Graham Corporation Form 10-Q Summary
Reporting period: Three and six months ended September 30, 2015, representing the second quarter and first half of fiscal 2016. The request metadata identifies “2014 Q2,” but the filing is for 2015 Q2/fiscal 2016 and compares against the corresponding fiscal 2015 periods.
Business Context
Graham designs and manufactures custom-engineered ejectors, vacuum systems, surface condensers, heat-transfer equipment, and nuclear fabrication products for energy, defense, chemical and petrochemical markets. Operations include facilities in Batavia, New York; Lapeer, Michigan; and Suzhou, China.
Financial Performance and Liquidity
| Metric | Three months ended September 30 | Six months ended September 30 |
|---|---|---|
| Net sales | $22.8 million vs. $35.6 million | $50.4 million vs. $64.1 million |
| Gross profit | $7.1 million vs. $11.0 million | $15.2 million vs. $18.9 million |
| Gross margin | 31% vs. 31% | 30% vs. 30% |
| Net income | $2.0 million vs. $4.2 million | $4.3 million vs. $6.6 million |
| Diluted EPS | $0.20 vs. $0.41 | $0.43 vs. $0.65 |
| Operating cash flow | Not separately provided | $7.7 million vs. $8.5 million |
SG&A declined 11% in the quarter and 2% year to date, but SG&A as a percentage of sales increased to 19% and 18%, respectively, from 13% and 14% because of lower volume. Effective tax rates were 33% for the quarter and 32% year to date.
At September 30, 2015, cash and cash equivalents were $29.4 million and investments were $33.0 million, for combined cash and investments of $62.4 million. Working capital was $82.0 million and the current ratio was 4.2. Total liabilities were $33.3 million compared with stockholders’ equity of $116.8 million.
The company had no borrowings under its credit facilities. Letters of credit outstanding were $11.2 million, with reported availability of $18.8 million under the Bank of America facility and an additional $5.0 million unsecured HSBC line. Capital lease obligations totaled $0.1 million.
Investing cash usage was $0.5 million for the first six months, including $0.5 million of capital expenditures. Financing cash usage was $4.9 million, including $1.6 million of dividends and $3.4 million of treasury-stock purchases. Fiscal 2016 capital expenditures were expected to be approximately $2.0 million to $2.5 million.
Material Changes Versus Prior Comparable Period
- Second-quarter sales decreased 36%; first-half sales decreased 21%, primarily because of weaker commercial orders and reduced chemical, petrochemical and international activity.
- Second-quarter net income fell 53%, and first-half net income fell 34%. Diluted EPS declined from $0.41 to $0.20 in the quarter and from $0.65 to $0.43 year to date.
- Orders decreased 42% in the quarter and 33% year to date. Second-quarter orders were $20.6 million net of a $3.9 million cancellation.
- Backlog declined to $108.1 million from $113.8 million at March 31, 2015, although 47% was attributable to U.S. Navy projects, compared with 21% at September 30, 2014.
- Gross margins were stable year over year, but management stated that the quarter benefited from favorable project mix, productivity improvements on the CVN-79 project and a vendor settlement. Excluding those items, quarterly gross margin would have been approximately 27% to 28%.
- The quarterly dividend increased 100% from $0.04 to $0.08 per share. The company repurchased 187,000 shares for $3.4 million under an $18.0 million authorization.
Guidance, Outlook, Risks and Unusual Items
- Management expected fiscal 2016 revenue of approximately $95 million to $105 million, gross margin of 27% to 28%, SG&A of 17% to 18% of sales, and an effective tax rate of 32% to 33%.
- Management expected strong fiscal 2016 cash flow as accounts receivable and unbilled revenue accumulated in late fiscal 2015 convert to cash.
- Lower oil prices had reduced customer capital spending in refining and chemical markets. Management expected near-term order levels to remain volatile and fiscal 2016 to be weaker than fiscal 2015, while retaining a long-term objective of exceeding $200 million in revenue across the next cycle.
- Approximately 45% to 50% of backlog was expected to convert to sales within 12 months; $15 million to $17 million of commercial projects had extended conversion schedules.
- One $3.9 million project was cancelled during the quarter. Management stated that progress-payment structures limit cash exposure to cancellations.
- The company faces asbestos-related lawsuits and other ordinary-course claims. Management could not estimate a reasonably possible loss range but did not expect a material financial effect.
- Revenue recognition depends substantially on percentage-of-completion estimates, including labor-hour forecasts and estimated costs at completion. Contract estimate changes could affect reported revenue and earnings.
- The filing reports no off-balance-sheet arrangements other than operating leases and letters of credit. Foreign exchange, commodity-price, project-cancellation and customer capital-spending risks remain material.
Important Investor Verification Items
- Reconcile the apparent discrepancy in the MD&A table, which reports first-half gross profit of $14.3 million, versus $15.2 million in the financial statements and narrative.
- Assess whether the $108.1 million backlog and its conversion profile support the $95 million to $105 million fiscal 2016 revenue guidance.
- Separate recurring operating margins from the quarter’s vendor settlement, project productivity benefits and favorable project mix.
- Monitor order intake, cancellations and the declining portion of backlog expected to convert within 12 months.
- Review contract-cost estimates, percentage-of-completion adjustments, customer deposits and unbilled revenue for potential earnings or cash-flow volatility.
- Confirm available credit after letters of credit and evaluate the effect of continued dividends and share repurchases on liquidity.
- Track the outcome and potential exposure from asbestos litigation and other legal proceedings.