Graham Corporation Form 10-Q Summary
Reporting period: Quarterly and year-to-date periods ended December 31, 2013, compared with December 31, 2012; balance sheet compared with March 31, 2013. The request metadata identifies “2012 Q3,” but the filing itself is the fiscal 2014 third-quarter Form 10-Q filed February 4, 2014.
Business Context
Graham designs and manufactures custom-engineered equipment for refining, petrochemical, power, nuclear, defense, and other industrial markets. Operations include facilities in New York and Michigan and a wholly owned subsidiary in China. Most longer-term contracts use percentage-of-completion revenue recognition.
Key Financial Metrics
| Metric | Three Months Ended Dec. 31, 2013 | Three Months Ended Dec. 31, 2012 | Nine Months Ended Dec. 31, 2013 | Nine Months Ended Dec. 31, 2012 |
|---|---|---|---|---|
| Net sales | $23.4 million | $25.6 million | $76.1 million | $74.1 million |
| Gross profit | $6.1 million | $7.1 million | $24.4 million | $21.3 million |
| Gross margin | 26% | 28% | 32% | 29% |
| Income before taxes | $2.0 million | $3.9 million | $11.5 million | $9.9 million |
| Net income | $1.4 million | $3.0 million | $7.8 million | $7.1 million |
| Diluted earnings per share | $0.14 | $0.30 | $0.78 | $0.70 |
- Operating margin was 9% in the third quarter and 15% for the first nine months, compared with 15% and 13%, respectively, in the prior-year periods.
- Cash and cash equivalents were $33.4 million at December 31, 2013. Short-term investments were $30.5 million, producing combined cash and investments of $63.9 million.
- Working capital was $71.7 million, with a current ratio of 3.9, compared with $64.0 million and 3.6 at March 31, 2013.
- Net cash provided by operating activities was $14.6 million for the first nine months, compared with $14.9 million in the prior-year period.
- Capital expenditures were $2.2 million year to date, compared with $1.0 million in the prior-year period. Full-year fiscal 2014 capital expenditures were expected to be $6 million to $7 million.
- The company had no borrowings under its revolving credit facility. The facility totaled $25 million, with an option to increase availability to $50 million; $12.5 million of letters of credit were outstanding, leaving $12.5 million of availability at December 31, 2013.
- Total liabilities were $33.9 million and stockholders’ equity was $101.7 million at December 31, 2013.
Material Changes Versus the Prior Comparable Period
- Third-quarter sales declined 9%, primarily because of lower international sales, particularly in the Middle East and Asia. Domestic sales increased 28%.
- Nine-month sales increased 3%, supported by higher domestic and Canadian sales, partly offset by lower Middle East sales.
- Third-quarter gross margin declined to 26% from 28% because of product mix. Nine-month gross margin improved to 32% from 29%, reflecting stronger short-cycle sales and more favorable project pricing in the first two quarters.
- Third-quarter net income declined 53%, but the comparison was affected by the prior year’s $975,000 reversal of an Energy Steel acquisition earn-out reserve. Excluding that reversal, prior-year third-quarter net income was $2.1 million, versus $1.4 million in 2013.
- Excluding the prior-year earn-out reversal, nine-month net income increased from $6.1 million to $7.8 million, and diluted EPS increased from $0.61 to $0.78.
- Orders were $23.5 million in the third quarter, down 5%, but $104.7 million for the first nine months, up 50%. Backlog reached a record $114.6 million at December 31, 2013, up 34% from March 31, 2013.
- The mix of orders shifted toward domestic markets, especially petrochemical and U.S. Navy projects. International sales represented 43% of nine-month sales, compared with 47% in the prior year.
Guidance, Outlook, Risks, and Unusual Items
- Fiscal 2014 revenue guidance was $100 million to $110 million.
- Fiscal 2014 gross margin guidance was 31% to 33%; SG&A was expected to be 16% to 17% of sales; and the effective tax rate was expected to be 33% to 34%.
- Management cited improving refinery and petrochemical markets, strong North American petrochemical activity, and opportunities in nuclear and U.S. Navy projects. It also expects order levels to remain volatile because of project timing and global economic conditions.
- Approximately 70% to 75% of backlog was expected to convert to sales within twelve months, with additional conversion in later periods. Some nuclear and Navy projects have multi-year schedules and potential stops and starts.
- Management expected fourth-quarter operating cash flow to be negative because of the planned capital expansion.
- The company expects emerging-market growth and international competition to pressure pricing and margins; management expects peak margins in the current cycle to be below the prior cycle.
- China refining and petrochemical projects had been delayed six to twelve months, although management characterized the delays as postponements rather than cancellations.
- Asbestos-related lawsuits and other ordinary-course claims remained outstanding. Management could not estimate a reasonably possible loss but did not expect a material financial impact.
- The IRS examination of tax years 2011 and 2012 was completed, reducing unrecognized tax benefits by $134,000. The company also recorded a $47,000 third-quarter reversal of excess product-warranty provisions.
- Key risks include contract cost-estimate revisions, project cancellation or delay, commodity and material-price volatility, foreign-exchange exposure, cyclical end markets, nuclear-market uncertainty, litigation, and backlog conversion timing.
Investor Verification Checklist
- Reconcile the $100 million to $110 million fiscal 2014 revenue outlook with the $114.6 million backlog and expected conversion timing.
- Assess whether the 31% to 33% gross-margin guidance is sustainable as the mix shifts toward petrochemical, international, nuclear, and Navy projects.
- Review contract estimates under percentage-of-completion accounting, including labor-hour assumptions and potential loss contracts.
- Monitor domestic petrochemical and U.S. Navy orders, delayed Chinese projects, and the conversion of long-lead-time backlog.
- Confirm the timing and return on the planned $6 million to $7 million facility and equipment investment.
- Evaluate liquidity after the expected fourth-quarter cash outflow and the $12.5 million of letters of credit outstanding.
- Follow asbestos litigation, tax examinations, warranty claims, and pension and postretirement obligations.