Graham Corporation Form 10-Q Summary
Reporting period: Three and six months ended September 30, 2011, representing fiscal 2012 second quarter and first half. The request metadata identifies “2010 Q2,” but the filing itself is for September 30, 2011 and compares against the corresponding 2010 periods.
Business Context
Graham designs and manufactures custom-engineered equipment for refining, petrochemical, power-generation, nuclear, alternative-energy, and other industrial markets. The company operates facilities in Batavia, New York; Lapeer, Michigan through Energy Steel & Supply Co.; and Suzhou, China.
Energy Steel, acquired on December 14, 2010 for an initially stated cash purchase price of $17.899 million, expanded Graham’s nuclear-market offerings. Energy Steel contributed $7.212 million of second-quarter sales and $11.077 million of first-half sales.
Financial Highlights
| Metric | Three months ended September 30 | Six months ended September 30 | ||
|---|---|---|---|---|
| 2011 | 2010 | 2011 | 2010 | |
| Net sales | $33.595 million | $15.723 million | $58.607 million | $29.074 million |
| Gross profit | $12.800 million | $5.347 million | $20.997 million | $9.197 million |
| Gross margin | 38% | 34% | 36% | 32% |
| Income before taxes | $8.234 million | $2.337 million | $12.731 million | $3.629 million |
| Net income | $5.468 million | $1.557 million | $8.484 million | $2.435 million |
| Diluted EPS | $0.55 | $0.16 | $0.85 | $0.24 |
Second-quarter sales increased 114% year over year, while first-half sales increased 102%. Net income increased 251% in the quarter and 248% year to date. Operating margin was 25% in the quarter and 22% for the first half, compared with 15% and 12%, respectively, in the prior-year periods.
SG&A expense increased 44% in the quarter and 43% year to date, but declined to 13% and 14% of sales, respectively, from 19% in both comparable prior-year periods. The effective tax rate was 34% for the quarter and 33% year to date; management projected a fiscal 2012 effective rate of 33% to 35%.
Liquidity, Cash Flow and Capital Structure
| Metric | September 30, 2011 | March 31, 2011 |
|---|---|---|
| Cash and cash equivalents | $33.043 million | $19.565 million |
| Short-term investments | $4.700 million | $23.518 million |
| Cash and investments | $37.743 million | $43.083 million |
| Working capital | $52.629 million | $44.493 million |
| Working-capital ratio | 3.0 | 2.4 |
| Total liabilities | $39.117 million | $44.416 million |
| Stockholders’ equity | $82.567 million | $73.655 million |
- Net cash used in operating activities was $3.579 million in the first half of fiscal 2012, compared with $2.195 million used in the prior-year period.
- Operating cash flow was pressured by a $9.384 million increase in accounts receivable, a $3.727 million decrease in accounts payable, and a $3.171 million decrease in customer deposits.
- Net cash provided by investing activities was $17.332 million, primarily reflecting investment maturities exceeding purchases.
- Capital expenditures were $1.494 million year to date; full-year capital expenditures were expected to be $3.0 million to $3.5 million.
- There were no borrowings outstanding under the revolving credit facility. The facility provided up to $25 million, with potential expansion to $50 million; availability was $9.604 million after outstanding letters of credit of $15.396 million.
- Capital lease obligations totaled $331,000, and no material conventional debt balance was disclosed.
Material Changes Versus the Prior Comparable Period
- Sales growth reflected higher volume across most product lines, stronger international and domestic demand, and the Energy Steel acquisition. Organic second-quarter growth was 68%.
- Sales mix shifted toward refining and power, including nuclear, while chemical and petrochemical sales represented a smaller percentage of quarterly sales than in the prior-year period.
- International sales increased 85% year to date, with the Middle East accounting for most of the increase. Domestic sales increased 122% year to date, with nearly 70% of that increase attributable to Energy Steel.
- Orders rose 124% in the quarter and 129% year to date. Backlog was $75.094 million at September 30, 2011, down 18% from March 31, 2011 and 12% from June 30, 2011.
- Backlog composition was 21% refining, 21% chemical and petrochemical, 18% power including nuclear, and 40% other industrial or commercial applications.
- The company recorded $389,000 of additional expense related to revaluation of the Energy Steel contingent earn-out: $230,000 in SG&A and $159,000 in interest expense. The expected earn-out liability increased to $1.887 million from $1.498 million at acquisition, with a maximum potential payout of $2.0 million.
Guidance, Outlook and Management Commentary
- Management forecast fiscal 2012 revenue of $104 million to $110 million, representing growth of approximately 40% to 45% over fiscal 2011.
- Energy Steel was expected to contribute approximately 16% to 20% of fiscal 2012 revenue.
- Full-year gross margin was expected at 32% to 33%, below the first-half margin because of anticipated lower utilization, less favorable product mix, and lower-margin international refining and petrochemical work.
- Fiscal 2012 SG&A was expected to be $15.6 million to $16.5 million, or approximately 15% of projected revenue.
- Management expected positive fiscal-year cash flow, with second-half cash generation offsetting first-half cash usage as accounts receivable and unbilled revenue declined.
- Approximately 80% to 85% of backlog was expected to convert to sales within twelve months. Two projects, a U.S. Navy project and a Middle East refinery project, were expected to represent approximately 25% of fiscal 2012 revenue.
- Management described the global recovery as early-stage but uneven, with continued order volatility, pricing pressure, and potentially lower margins in emerging international markets.
Risks, Contingencies and Unusual Items
- One $1.010 million project was on hold at September 30, 2011 after being placed back on hold by the customer.
- The company faces asbestos-related personal-injury lawsuits. Outcomes and potential liability could not be determined.
- The IRS was examining tax years 2009 and 2010 and had proposed disallowing research and development tax credits. The cumulative tax benefit for tax years 1999 through 2011 was $2.381 million; the recorded unrecognized tax benefit related to this position was $477,000.
- Additional tax uncertainty included an $888,000 unrecognized tax benefit. The filing does not provide a clear estimate of the ultimate exposure from the IRS examinations.
- Revenue recognition relies significantly on percentage-of-completion estimates of labor hours and contract costs. Changes in estimated costs could affect reported revenue and profit.
- Material risks include project cancellation or delay, commodity-price volatility, foreign-currency exposure, customer concentration, acquisition integration, nuclear-market uncertainty, and reliance on converting backlog into sales.
- Management stated that disclosure controls and procedures were effective and that no material change occurred in internal control over financial reporting.
Most Important Facts to Verify
- Whether fiscal 2012 revenue reaches the $104 million to $110 million outlook and whether the projected 32% to 33% gross margin is achieved.
- Conversion of the $75.094 million backlog, particularly the U.S. Navy and Middle East refinery projects and the $1.010 million project on hold.
- Collection of elevated accounts receivable and unbilled revenue and the resulting improvement in operating cash flow.
- Final payment and accounting for the Energy Steel earn-out, which had an expected value of $1.887 million and a maximum payout of $2.0 million.
- Resolution of the IRS research and development tax-credit examinations and related unrecognized tax benefits.
- Developments in asbestos litigation and any resulting liability.