Business Context and Reporting Period
Graham Corporation designs and manufactures custom-engineered vacuum, heat-transfer, nuclear, defense, energy, chemical and petrochemical equipment. This Form 10-Q covers the three months ended June 30, 2015, the first quarter of fiscal 2016, with comparison to the three months ended June 30, 2014. The request identifies “2014 Q1,” but the filing period is June 30, 2015.
Key Financial Metrics
| Metric | Q1 FY2016 | Q1 FY2015 | Change |
|---|---|---|---|
| Net sales | $27.617 million | $28.502 million | Down 3% |
| Gross profit | $8.037 million | $7.932 million | Up 1% |
| Gross margin | 29% | 28% | Up 1 percentage point |
| SG&A expense | $4.638 million | $4.349 million | Up 7% |
| SG&A as a percentage of sales | 17% | 15% | Up 2 percentage points |
| Net income | $2.361 million | $2.392 million | Down 1% |
| Diluted EPS | $0.23 | $0.24 | Down $0.01 |
| Operating cash flow | $3.331 million | $3.189 million | Up 4% |
- Cash and cash equivalents were $29.616 million at June 30, 2015, and certificates of deposit totaled $33.000 million, for cash and investments of $62.616 million.
- Working capital was $83.810 million, compared with $81.367 million at March 31, 2015; the current ratio was 4.2 versus 3.7.
- Total liabilities were $34.020 million and stockholders’ equity was $118.622 million. Capital lease obligations totaled $143 thousand; there were no borrowings outstanding under the credit facilities.
- The Bank of America facility provided $25 million of committed availability, with the ability to increase total capacity to $50 million, and the HSBC line provided $5 million. Letters of credit outstanding were $10.444 million, leaving stated Bank of America availability of $19.556 million.
- Capital expenditures were $264 thousand, compared with $2.569 million in the prior-year quarter. Dividends paid were $813 thousand, versus $405 thousand.
- International sales represented 36% of revenue versus 22% in the prior-year quarter. Domestic sales decreased 21%, while international sales increased 59%.
Material Changes Versus the Prior Comparable Period
- Revenue declined primarily because lower power-market sales more than offset higher refining-market volume.
- Gross profit and gross margin improved because of a more favorable product mix.
- SG&A increased principally because of higher sales commissions associated with the sales mix, pressuring operating margin to 12% from 13%.
- The effective tax rate declined to 32% from 34%, partially offsetting the effect of lower sales and higher SG&A.
- Orders booked fell 23% to $23.976 million from $31.108 million. Backlog declined 3% to $110.074 million from $113.811 million at March 31, 2015.
- Backlog composition shifted materially toward U.S. Navy work: 48% at June 30, 2015, compared with 23% at June 30, 2014. Refinery and chemical/petrochemical work represented 24% and 12%, respectively.
Guidance, Outlook, Risks and Unusual Items
- Management expects fiscal 2016 revenue of approximately $95 million to $105 million, gross margin of 26% to 28%, SG&A of 17% to 18% of sales and an effective tax rate of 32% to 33%.
- Fiscal 2016 capital expenditures are expected to be approximately $2 million to $2.5 million. Management expects strong cash flow as accounts receivable and unbilled revenue accumulated in fiscal 2015 are converted to cash.
- Management stated that lower crude oil prices have reduced customer capital spending in the refining and chemical markets. New orders are expected to remain volatile, and approximately $10 million of projects previously expected to convert to fiscal 2016 revenue are now expected to convert in fiscal 2017 because of customer-requested delays.
- Approximately 45% to 50% of backlog is expected to convert within 12 months, 5% to 10% in 12 to 24 months and 40% to 45% beyond two years. No projects were on hold at June 30, 2015.
- Key risks include energy-market contraction, pricing pressure, materials-cost volatility, project cancellation or delay, foreign currency exposure, customer concentration in U.S. Navy work, contract-estimate risk under percentage-of-completion accounting, and litigation.
- The company is defending asbestos-related personal-injury lawsuits and other ordinary-course claims. Management cannot estimate a reasonably possible loss but does not believe the outcomes will materially affect operations, financial position or cash flows.
- Pension and postretirement accounting produced unusual period effects: pension benefit income was $12 thousand versus $117 thousand, and postretirement benefit cost was $17 thousand versus income of $8 thousand in the prior-year quarter. No pension contributions were made, and none were expected for the balance of fiscal 2016.
Investor Verification Priorities
- Verify the filing period and fiscal-year labeling, since the supplied request references 2014 Q1 while the filing reports June 30, 2015.
- Assess whether orders, backlog conversion and customer-requested delays support management’s fiscal 2016 revenue guidance.
- Monitor exposure to refining and petrochemical capital spending, oil-price trends and pricing pressure.
- Evaluate the sustainability of the 29% quarterly gross margin against the 26% to 28% fiscal-year outlook and expected lower facility utilization.
- Review backlog concentration, particularly the 48% U.S. Navy exposure and the timing of long-lead-time projects.
- Confirm liquidity after considering letters of credit, capital expenditures, dividends and any future borrowing needs.
- Track asbestos litigation, warranty liabilities and estimates used for percentage-of-completion contracts and pension obligations.