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Executives

Deborah K. Pawlowski – Investor Relations

James R. Lines – President and Chief Executive Officer

Jeffrey Glajch – Chief Financial Officer

Analysts

Richard Hoss - Roth Capital Partners LLC

James Bank - Sidoti & Company, LLC

Richard Ryan - Doughtery & Company LLC

George Melas – MKH Management

[John Bayer] – SKA Financial Services Inc.

Tim [Edmond] – Individual Investor

George Walsh - Gilford Securities

Graham Corporation (GHM) F4Q09 Earnings Call May 29, 2009 11:00 AM ET

Operator

Greeting and welcome to the Graham Corporation fourth quarter fiscal year 2009 earnings conference call. (Operator Instructions) As a reminder this conference is being recorded.

It is now my pleasure to introduce your host, Miss Deborah Pawlowski, IR for Graham Corporation. Thank you. Miss Pawlowski you may now begin.

Deborah K. Pawlowski

Thank you and good morning everyone. We appreciate your joining us today on Graham Corporation’s fiscal 2009 year end financial results call. On the call I have with me today Jim Lines, President and CEO of Graham and Jeff Glajch, Chief Financial Officer. Join me in welcoming Jeff on his first conference call with Graham. Jeff joined Graham as CFO at the beginning of March this year, succeeding Ron Hansen who retired in August of 2008. Some of you may have already met Jeff, however, as we had been getting him out on the road quite a bit already to meet investors.

Jim and Jeff will be reviewing the results of the fourth quarter and fiscal year as well as the company’s strategy and outlook during this contraction in the business cycle. You should have a copy of the earnings release that was put out this morning. If not you can access it at the company’s website which is www.graham-mfg.com., graham-mfg.com. In addition we have posted supplemental slides on the website to provide a visual overview of some of the results for the year and the quarters.

As you are aware we may make some forward-looking statements during the formal discussion as well as during the Q&A. These statements apply to future events and are subject to risks and uncertainties, as well as other factors that could cause actual results to differ from what was stated here today. These risks and uncertainties and other factors are provided in the earnings release as well as other documents filed by the company with the Securities and Exchange Commission. These documents can be found at the company’s website or also at www.sec.gov.

With that let me turn it over to Jim to begin the discussion.

James R. Lines

Thank you Debbie and good morning everyone. I will provide introductory comments regarding fiscal 2009 results, give a little color about the outlook for fiscal 2010 and beyond, and then Jeff will provide details for the fourth quarter and fiscal 2009 and some comment on 2010.

I’m extremely pleased by our performance in fiscal 2009 and I wish to acknowledge and thank our employees for their resourcefulness, dedication and careful execution of our strategies, their commitment to implement process improvements across the company and their focus to improve cash management. As a result of their efforts we were able to take full advantage of the strong market conditions we enjoyed the past several years, expand our manufacturing and engineering capacity and measurably improve our operating and financial performance.

Several records were set in 2009. Sales exceeded $100 million, up from $86 million last year. Net income and diluted earnings per share were both records with net income at $17.5 million and diluted earnings per share of $1.71, up from $15 million in net income for 2008. Operating working capital averaged 5% of sales for fiscal 2009 which compares with 9% in fiscal 2008 and 14% in 2007. Inventory turns increased to greater than 12 times per year, up from 11 last year and significantly up from four to six turns just a few short years ago.

2009 was a great year for our company but it also was a year of continued investment to improve Graham. The management team and employees understand that the company must deliver solid operating performance while we concurrently drive improvements across the company, to expand capacity, reduce our lead times and improve the quality of our products and services provided to customers.

2009 represented another year where we successfully executed on both fronts. Highlighting the advancements we made were immeasurable improvement to on time delivery with current on time delivery above 92%. Our capital investments provided approximately 5% gain in productivity. Our capability to effectively outsource production improved, 11% of production was outsourced last year including production done in Asia and in North America. We strengthened our market position in China for oil refining applications. Approximately 6% of sales in 2009 were incremental due to our China strategy. Engineering, automation and 3D modeling progressed as scheduled for surface condensers and injector systems. And our continued alignment of business processes to improve efficiency contributed to our strong performance and our flexibility.

