Graham Corporation Form 10-Q Summary
Reporting period: The filing covers the three and nine months ended December 31, 2016, within fiscal 2017, which ends March 31, 2017. The request metadata identifies “2015 Q3,” but the filing itself is a December 31, 2016 Form 10-Q and compares results with the corresponding 2015 periods.
Business Context
Graham designs and manufactures custom-engineered vacuum and heat-transfer equipment and specialty fabricated components for the energy, defense, chemical and petrochemical industries. Its markets include oil refining, power and nuclear applications, the U.S. Navy, and other industrial applications. Operations are located in the United States and China.
Key Financial Metrics
| Metric | Three months ended December 31, 2016 | Three months ended December 31, 2015 | Nine months ended December 31, 2016 | Nine months ended December 31, 2015 |
|---|---|---|---|---|
| Net sales | $22.654 million | $17.323 million | $66.145 million | $67.738 million |
| Gross profit | $6.301 million | $3.524 million | $15.422 million | $18.696 million |
| Gross margin | 28% | 20% | 23% | 28% |
| Net income | $1.840 million | $1.274 million | $3.222 million | $5.611 million |
| Diluted EPS | $0.19 | $0.13 | $0.33 | $0.56 |
| Operating cash flow | Not separately provided | Not separately provided | $10.707 million | $22.171 million |
- Third-quarter sales increased 31%, while nine-month sales declined 2%.
- Third-quarter operating margin was approximately 11%, versus 9% in the prior-year quarter. Nine-month operating margin was approximately 6%, versus 12% in the prior-year period.
- SG&A was $3.804 million in the quarter and $10.637 million year to date, representing 17% and 16% of sales, respectively.
- The nine-month effective tax rate was 27%, compared with 30% in the prior-year period.
- Cash and investments totaled $72.677 million at December 31, 2016, compared with $65.072 million at March 31, 2016.
- Working capital was $77.705 million, with a current ratio of 3.5.
- Total debt was limited to capital lease obligations of $174,000. No borrowings were outstanding under the credit facilities.
- Capital expenditures were $241,000 for the first nine months; fiscal 2017 capital expenditures were expected to be approximately $500,000.
- Dividends paid were $2.616 million for the first nine months, and dividends declared per share increased to $0.27 from $0.24.
Material Changes Versus Prior Comparable Period
- Quarterly sales growth was driven primarily by higher domestic sales, which increased 61%; international sales decreased 20%, particularly in the Middle East and Canada.
- For the first nine months, domestic sales increased 13%, while international sales decreased 29%, reducing international sales to 26% of total sales from 35%.
- Quarterly gross margin improved because of higher volume and conversion of a large, non-typical order. Management noted that the prior-year quarter had an unfavorable project mix.
- Nine-month gross margin declined because of lower pricing associated with deteriorating market conditions.
- Nine-month net income was reduced by a $630,000 restructuring charge related to workforce reductions. Excluding this charge, management reported adjusted nine-month net income of $3.663 million and diluted EPS of $0.38; these are non-GAAP-style figures presented by management and should be reconciled to GAAP results.
- Prior-year results included $1.784 million of other income from customer cancellation charges. No comparable amount was recorded in 2016.
- Operating cash flow fell to $10.707 million from $22.171 million, partly because the prior year benefited from collections of accounts receivable and unbilled revenue. Current-year cash flow also benefited from a $6.699 million increase in customer deposits, which management expects to unwind over the next several quarters.
- Orders declined 21% in the quarter and 15% for the first nine months. Backlog was $99.104 million, down 8% from March 31, 2016.
Guidance, Outlook, Risks and Unusual Items
- Management projected fiscal 2017 revenue of $88 million to $92 million, gross margin of 21% to 23%, SG&A of $15 million to $15.5 million including the restructuring charge, and an effective tax rate of 28% to 30%.
- Management expected 50% to 55% of December 31, 2016 backlog to convert to sales within the following 12 months. Backlog conversion beyond 12 months is largely associated with U.S. Navy projects and certain delayed commercial orders.
- Management expects fiscal 2017 cash flow to be considerably more moderate than fiscal 2016 because customer deposits are expected to unwind.
- Global oil refining and chemical markets remained weak because of low and volatile crude oil prices and reduced customer capital spending. Near-term order levels were expected to remain volatile.
- At December 31, 2016, 57% of backlog related to U.S. Navy projects, 17% to refinery projects, 14% to chemical and petrochemical projects, 9% to power projects and 3% to other industrial applications.
- Two projects totaling $6.461 million were on hold at December 31, 2016.
- The company had a $25 million secured revolving credit facility, expandable by another $25 million, and a $5 million unsecured HSBC line. Letters of credit outstanding were $9.984 million, with no other facility borrowings.
- Pending and potential asbestos-related lawsuits and other ordinary-course legal proceedings were disclosed. Management could not estimate a reasonably possible loss but did not expect a material financial impact.
- Revenue is substantially recognized using percentage-of-completion estimates, making results sensitive to estimated labor hours, project milestones, contract values and costs to complete.
- The company was evaluating the future effects of new revenue recognition, inventory, lease, stock compensation and cash flow standards. The filing does not provide a clear quantified impact for the standards not yet adopted.
- Management concluded that disclosure controls and procedures were effective and reported no material change in internal control over financial reporting.
Investor Verification Checklist
- Verify the period designation: the filing is for the quarter ended December 31, 2016, not 2015.
- Assess whether the quarterly margin improvement from the large non-typical order is repeatable.
- Reconcile GAAP nine-month earnings of $3.222 million with management’s $3.663 million result excluding restructuring.
- Monitor backlog conversion, the two projects on hold, order trends and the concentration of backlog in U.S. Navy work.
- Evaluate the expected unwind of customer deposits and its effect on fiscal 2017 cash flow.
- Review exposure to weak refining and chemical markets, pricing pressure, material costs and foreign currency movements.
- Review the potential effect of percentage-of-completion estimates, asbestos litigation and pending accounting standard adoptions.