 revenue of $80,000 to $95,000, gross margin of 24% to 26%, SG&A of $16,000 to $17,000, and an effective tax rate of 30% to 31%. Expected fiscal 2017 cash flow is described as more moderate than fiscal 2016.
Management expects approximately 45% to 55% of the March 31, 2016 backlog to convert to fiscal 2017 sales. Approximately 45% to 50% of the June 30, 2016 backlog is expected to convert within one year, while 40% to 45% is expected to ship beyond two years. Three projects totaling $6,860 were on hold at June 30, 2016.
Continued low and volatile oil prices have reduced customer capital spending, requests for quotations and orders in refining and chemical markets. Management expects near-term order levels to remain volatile and fiscal 2017 to be challenging, while anticipating strength in the power business and longer-term growth from energy markets, the U.S. Navy and nuclear-related work. The company continues to target revenue above $200,000 across the next business cycle, but this is a long-term aspiration rather than current-year guidance.
The company recorded a $555 restructuring charge for severance and related benefits after eliminating positions representing approximately 10% of its global workforce. Additional restructuring costs of approximately $100 are expected in the second quarter. Expected annual savings are approximately $2,700, with approximately $2,000 expected in fiscal 2017.
Asbestos-related personal-injury lawsuits and other ordinary-course claims remain outstanding. Management cannot estimate a reasonably possible loss or range of loss but does not believe the matters will materially affect results, financial position or cash flows.
Revenue is recognized largely under the percentage-of-completion method, requiring estimates of total labor and contract costs. The company is evaluating the impact and adoption method for the new revenue-recognition standard and other accounting updates; the filing does not provide a clear estimate of the potential impact.
Investor Verification Points
- Verify the timing and profitability of backlog conversion, particularly the three projects on hold and the portion expected beyond fiscal 2017.
- Assess whether refining and chemical market weakness, pricing pressure and production under-utilization cause gross margin to fall below the 24% to 26% guidance range.
- Monitor order intake, cancellations, customer deposits and international sales, especially Middle East activity.
- Confirm realization of restructuring savings and whether the expected additional $100 charge is incurred.
- Review cash-flow quality, including the effects of customer deposits, receivables, unbilled revenue and inventory changes.
- Evaluate exposure from asbestos litigation, product warranties and pension/postretirement obligations; the filing does not provide a quantifiable loss range for the litigation.
- Track adoption planning and potential effects of the new revenue, inventory, lease, credit-loss and stock-compensation accounting standards.