Graham Corporation — Form 10-Q Summary
Reporting period: Filing covers the three and six months ended September 30, 2020, Graham’s fiscal 2021 second quarter and first half. The request metadata identifies “2019 Q2,” but the filing itself is for September 30, 2020. Financial amounts are in thousands, except per-share data.
Business Context and Reporting Period
Graham designs and manufactures custom-engineered vacuum and heat-transfer equipment for energy, defense, chemical and petrochemical, and other industrial markets. Its U.S. Navy defense business represented approximately 50% of backlog at September 30, 2020. The company operates in Batavia, New York, with subsidiaries in China and India. The commercial energy markets remained pressured by excess crude oil supply, lower commodity prices, reduced customer capital spending, and COVID-19-related economic disruption.
Key Financial Metrics
| Metric | Three months ended Sept. 30, 2020 | Three months ended Sept. 30, 2019 | Six months ended Sept. 30, 2020 | Six months ended Sept. 30, 2019 |
|---|---|---|---|---|
| Net sales | $27,954 | $21,643 | $44,664 | $42,236 |
| Gross profit | $7,693 | $4,948 | $9,261 | $9,662 |
| Gross margin | 28% | 23% | 21% | 23% |
| Net income | $2,744 | $1,205 | $926 | $1,287 |
| Diluted EPS | $0.27 | $0.12 | $0.09 | $0.13 |
| Operating margin | 12% | 5% | 2% | 2% |
- Revenue mix: Second-quarter sales were 37% refining, 19% chemical and petrochemical, 34% U.S. Navy defense, and 10% other applications. First-half sales were 29%, 30%, 29%, and 12%, respectively.
- Cash flow: Net cash used in operating activities was $2,258 for the first six months of fiscal 2021, compared with $1,915 used in the prior-year period. Capital expenditures were $797, and dividends paid were $2,195.
- Liquidity: Cash and investments totaled $67,856 at September 30, 2020, versus $73,003 at March 31, 2020. Working capital was $77,546, with a current ratio of 2.7.
- Debt and credit: No amounts were outstanding under the company’s credit facilities. Letters of credit totaled $17,161. The company had a $25,000 JPMorgan facility, expandable by an additional $25,000, and a $14,000 HSBC line, subject to outstanding letters of credit and other terms.
- Backlog: Backlog was $114,851, compared with $112,389 at March 31, 2020. Management expected approximately 60% to 65% of backlog to convert to revenue within one year.
- Dividends: Dividends declared were $0.11 per share in the quarter and $0.22 per share for the six-month period.
Material Changes Versus the Prior Comparable Period
- Second-quarter sales increased 29%, driven by higher throughput at Batavia, accelerated conversion at a global fabrication partner, and completion of a materials-only order. International sales increased 81%, while domestic sales increased 10%.
- Second-quarter gross margin improved to 28% from 23%, and net income increased to $2,744 from $1,205. SG&A increased to $4,253 from $3,847, but SG&A declined as a percentage of sales to 15% from 18%.
- First-half sales increased 6%, but gross profit declined 4% and gross margin declined to 21% from 23%. The first quarter was adversely affected by COVID-19-related production reductions at Batavia.
- First-half net income declined to $926 from $1,287. The prior-year period included an $893 loss related to the divested Energy Steel commercial nuclear utility business, as well as other expense items related to a customer bankruptcy and the Energy Steel sale.
- Interest income declined substantially to $120 from $762 for the first six months because of lower market investment rates.
- Orders were $34,974 in the second quarter, up from $32,552, but first-half orders declined to $46,442 from $47,641.
Guidance, Outlook, Risks, and Unusual Items
- Fiscal 2021 guidance: Revenue of $90,000 to $95,000, gross margin of 22% to 24%, SG&A expense of $17,000 to $17,500, an effective tax rate of approximately 22%, and capital expenditures of approximately $2,000 to $2,500.
- Management expected positive operating cash flow for the remainder of fiscal 2021 and assumed near-normal Batavia production capacity, global supply-chain access, and minimal COVID-19 disruption.
- Three projects totaling $4,118 were expected to be delayed beyond fiscal 2021. Two projects totaling $562 were on hold, and a $654 project had been cancelled during the first six months of fiscal 2021.
- Defense backlog was expected to generate approximately $20 million to $30 million of annual revenue in fiscal 2021 and beyond. Defense orders have longer conversion cycles, in some cases up to five years.
- Principal risks include COVID-19 impacts on employees, suppliers and customers; further production or supply-chain interruptions; weak commercial energy markets; project cancellations or delays; commodity and material-price volatility; foreign currency exposure; tariffs and trade policy; dependence on U.S. Navy programs; and execution risk on contracts recognized over time.
- The company is defending asbestos-related personal-injury lawsuits and other ordinary-course claims. Management could not estimate reasonably possible losses for most claims but did not believe the matters would have a material adverse effect.
- The company reported no off-balance-sheet arrangements other than letters of credit. Disclosure controls were deemed effective, with no material change in internal control over financial reporting.
Investor Verification Points
- Verify whether fiscal 2021 revenue and margin guidance remained achievable given COVID-19, commercial-market weakness, project delays, and the first-half operating cash outflow.
- Monitor conversion of the $114.9 million backlog, including the 50% defense concentration and the timing of U.S. Navy awards.
- Assess operating cash conversion, accounts receivable growth, unbilled revenue, customer deposits, and the effect of working-capital timing.
- Review cancellations, projects on hold, customer delays, and any changes in contract cost estimates or losses on contracts recognized over time.
- Track liquidity after letters of credit, dividend payments, capital expenditures, and any future borrowings under the available credit facilities.
- Evaluate the continuing effects of energy-market conditions, lower interest income, material costs, foreign exchange, and asbestos or other legal contingencies.