I am also pleased with how the company responded to adverse and abrupt changes in our markets mid-year. There was considerable disruption to backlog continuity as our customers canceled three projects totaling $3.3 million, placed another five projects on hold totaling $4.4 million, while various other orders in backlog also had customer initiated changes to deliveries scheduled. Our employees acted quickly to realign projects schedule so that production continuity was preserved and operating efficiencies maintained.

In addition as the order rate dropped starting in the third quarter, our managers acted swiftly to the market change and adjusted our cost structure to reflect this change in our markets. Approximately $2.7 million in annual savings will be realized as a result of the restructuring.

The steps taken to adjust our costs were difficult but necessary in light of the abrupt changes in our markets. Those steps, along with our approach to managing the business during the growth surge of 2005 through mid-2009, improvements in our company and our solid financial position puts Graham in an excellent position as we are well prepared to weather this market downturn. We will continue to invest in the company during the downturn to make certain we are where the company needs to be when our markets recover. Our sight is set on the next up cycle and how we can gain additional market share, add geographic diversity to our sales mix, provide additional products and services, and improve further our operating performance.

I am confident that we can effectively manage through this downturn and position our company for the up cycle. These are challenging times in our industries as capital spending has been dramatically cut. We are aggressively pursuing what work is available. Nonetheless, for this contraction I expect that year-over-year revenue may decline by 30 to 40%, not dissimilar from past declines. However, I believe the company will perform much differently during this downturn that it had in prior downturns and in a very strong way.

Jeff will comment on margin expectations for the year. Our pipeline of large projects that can lead to future orders remains active. In general, our sales and application engineering personnel have remained busy during the past three quarters. There hasn’t been much change. We can identify between $125 and $150 million of live projects that require $250,000 and more of Graham equipment. This figure hasn’t changed much over the last several quarters. What does remain difficult to predict is when purchase decisions will be made for this work. I expect order intake during the next several quarters will vary greatly from one quarter to the next.

We believe major project work in the Middle East, Asia and South America will become active before the domestic markets begin to recover. As a matter of fact, there are several refining and petrochemical projects that are expected to commence equipment procurement in the coming quarters. Again these are large projects in the Middle East, Asia and South America. Our sales and engineering personnel continue to develop relationships with decision makers for these projects to position our company when procurement decisions will be made. The underlying fundamentals that create increased demand for energy products have not changed. Certainly it is a challenging environment short term, however, our view regarding energy markets over the next 20 years has not changed. We are prepared for the short term challenges, I believe more so than in the past and our strategies regarding long term growth and sustained business improvement are intact.

I will now turn it over to Jeff Glajch. Jeff has gotten onboard quickly and is an excellent addition to our executive team. So welcome, Jeff, to your first conference call with our investors. Jeff?

Jeffrey Glajch

Thank you Jim and good morning everyone. I’ll start with a review of sales and order activity before moving on to operations.

Net sales in the fourth quarter of fiscal 2009 were $24.8 million compared with $22.8 million in the fourth quarter of fiscal 2008. As most of you are aware, quarter by quarter sales can be lumpy for us given the magnitude of our orders coupled with the high variability that can occur in engineer ordered manufacturing.

Sales advances in the fourth quarter reflected the strong order activity that Graham had in the latter half of fiscal 2008 and the first half of this past fiscal year. Ejector and condenser sales increased 22.6% and 27.3% respectively in the quarter compared with last year’s fourth quarter, while all other product categories decreased 11.9% on a quarter-to-quarter basis. The increases in ejector and condenser sales, which combined represent two-thirds of Graham’s total revenue, was a result of the strong demand we had seen in the refinery, petrochemical and alternative energy markets before the sudden slowdown in the second half of last year.

