Graham Corporation — Form 10-Q Summary
Reporting period: Three months ended June 30, 2018, the first quarter of fiscal 2019. The request metadata identifies “2017 Q1,” but the filing itself reports fiscal 2019 and compares with the three months ended June 30, 2017.
Business Context
Graham designs and manufactures custom-engineered vacuum and heat-transfer equipment, nuclear components, and specialty fabrication products for energy, defense, chemical and petrochemical, power, and other industrial markets. Operations include facilities in Batavia, New York; Lapeer, Michigan; and Suzhou, China.
Financial Results and Key Metrics
| Metric | Q1 FY2019 | Q1 FY2018 | Change |
|---|---|---|---|
| Net sales | $29.551 million | $20.851 million | Up 42% |
| Gross profit | $7.142 million | $4.778 million | Up 49% |
| Gross margin | 24% | 23% | Up 1 percentage point |
| SG&A expense | $4.610 million | $3.712 million | Up 24% |
| Operating margin | 9% | 5% | Up 4 percentage points |
| Net income | $2.323 million | $0.935 million | Up 148% |
| Diluted EPS | $0.24 | $0.10 | Up $0.14 |
| Effective tax rate | 23% | 30% | Lower rate |
| Operating cash flow | $0.068 million | $2.876 million | Down $2.808 million |
Sales growth was driven primarily by a large Canadian refining project. International sales increased 167% to approximately $16.1 million, while domestic sales declined 9%. Product-line sales included $17.216 million of vacuum equipment, $4.158 million of heat-transfer equipment, and $8.177 million of other products.
Cash and investments totaled $75.288 million at June 30, 2018, compared with $76.479 million at March 31, 2018. Cash and cash equivalents were $16.677 million, and short-term investments were $58.611 million. Working capital was $78.786 million, with a current ratio of 2.8.
Total debt was minimal: capital lease obligations were $116,000, and there were no borrowings under the company’s credit facilities. Letters of credit outstanding were $7.308 million. Graham had a $25 million revolving facility, potential expansion capacity of an additional $25 million, and a separate $5 million unsecured line; reported availability under the facilities was $25.261 million.
Capital expenditures were $163,000 during the quarter. Fiscal 2019 capital expenditures were expected to be approximately $2.0 million to $2.5 million. Dividends paid were $885,000, and dividends declared were $0.09 per share.
Material Changes Versus the Prior Comparable Period
- Revenue increased 42%, principally because of higher international sales and refining-project activity.
- Orders booked increased 99% to $21.977 million from $11.064 million.
- Backlog was $114.855 million, down 3% from March 31, 2018 but up from $72.908 million at June 30, 2017.
- Gross margin improved to 24% from 23%, reflecting higher volume and overhead absorption.
- SG&A increased 24%, primarily due to compensation, new hires supporting anticipated market expansion, and variable performance-related costs.
- Net income increased substantially, aided by higher sales, improved margins, greater interest income, and a lower tax rate.
- Operating cash flow fell to $68,000 from $2.876 million because of timing effects involving accounts payable and unbilled revenue.
- Graham adopted ASC 606 revenue recognition on April 1, 2018 using the modified retrospective method. The adoption reduced opening retained earnings by $1.022 million and increased reported first-quarter sales by $3.029 million and net income by $140,000, or approximately $0.01 per diluted share, compared with amounts that would have been reported under the prior standard.
- Approximately 70% of current-quarter revenue was recognized over time and 30% upon shipment.
Outlook, Risks, and Unusual Items
Management forecast fiscal 2019 revenue of approximately $95 million to $105 million, gross margin of 24% to 26%, SG&A of $18 million to $18.75 million, and an effective tax rate of 20% to 22%. Cash flow was expected to remain moderate.
Management reported improving energy and petrochemical activity, particularly in refining, but stated that order timing remains volatile and customer project decisions remain cautious. Commercial nuclear markets remain weak. Approximately 55% to 60% of backlog was expected to convert to revenue within one year. U.S. Navy projects represented 56% of backlog and generally have longer conversion cycles.
Key risks include execution and cost estimates on long-term contracts, timing or cancellation of customer projects, commodity and material-price volatility, foreign-currency movements, dependence on U.S. Navy and refining activity, international operations, litigation, and the uncertain pace of energy-market recovery. The company reported no projects on hold at June 30, 2018.
Graham faces asbestos-related personal-injury lawsuits and other ordinary-course claims. Management could not estimate a reasonably possible loss range but did not believe the matters would have a material effect on results, financial position, or cash flows. The company also noted that the Tax Cuts and Jobs Act accounting remained subject to possible adjustments as tax-return and regulatory analyses were finalized.
Pension and postretirement obligations remained on the balance sheet. No pension contributions were made during the quarter, and none were expected for the remainder of fiscal 2019. The company expected approximately $83,000 of postretirement benefit payments during the remainder of the fiscal year.
Important Facts for Investors to Verify
- Reconcile reported sales and earnings with the ASC 606 adoption impact, including the $3.029 million sales and $140,000 net-income effects disclosed for the quarter.
- Assess whether the unusually large Canadian refining project and the 42% sales increase are repeatable.
- Monitor backlog conversion, particularly the stated 55% to 60% expected conversion within one year and the long-cycle U.S. Navy portion.
- Review operating cash conversion, as operating cash flow was only $68,000 despite $2.323 million of net income.
- Track customer deposits, which were $25.867 million, and unbilled revenue, which was $11.844 million, as indicators of contract timing and cash requirements.
- Verify progress toward fiscal 2019 revenue, margin, SG&A, and tax-rate guidance.
- Evaluate exposure to refining, petrochemical, commercial nuclear, and U.S. Navy market conditions.
- Monitor asbestos litigation, project cancellation risk, contract-cost estimates, and any changes to provisional Tax Act accounting.