Graham Corporation — Form 10-Q Summary
Reporting period: The supplied filing is for the quarter and nine months ended December 31, 2014, representing the third quarter and first nine months of fiscal 2015. The request metadata references “2013 Q3,” but the filing itself reports fiscal 2015 results compared with fiscal 2014. Amounts are in thousands except per-share data.
Business Context
Graham designs and manufactures custom-engineered equipment for refining, petrochemical, chemical, power, nuclear, defense, and other industrial markets. Operations include facilities in New York and Michigan and a wholly owned subsidiary in China.
Financial Performance and Liquidity
| Metric | Three months ended Dec. 31, 2014 | Three months ended Dec. 31, 2013 | Nine months ended Dec. 31, 2014 | Nine months ended Dec. 31, 2013 |
|---|---|---|---|---|
| Net sales | $33,646 | $23,385 | $97,714 | $76,131 |
| Gross profit | $10,103 | $6,090 | $29,019 | $24,394 |
| Gross margin | 30% | 26% | 30% | 32% |
| Net income | $3,992 | $1,431 | $10,570 | $7,828 |
| Diluted EPS | $0.39 | $0.14 | $1.04 | $0.78 |
- Third-quarter sales increased 44%; nine-month sales increased 28%.
- Third-quarter operating margin was 17%, versus 9% in the prior-year quarter. Nine-month operating margin was 16%, versus 15%.
- SG&A increased 9% in the quarter and 5% year to date, but declined to 13% and 14% of sales from 18% and 17%, respectively.
- Net cash provided by operating activities was $7,505 for the first nine months, down from $14,571. The decline primarily reflected a $5,463 increase in unbilled revenue and a $4,938 increase in accounts receivable.
- Capital expenditures were $4,965 year to date, compared with $2,161 in the prior-year period. Fiscal 2015 capital spending was expected to be approximately $5,500 to $6,000.
- Cash and cash equivalents were $29,496 and investments were $33,000 at December 31, 2014, for combined liquidity of $62,496.
- Working capital was $77,546, with a current ratio of 3.6. Total liabilities were $39,619 and stockholders’ equity was $116,255.
- Debt was minimal: capital lease obligations totaled $151. No amounts were outstanding under the company’s credit facilities; letters of credit totaled $16,185.
- The company had a $25,000 Bank of America revolving facility, expandable to $50,000, and a $5,000 unsecured HSBC line. Management believed operating cash flow, investments, and available financing were adequate for near-term needs.
Material Changes Versus Prior Comparable Period
- Sales growth was driven by strong domestic chemical and petrochemical activity and higher international sales, particularly in Canada, South America, and the Middle East.
- International sales represented 45% of third-quarter sales versus 38% previously, while first-nine-month international sales represented 36% versus 43%.
- Third-quarter gross margin improved through volume leverage. Year-to-date margin declined because of less favorable product and project mix and increased subcontracting.
- Orders declined 4% in the quarter to $22,558 and 15% year to date to $89,069. Backlog declined to $103,754 from $112,108 at March 31, 2014.
- Backlog composition shifted toward refinery and U.S. Navy work, while the shares attributable to chemical and petrochemical and power projects declined.
- A $7,827 oil-sands project was on hold pending the customer’s final project design analysis; management expected release during calendar 2015, with completion 18 to 30 months thereafter.
- The product warranty liability increased to $720 from $223 at December 31, 2013, primarily reflecting warranty expense of $573 for the first nine months versus $11 in the prior-year period. The prior-year quarter included a $47 reversal of warranty provisions.
Guidance, Outlook, Risks, and Unusual Items
- Management expected fiscal 2015 revenue in the upper half of its previously stated $125,000 to $130,000 range.
- Fiscal 2015 gross margin was expected at 30% to 31%, SG&A at 14% to 14.5% of sales, and the effective tax rate at 32% to 33%. Fiscal 2015 cash flow was expected to remain positive.
- Management warned that crude oil prices had fallen sharply and expected near-term pressure on customer investment, pricing power, backlog growth, revenue expansion, and margins over the following 12 to 18 months.
- Refinery, petrochemical, and large capacity-expansion projects could be delayed, while short-cycle, aftermarket, defense, and power work was expected to be comparatively less affected.
- Long-term growth drivers included global energy demand, petrochemical investment, nuclear plant life extensions, U.S. Navy programs, diversification, acquisitions, and business partnerships.
- Key risks include project timing and cancellation, customer concentration and end-market cyclicality, foreign currency and international competition, material costs, execution of long-term contracts, litigation, and the company’s use of percentage-of-completion accounting based on estimated labor hours and costs.
- The company faced asbestos-related lawsuits and other ordinary-course claims. Management could not estimate a reasonably possible loss range but did not believe the matters would materially affect results, financial position, or cash flows.
- The company had no material off-balance-sheet arrangements other than operating leases and ordinary-course letters of credit. Disclosure controls were concluded to be effective.
Investor Verification Items
- Verify that the intended period is the fiscal 2015 third quarter ended December 31, 2014, rather than 2013 Q3.
- Assess whether the decline in orders and backlog persists and whether the $7,827 on-hold oil-sands project is released as expected.
- Reconcile earnings growth with weaker operating cash flow and monitor collections of accounts receivable and unbilled revenue.
- Compare actual fiscal 2015 revenue, margins, SG&A, tax rate, and capital expenditures with management’s stated guidance.
- Review warranty claims and liability trends, including the significant increase from the prior year.
- Evaluate the impact of oil prices on refinery and petrochemical customers, pricing, project cancellations, and future backlog conversion.
- Review percentage-of-completion estimates, contract profitability revisions, commitments, letters of credit, and asbestos-related contingencies.