By industry, 37% of sales in the fourth quarter of fiscal 2009 were to refineries compared with 33% in the same period last year. 35% of sales went to the chemical and petrochemical industries, up from 32% and 28% were to the power industry and other industrial applications, down from 35%.

Graham’s sales to the U.S. market were very strong in the fourth quarter of fiscal 2009 at $15.8 million, up $4.4 million or 38.4% above last year’s fourth quarter and represented 64% of total sales. Again this growth was driven by the strength of the U.S. refining and petrochemical markets. Offsetting this increase was a $2.4 million or 20.3% decline in international sales to $9 million. In the quarter we saw weakness in South America, Western Europe and the Middle East.

For fiscal 2009, total net sales increased 17% to a record $101.1 million compared with $86.4 million in fiscal 2008. We saw increased sales in all product groups, with condensers increasing 8.2% to $22.9 million and ejector sales advancing 5% to $38.5 million. After market, heat exchanger and pump packages sales advanced a strong 38.9% to $39.7 million.

In fiscal 2009, 46% of sales were to the refining industry, 27% were to the chemical and petrochemical industries and 27% were to the power industry and other industrial applications. This was similar to 2008 with slightly higher weighting toward the refining industry. U.S. sales for fiscal 2009 were 63% of total sales, up from 54% in fiscal 2008. As Jim mentioned earlier, we expect moving forward to see higher levels of international sales and that was reflected in our most recent quarter mix.

Looking at orders in backlog, we received $20.5 million of net orders in the fourth quarter of fiscal 2009, down from $35.1 million in the same period last year. Fourth quarter orders were well ahead of the $8.1 million Graham received in orders during the trailing third quarter. We recommend not focusing on one quarter’s worth of orders but rather the trailing 12 month order level. In this regard for fiscal 2009, we received $73.9 million in orders, down from $107.1 million in fiscal 2008 with all of the fall off occurring in the second half of the year.

Geographically, fourth quarter orders decreased across most regions led by the U.S. The most notable exception were orders in the Middle East, which saw a strong increase for the second consecutive quarter. Orders received from customers in Africa were also up significantly for the quarter. For fiscal 2009 this pattern held true with the inclusion of Asian orders, which were also very strong, but this occurred primarily in the first quarter. U.S. orders for the fourth quarter represented 37% of the total compared with 67% in the fiscal 2008 fourth quarter. For fiscal 2009, U.S. orders comprised 43% of total orders, down from 70% last year.

At the end of the year, the backlog was $48.3 million, down 36% compared with $75.7 million at the end of fiscal 2008. The quarter end backlog number excluded $3.3 million related to three canceled projects but included in the backlog is approximately $4.4 million in orders related to suspended projects. 38% of projects in the backlog are for refineries, 35% for chemical and petrochemical and 27% for power and other industrial applications. The backlog at the end of fiscal 2008 was much more weighted towards refineries, with nearly half of the backlog in that area. We expect 90% of our existing backlog to ship in the next 12 months.

Looking at Graham’s operational and bottom line performance for the quarter and fiscal year, our net income was $3.6 million in the fourth quarter of fiscal 2009, down 14.6% from $4.2 million in the fiscal 2008 fourth quarter. Earnings per diluted share came in at $0.05, $0.06 below last year’s fourth quarter EPS of $0.41. For the full fiscal year, net income and earnings per share were at record levels. Net income was $17.5 million, 15.2% above net income of $15 million in fiscal 2008 while diluted EPS was $1.71, 14.8% above the $1.49 achieved in fiscal 2008.

Gross profit in the fourth quarter was $9.6 million compared with $8.9 million in last year’s fourth quarter. The gross margin percentage in the quarter declined slightly to 38.8% of sales compared with 39.3% in the fiscal 2008 fourth quarter. However, the gross margin was improved from the 37.9% achieved in the trailing third quarter of fiscal 2009.

For fiscal 2009, gross margin was at 41.3% compared with 39.5% in fiscal 2008. Better product mix and operational improvements in engineering and manufacturing contributed to the year-over-year increase.

