Graham Corporation — Form 10-Q Summary
Reporting period: Three and nine months ended December 31, 2019, representing the third quarter and first nine months of fiscal 2020. The request metadata identifies “2018 Q3,” but the filing text is clearly a December 31, 2019 Form 10-Q.
Business Context
Graham designs and manufactures custom-engineered vacuum and heat-transfer equipment for energy, refining, chemical and petrochemical, defense, and other industrial markets. Its products include ejectors, vacuum pumping systems, surface condensers, and related systems. The company operates primarily from Batavia, New York, with subsidiaries in China and India.
Graham completed the sale of its commercial nuclear subsidiary, Energy Steel & Supply Co., on June 24, 2019. The business was not classified as discontinued operations. Fiscal 2020 ends March 31, 2020.
Financial Performance
| Metric | Q3 FY2020 | Q3 FY2019 | 9M FY2020 | 9M FY2019 |
|---|---|---|---|---|
| Net sales | $25.286 million | $17.198 million | $67.522 million | $68.190 million |
| Gross profit | $4.044 million | $3.742 million | $13.706 million | $17.111 million |
| Gross margin | 16% | 22% | 20% | 25% |
| Net income | $9 thousand | $95 thousand | $1.296 million | $4.245 million |
| Diluted EPS | $0.00 | $0.01 | $0.13 | $0.43 |
| Orders booked | $20.057 million | $23.169 million | $67.698 million | $79.562 million |
- Q3 sales increased 47%, while nine-month sales declined 1%.
- Q3 operating margin was negative 2%, compared with negative 3% in the prior-year quarter. Nine-month operating margin was approximately 0%, versus 5% previously.
- Interest income was $318 thousand in Q3 and $1.080 million year to date. Interest expense was immaterial at $2 thousand in Q3 and $9 thousand year to date.
- Dividends declared were $0.11 per share in Q3 and $0.32 per share for the first nine months, compared with $0.10 and $0.29, respectively, in the prior-year periods.
Liquidity, Cash Flow, Debt and Balance Sheet
- Cash and investments totaled $69.851 million at December 31, 2019, down from $77.753 million at March 31, 2019. Cash was $10.851 million and short-term certificates of deposit and other investments were $59.000 million.
- Working capital was $78.583 million, with a current ratio of 2.7. Working capital excluding cash and investments was $8.732 million.
- Operating activities used $4.119 million during the first nine months, compared with $8.535 million of operating cash flow generated in the prior-year period. The primary uses were increased unbilled revenue, lower accounts payable and lower customer deposits, together with lower earnings.
- Capital expenditures were $1.389 million and dividends paid were $3.163 million during the first nine months. Fiscal 2020 capital expenditures are expected to be $2.5 million to $2.8 million.
- Graham had no borrowings under its credit facilities at December 31, 2019. Its JP Morgan Chase facility provides $25 million of capacity, with an option to increase total capacity to $50 million, and it also had a $10 million unsecured HSBC line. Outstanding letters of credit totaled $13.346 million.
- Total liabilities were $48.760 million and stockholders’ equity was $98.041 million. Finance and operating lease liabilities were recorded following adoption of the new lease standard.
Material Changes and Unusual Items
- Gross margin declined because of an unfavorable project mix and a lower level of short-cycle and aftermarket sales, despite higher Q3 volume.
- Nine-month gross profit fell 20% on approximately flat sales, primarily due to project mix.
- The sale of Energy Steel generated $602 thousand of proceeds and an $87 thousand disposal loss in the first quarter. The prior-year comparison includes commercial nuclear revenue and expenses that are no longer part of the continuing business.
- The company adopted ASC 842 leases on April 1, 2019, recognizing operating lease right-of-use assets of $676 thousand, lease liabilities of $732 thousand, and an $80 thousand reduction to opening retained earnings.
- Unbilled revenue increased to $14.321 million from $7.522 million at March 31, 2019, while customer deposits declined to $28.816 million from $30.847 million. Net contract liabilities improved to $14.495 million from $23.325 million.
- Backlog was $122.899 million at December 31, 2019, down from $132.127 million at March 31, 2019 and $127.765 million at September 30, 2019. Approximately 55% to 60% is expected to convert to revenue within one year.
Guidance, Outlook and Risks
- Management expects fiscal 2020 revenue of approximately $100 million to $105 million, excluding the divested commercial nuclear utility business.
- Expected fiscal 2020 gross margin is 21% to 22%, compared with 23.9% in fiscal 2019. Expected SG&A is $17 million to $17.5 million, excluding first-quarter SG&A from the divested subsidiary. The expected effective tax rate is approximately 20%.
- Management reports active energy and petrochemical bidding and project activity but expects quarterly order levels to remain variable because customers remain cautious in releasing orders.
- At December 31, 2019, 52% of backlog related to U.S. Navy projects, 30% to refinery projects, 13% to chemical and petrochemical projects, and 5% to power and other industrial applications.
- Key risks include project timing and cancellation, contract cost-estimate changes, commodity and materials pricing, foreign currency exposure, tariffs and trade relations, dependence on U.S. Navy programs, market cyclicality, litigation, and the company’s ability to execute its backlog and improve productivity.
- The company is a defendant in asbestos-related lawsuits and other ordinary-course claims. Management states that the outcomes are not estimable for most claims but does not expect a material impact on consolidated results, financial position, or cash flows.
- No projects were on hold at December 31, 2019. Management believes cash, investments, operating cash flow, and available credit capacity are sufficient for immediate needs and growth initiatives.
Investor Verification Points
- Verify whether revenue and gross-margin performance are tracking toward the fiscal 2020 guidance range, particularly given the weak nine-month earnings and negative operating margin in Q3.
- Assess conversion of the $122.899 million backlog into revenue and cash, including the concentration of backlog in U.S. Navy work.
- Monitor unbilled revenue, customer deposits, accounts payable, and operating cash flow for working-capital pressure.
- Evaluate order trends, which declined year over year in both the quarter and nine-month period.
- Review the impact of the Energy Steel divestiture on year-over-year revenue, orders, margins, and business mix.
- Confirm available borrowing capacity after considering the $13.346 million of outstanding letters of credit and the secured nature of the primary facility.
- Review contract-cost estimates, material-price exposure, project cancellation risk, asbestos litigation, and other contingencies in subsequent filings.