Graham Corporation Form 10-Q Summary
Reporting period: Three and six months ended September 30, 2016, representing the second quarter and first half of fiscal 2017. The request metadata identifies “2015 Q2,” but the filing itself is for fiscal 2017 Q2. Results are unaudited and compared with the corresponding fiscal 2016 periods.
Business Context
Graham designs and manufactures custom-engineered vacuum and heat-transfer equipment, nuclear components, and related systems for energy, defense, chemical and petrochemical, power, industrial, and U.S. Navy applications. Operations include facilities in Batavia, New York; Lapeer, Michigan; and Suzhou, China.
Key Financial Metrics
| Metric | Q2 FY2017 | Q2 FY2016 | Six Months FY2017 | Six Months FY2016 |
|---|---|---|---|---|
| Net sales | $21.1 million | $22.8 million | $43.5 million | $50.4 million |
| Gross profit | $5.0 million | $7.1 million | $9.1 million | $15.2 million |
| Gross margin | 24% | 31% | 21% | 30% |
| Net income | $1.3 million | $2.0 million | $1.4 million | $4.3 million |
| Diluted EPS | $0.13 | $0.20 | $0.14 | $0.43 |
| Operating margin | 8% | 13% | 4% | 13% |
- Q2 sales declined 7%; six-month sales declined 14% year over year.
- Q2 gross profit fell 30%, while six-month gross profit fell 40%, primarily because of lower volume, lower-margin backlog orders, fewer short-cycle sales, and under-absorption of production overhead.
- SG&A declined 25% in Q2 and 23% for the first six months. The reduction benefited from $759 thousand of insurance proceeds, lower compensation and commissions, and cost-reduction actions.
- The effective tax rate was 30% in Q2 and 24% for the first six months, compared with 33% and 32%, respectively, in the prior-year periods.
- Excluding restructuring charges, reported net income was $1.35 million, or $0.14 per diluted share, in Q2 and $1.82 million, or $0.19 per diluted share, for the first six months.
Cash Flow, Liquidity, and Debt
- Cash and short-term investments totaled $66.3 million at September 30, 2016, compared with $65.1 million at March 31, 2016.
- Cash and cash equivalents were $31.3 million; certificates of deposit and other investments were $35.0 million.
- Six-month operating cash flow was $3.3 million, down from $7.7 million in the prior-year period. Lower earnings, higher receivables, and lower accounts payable were partly offset by higher customer deposits.
- Capital expenditures were $159 thousand; fiscal 2017 capital expenditures are expected to be approximately $500 thousand to $1.0 million.
- Working capital was $76.1 million, with a current ratio of 3.6.
- There were no borrowings outstanding under the credit facilities. Graham had a $25 million JPMorgan Chase facility, expandable by up to $25 million, and a separate $5 million unsecured HSBC line. Letters of credit totaled $9.3 million.
- Total capital lease obligations were $192 thousand. The filing does not report material funded debt beyond these obligations.
Material Changes and Operating Developments
- Q2 orders increased 20% to $24.8 million, but orders for the first six months declined 12% to $39.4 million.
- Backlog was $104.0 million at September 30, 2016, down from $108.0 million at March 31, 2016 but up from $99.9 million at June 30, 2016.
- Approximately 57% of backlog related to U.S. Navy projects, compared with 47% one year earlier. Refining backlog represented 16%, chemical and petrochemical 13%, power 11%, and other industrial applications 3%.
- International sales declined 25% in Q2 and 33% for the first six months, while domestic sales were comparatively more resilient.
- Graham recorded $630 thousand of restructuring charges in the first half, including $75 thousand in Q2, after eliminating positions representing approximately 10% of the global workforce. Expected annual savings are approximately $2.7 million, with approximately $2.0 million expected in fiscal 2017.
- The company received $759 thousand of insurance proceeds in Q2, which reduced SG&A.
- A $54 thousand Q2 reversal of product warranty provisions reflected lower claims experience.
Guidance, Outlook, Risks, and Contingencies
- Fiscal 2017 revenue guidance is $85 million to $95 million, with expected gross margin of 21% to 23%, SG&A of $15 million to $15.5 million, and an effective tax rate of 30% to 31%.
- Management expects fiscal 2017 cash flow to be much more moderate than fiscal 2016 because the prior year benefited from converting accumulated receivables and unbilled revenue into cash.
- Management expects continued weakness in global energy markets, low and volatile oil prices, customer capital-spending reductions, pricing pressure, and production under-utilization to affect the remainder of fiscal 2017.
- Approximately 50% to 55% of September 30, 2016 backlog is expected to convert to sales within the next twelve months. Three projects totaling $6.9 million were on hold.
- Key risks include contract execution, percentage-of-completion estimates, project delays or cancellations, backlog conversion timing, foreign-currency exposure, material prices, customer concentration in the U.S. Navy, and demand in refining and chemical markets.
- The company is a defendant in asbestos-related and other legal proceedings. Management cannot estimate a reasonably possible loss but does not believe the matters will have a material effect on results, financial position, or cash flows.
- Management stated that disclosure controls were effective and that there were no material changes in internal control over financial reporting.
Important Facts for Investors to Verify
- Whether the announced restructuring savings are realized and offset continued gross-margin pressure.
- Whether revenue converts within the stated $85 million to $95 million fiscal 2017 range and whether gross margin remains within 21% to 23%.
- The timing and quality of backlog conversion, particularly the $6.9 million of projects on hold and the high proportion of U.S. Navy backlog.
- Whether lower international sales and weak refining and chemical demand persist.
- Cash-flow performance, receivables and customer deposits, and continued absence of borrowings under the credit facilities.
- The potential financial effect of asbestos litigation, project cancellations, and contract-estimate revisions.