I would like to point out that as our sales in the next several quarters are negatively affected by the recession, we do not see the recent gross margin levels as sustainable and think margins will likely decline to the 28 to 31% range for fiscal 2010.

In the fourth quarter, Graham took the difficult and necessary steps to restructure our cost base. We recognized $559,000 of restructuring expenses, primarily severance costs. As Jim mentioned earlier, this action will reduce our manufacturing and SG&A costs by a total of $2.7 million in fiscal 2010. SG&A as a percentage of sales declined to 14.1% in the fourth quarter of fiscal 2009 compared with 14.8% in the fourth quarter of fiscal 2008 and 14.4% in the trailing third quarter of fiscal 2009. For fiscal 2009, SG&A expenses were $14.8 million or 14.7% of sales compared with $13.1 million or 15.1% of sales in fiscal 2008. The increase in dollars is related to higher variable compensation costs associated with the significant sales and net income improvement. We expect that SG&A for fiscal 2010 will be down from 2009 at $13 to $14 million.

Interest income in the fourth quarter of fiscal 2009 declined to $30,000 compared with $227,000 in the same period last year, primarily as a result of the significant decline in U.S. Treasury yields. Our investments are in U.S. Treasury Securities with maturities of 91 to 180 days.

Our effective tax rate for fiscal 2009 was 35%, up from 32% last year. We estimate our effective tax rate for fiscal 2010 to be approximately 34%.

We have built up a large cash reserve during the strong part of the business cycle. Cash, cash equivalents and investments were at a record level of $46.2 million at March 31, 2009, up from $36.8 million at March 31, 2008 and relatively unchanged from $45.4 million at the end of trailing third fiscal quarter. We have no borrowings on our $30 million bank line, utilizing it solely for outstanding letters of credit.

Our increased focus on cash management from a point of sale through delivery has reduced our cash conversion cycle to 17 days, which is an all time low for Graham. We believe we are financially well positioned to weather this downturn.

Net cash provided by operations was $11 million in fiscal 2009 compared with $19.7 million for fiscal 2008. The increase in sales in 2009 affected our working capital requirements relative to 2008. We also saw an increase in income taxes paid on our higher fiscal 2009 net income and we made a significant $7.5 million contribution to Graham’s defined benefit pension plan. We do not expect to need to fund our pension plan in 2010.

Capital expenditures increased to $1.5 million in fiscal 2009 compared with $1 million in fiscal 2008. However, we had previously estimated capital expenditures for the year to be in the $1.8 to $2 million range. We adjusted our spending plans downward in the fourth quarter as the looming recession was evident. The fourth quarter capital expenditures were $299,000 compared with $368,000 in last year’s fourth quarter. Capital expenditures for fiscal 2010 are expected to be approximately $1 million, 65% of the allocated for machinery and equipment, 28% for information technology upgrades and 7% for other improvements. Approximately 50% of our fiscal 2010 capital spending is expected to be for productivity improvements and the balance will be used for capitalized maintenance and other general purposes.

That concludes my remarks. Jim, I will turn it back to you.

James R. Lines

Thank you Jeff. At this time we will take your questions now.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Your first question comes from Richard Hoss - Roth Capital Partners LLC.

Richard Hoss - Roth Capital Partners LLC

Jim, you talked about the new order environment being fairly stable and comparable to years past, or at least the proposal level I think. What’s keeping people from signing contracts? Is it credit? Is it uncertainty and energy markets? And what’s the view on project costs and the expectations for those, to decrease further or to stabilize?

James R. Lines

Hi Rick. What we’re hearing from our customers is the project costs still remain a problem relative to the price of oil, and that’s affecting the return on investments for these massive projects. It’s believed by our customers that the costs for the projects will continue to come down. They’ve come down somewhat, I’d say between 15 to 20% over the last six months. And they anticipate they will come down further. In addition more of a short term issue is what does the demand profile look like, refinery utilization as an example is low compared to where it had been last year or two years ago, so there is some capacity within the refinery to soak up additional demand before investment is needed. But again we continue to hear long term from our customers that investments need to be made to keep up with increasing demand for energy related products, and this is a short term issue that will right itself over time.

