Graham Corporation — Form 10-Q Summary
Reporting period: Quarterly and six-month periods ended September 30, 2014, representing fiscal 2015 second quarter and first half. The request metadata identifies “2013 Q2,” but the filing itself is for September 30, 2014 and compares against September 30, 2013.
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. Revenue is primarily recognized using percentage-of-completion accounting for longer manufacturing contracts.
Key Financial Metrics
| Metric | Three months ended September 30 | Six months ended September 30 |
|---|---|---|
| Net sales | $35.566 million, up 45% | $64.068 million, up 21% |
| Gross profit | $10.984 million | $18.916 million |
| Gross margin | 31%, versus 34% | 30%, versus 35% |
| Net income | $4.186 million, versus $2.589 million | $6.578 million, versus $6.397 million |
| Diluted EPS | $0.41, versus $0.26 | $0.65, versus $0.63 |
| Operating cash flow | Not separately provided for the quarter | $8.490 million, versus $4.293 million |
- Operating expenses: SG&A, including amortization, was $4.752 million in the quarter and $9.101 million for the first six months. SG&A as a percentage of sales declined to 13% and 14%, respectively, from 18% and 17%.
- Effective tax rate: 33% in the quarter and 34% year to date; management expects 33% to 34% for fiscal 2015.
- Liquidity: Cash and cash equivalents were $31.795 million and short-term investments were $33.000 million at September 30, 2014, for total cash and investments of $64.795 million.
- Working capital: $74.062 million, with a 3.3 current ratio, compared with $71.346 million and 3.7 at March 31, 2014.
- Debt: No borrowings were outstanding under the company’s credit facilities. Capital lease obligations totaled $171,000, including $61,000 current.
- Credit capacity: The company had a $25 million Bank of America revolving facility, with an option to increase total availability to $50 million, plus a $5 million unsecured HSBC line. Letters of credit outstanding were $17.719 million.
- Capital expenditures: $4.096 million year to date, versus $898,000 in the prior-year period. Fiscal 2015 capital spending is expected to be approximately $5.5 million to $6.0 million, primarily for the Batavia capacity expansion.
- Dividends: $810,000 paid year to date; dividends declared were $0.08 per share, compared with $0.06 in the prior-year period.
Material Changes Versus the Prior Comparable Period
- Quarterly sales increased 45%, driven primarily by stronger domestic chemical and petrochemical sales and higher international sales in South America and the Middle East.
- Six-month sales increased 21%; domestic sales rose 52%, while international sales declined 16%, primarily because of lower Asian sales.
- Gross margin declined because of less favorable product mix. Management cited a high level of chemical and petrochemical work and the loss of more favorable short-cycle and project conversion mix present in the prior year.
- Net income increased 62% in the quarter but only 3% year to date, reflecting the lower year-to-date gross margin.
- Orders declined 27% in the quarter and 18% year to date. Quarterly orders were $35.403 million, and year-to-date orders were $66.511 million.
- Backlog increased to $114.816 million at September 30, 2014, from $112.108 million at March 31, 2014. Approximately 70% to 75% of backlog is expected to convert to sales within 12 months.
- Operating cash flow nearly doubled year to date, helped by lower inventory and higher accounts payable and customer deposits, partly offset by higher unbilled revenue.
Guidance, Outlook, Risks and Unusual Items
- Management expects fiscal 2015 revenue in the upper half of the previously stated $125 million to $130 million range, implying approximately 22% to 27% growth over fiscal 2014.
- Fiscal 2015 gross margin is expected to be 30% to 31%, while SG&A is expected to be 15% to 15.5% of sales.
- Management expects positive fiscal 2015 cash flow, driven by net income and partly offset by capital spending and modest working-capital needs.
- Management sees improved refinery and petrochemical activity and an elevated project pipeline, but warns that order timing may create substantial quarter-to-quarter volatility.
- Management expects current-cycle peak gross margins to be in the mid-to-upper 30% range rather than the approximately 40% achieved in the prior cycle, owing to geographic mix, emerging-market competition, and petrochemical pricing pressure.
- A $7.827 million oil-sands project in backlog was on hold pending the end user’s final project-design analysis. Management expected release during fiscal 2015; completion is expected to take 24 to 36 months after release.
- Risks include project delays or cancellations, customer investment cycles, energy-price changes, foreign competition and currency movements, material-cost volatility, political uncertainty affecting defense and nuclear programs, and contract-estimate risk under percentage-of-completion accounting.
- The company faces asbestos-related lawsuits and other ordinary-course claims. Management cannot estimate a reasonably possible loss but does not expect a material financial impact.
- The company had no off-balance-sheet arrangements other than operating leases and letters of credit. Disclosure controls were deemed effective, with no material change in internal control over financial reporting.
Investor Verification Checklist
- Verify the filing period: this Form 10-Q covers September 30, 2014, not 2013 Q2.
- Assess whether declining orders are consistent with the backlog level and the expected 70% to 75% conversion rate.
- Monitor gross-margin performance against the 30% to 31% fiscal 2015 outlook and the stated product-mix pressures.
- Track release, execution, and collectability of the $7.827 million oil-sands project on hold.
- Review the impact of elevated capital expenditures and capacity expansion on free cash flow.
- Evaluate exposure to customer project delays, cancellations, commodity and material-price volatility, international markets, and asbestos litigation.
- Consider the effect of percentage-of-completion estimates, including labor-hour assumptions and revisions to contract costs, on reported revenue and earnings.