Richard Hoss - Roth Capital Partners LLC

As far as gross margins go, you gave a range of 28% to 31%. How much is the decrease attributable to bidding on less profitable projects?

James R. Lines

If you think about the sales mix as Jeff described it becoming more weighted toward international. We’ve talked in the past that sales mix has an impact on gross margin. U.S. projects, in particular U.S. refining and petrochemical projects have better gross margin potential than Asian projects. We think the recovery will be started in the Middle East and Asia, then followed by South America, so there is a mix component there that’s affecting the margin potential. In addition, in an environment where there are fewer projects proceeding at a given point in time, the competitive landscape becomes fiercer. And that has an effect on margin as well. So there’s two aspects to it. One is geographic sales mix, the other is the selling environment at this particular point in time.

Richard Hoss - Roth Capital Partners LLC

And last question, and this is really for Jeff, when you first showed up at Graham what jumped out at you as the greatest opportunity or, you know, what gets you most excited about this business?

Jeffrey Glajch

Sure. Thanks Rick. You know I think if you look, a couple of things. I think if you look at the long term outlook for this business, while the short term’s a little bumpy, long term there’s the need for increased energy around the world and so Graham is well positioned in that regard. And then secondly, looking at Graham’s balance sheet, obviously we have a very strong balance sheet and have the opportunity to potentially utilize that balance sheet to expand either internationally or domestically. And I think both of those areas are very exciting to us.

Finally, the, you know I think the first thing that really jumped out at me was the quality of the management team and the strength of the employees. We’ve got a very deep management team with a lot of experience within this industry, specifically a lot of experience within Graham. And, you know, combine that with the business factors around here, I think we’ve got a very strong future.

Operator

Your next question comes from James Bank - Sidoti & Company, LLC.

James Bank - Sidoti & Company, LLC

Jim, I believe and please correct me if I’m wrong, in the fourth quarter of fiscal ’09 just reported I thought the guidance was roughly 28 to 32% for gross margin. If that was the case I was just wondering what sort of surprised you here in the fourth quarter?

James R. Lines

I just want to clarify the question. You felt the guidance in the fourth quarter for financial performance was to be between 28 and 32%?

James Bank - Sidoti & Company, LLC

I believe so. I’m just trying to reach back and trying to remember because then I notice that international sales was up, and I guess that was partly attributable to the margin in the fourth quarter. Just to me it just blew out my expectations of what you guys were going to do for gross margin 4Q fiscal ’09. Was there anything in there that surprised, I guess, given that guidance that you had leading into the quarter?

James R. Lines

I don’t recall, James, specifically giving guidance for the quarter. We did come in within the range that we had given for the full year which was 39 to 42%. And so from that perspective it was right in line with what we had set for the full year on average. We don’t give guidance quarter by quarter because of the lumpiness of our business.

James Bank - Sidoti & Company, LLC

I was wondering then if you could speak to April order trends by any chance.

James R. Lines

The market is a tough environment right now. I’d say the April order trends were soft. We have given guidance that we should expect from quarter-to-quarter significant variability. That’s not to say that the coming quarter’s going to be low by comparison to the prior quarter. We just don’t have all the details yet, but April has started out slow.

James Bank - Sidoti & Company, LLC

The backlog, the $4.4 million of work, is there a timeframe on it, the work that’s been put on hold? Is there a timeframe at all for that when these companies will let you know or is it just sort of an indefinite delay?

James R. Lines

It’s, they’re on hold pending notification from our customers that they want to reinitiate the projects. We have not been advised at this point for the five contracts totaling $4.4 million that are on hold that there’s risk of cancellation. It’s a difficult environment for our customers. Even for orders that are moving through backlog we are seeing changes in delivery schedules being initiated by our customers just because they’re slowing down the projects. They’re preserving their capital. They’re pushing out the timelines to erect these facilities by one or two years and that’s affecting the pacing of production of equipment or the need for equipment at the site. It’s difficult for us to project when the projects on hold will get released, but at this point we continue to stay in contact with our customers for those five projects and all I can say at this point is we have not been advised that they are moving towards cancellation.

James Bank - Sidoti & Company, LLC

I don’t know if you did this earlier in your prepared remarks. Were these more in the chemical sector or refining sector or I guess they’ve been aggregate of all your sectors?

James R. Lines

It was refining.

James Bank - Sidoti & Company, LLC

And the $2.7 million in savings, I’m sorry, Jeff, you said that was coming from SG&A?

Jeffrey Glajch

Both SG&A and from operations.

James Bank - Sidoti & Company, LLC

Is there a breakdown mix we could have?

Jeffrey Glajch

No, we don’t disclose that.

Deborah K. Pawlowski

James?

James Bank - Sidoti & Company, LLC

Yes?

Deborah K. Pawlowski

We did provide some understanding of what we expect SG&A to be.

James Bank - Sidoti & Company, LLC

Right. Did I hear it was like $13 to $14, if I?

James R. Lines

That’s correct.

James Bank - Sidoti & Company, LLC

And then sort of a macro question, Jim, if you could. I guess on the nuclear front probably more of an international opportunity, maybe what’s going there. And are you becoming anymore enthusiastic about potential acquisitions and what you’re going to use this cash for? I know that’s something I think I ask on every single conference call, but if I could just get an update that’d be terrific.

James R. Lines

You are consistent. Regarding the nuclear market, particularly in the U.S., we have seen that slow down. We think that’s an effect of the tight credit market. It’s a difficult projection as to when nuclear will take off in the U.S. market. Regarding nuclear international, the nuclear energy market internationally, really our sights were focused on the growth that was going to come from the North American fleet that was going to come under construction over the next decade or so. And regarding the acquisition front, I would like to turn it over to Jeff.

Jeffrey Glajch

Sure. James, on the acquisition side we are continuing to look at potential opportunities, both domestically and internationally. And really what we’re looking at is, we’re strategically looking at the opportunity to geographically expand our base, primarily in the same arena that we’re in now. And then domestically and internationally we’re potentially looking at product ref expansion, product line expansion. One of the concerns that we have right now and the patience that we believe we need to show is that from an evaluation standpoint, we’re still seeing valuations a bit higher than we would expect. People are looking back a lot more than they’re looking forward right now. So we want to be very careful that we first strategically make the right decision but then once we’ve identified the right strategic decision to make that we don’t over pay.

Operator

Your next question comes from Richard Ryan - Doughtery & Company LLC.

Richard Ryan - Doughtery & Company LLC

Hey Jim when you talk about the gross margin holding up better this time than previous down cycles, is that primarily due to, you know, maybe a higher percentage of smaller projects in the mix and what’s kind of the pipeline look like with, you know, with the smaller projects versus larger projects that may be more competitive?

James R. Lines

That’s a good question, Dick. Sales mix does have an effect. Smaller projects tend to have a higher gross margin. But I would say what’s caused the improvement going forward in our gross margin when we compare Graham to how it looked in the past has been the capital plan that we had, and the productivity and efficiency that we’ve put into the business over the last four years, our ability to execute more efficiently as a company than we had in the past. Sales mix, that varies from period to period, but our business will perform differently than it had in the past and I think that’s the largest contributor to the improvement in gross margin.

Richard Ryan - Doughtery & Company LLC

When you talked about your customers and their outlook for further declines in cost, do you get a sense and not speaking for them, but do you get a sense what they’re trying to evaluate in coming to that conclusion? I mean if you look at, you know, just one or the other heavier industries, the aluminum industry, you know, Alcoa made a presentation today that there’s been tremendous destocking and inventories are at record lows. So I mean, you know, is there, you know, do you get a sense that those expectations for lower costs are reasonable or, you know, what’s kind of the sensitivity there?

James R. Lines

Initially I’d say in our third quarter, the December ending quarter, what we had heard from our customers as they began to delay purchase decisions was by waiting six to 12 months they expected to get between 10 to up to 20% reduction in the cost of their projects. I believe at this time they’ve been able to realize virtually all of that, and they’re still expecting additional reduction in cost to be realized over the next few quarters.

Looking at the commodity prices for raw materials that go into the equipment and the erection of the facility, carbon steel, nickel based alloys, copper based alloys, they’ve all come down pretty significantly over the last several quarters.

Operator

Your next question comes from George Melas – MKH Management.

George Melas – MKH Management

I have a question on visibility. If I go back last year, at the end of last year and if I look at your backlog at that time, and then you look at the revenue that you guys reported in fiscal ’09, the backlog if I take the backlog and multiply by 90% so I’m assuming that 90% of that backlog shipped over the next 12 months, you get sort of a visibility of roughly two-thirds of the coming revenue. And if I take your revenue in fiscal ‘010 down roughly 35% to the mid-range of the 30 to 40, and you look at your backlog and you multiply by 90%, it’s about the same. So is that sort of a good look at the business, that the backlog, so you enter a year with roughly two-thirds of the revenue with very good visibility from your backlog, but you have to sell the other third? And what would that other third be? How much of that would be after market work and how much would be work that you have to book during that 12 months?

James R. Lines

The analysis that you’ve done, George, is fairly accurate and it’s held up over the last several, the last couple of years. The additional business to book comes from our smaller products. Backlog at a given point in time, say at the end of a quarter, has about one quarter’s worth of small product sales. So therefore we have three more quarters of small product sales to book to effect a given fiscal year if you’re talking in the first quarter. And then in addition to that, there are large projects to be won that can be converted into revenue during the course of the year.

We believe somewhere up through mid-October it’s possible to convert a portion of a large project to revenue before March 31.

George Melas – MKH Management

For?

James R. Lines

Yes.

George Melas – MKH Management

Yes.

James R. Lines

Yes. That’s part of that backlog that I referred to as coming out in one quarter. Because it converts in one quarter.

Operator

Your next question comes from [John Bayer] – SKA Financial Services Inc.

[John Bayer] – SKA Financial Services Inc.

Just sort of a bit of a follow up to a previous question and that was if you are seeing any increases in interest in the after market, given that some of your projects are being drawn out or a few cancellations? Are you seeing any increase in that trend?

James R. Lines

Actually we haven’t, and in talking to our customers our refining customers in particular, their strategy is during this time of downturn is driving operational efficiency to gain leverage from their existing plant, and capital preservation. So we’ve actually not significantly but have begun to see some slowing of after market orders.

[John Bayer] – SKA Financial Services Inc.

And another question would be in other markets outside of the refining and the petrochemical areas, do you see opportunities there where you might be able to focus a little bit more on, and I guess I’m thinking in the ideas of maybe food processing or power or something like that, and particularly in some of the emerging market areas whether it’s Latin America or Asia-Pacific or wherever?

James R. Lines

We see opportunity and it will be intermittent, but we see opportunity coming from the fertilizer market. That’s Asia, Middle East, some South America. Edible oils, those are smaller projects but there’s some demand we’re seeing coming from edible oils and [Oleo] chemicals. Power generation, we see that linked to very closely to the credit market and we’ve seen some slowing in the power market and our customers have indicated they’re pulling back on investment there.

[John Bayer] – SKA Financial Services Inc.

And kind of in a big picture sense with the big, you know, emphasis towards higher fuel efficiency for vehicles and so forth, you know, looking out in the longer term how do you try to assimilate that into your projections as far as it would impact large scale projects of, you know, say new complexes, refining complexes or what not? How can, can you factor that in or do you look at that in any way?

James R. Lines

We see that as a component that will require mandatory CapEx at an existing refinery to produce more efficient transportation fuels. That could lead to need for our products. Also along those lines, our cleaner transportation fuels, lower sulphur content in gasoline, lower sulphur content in diesel, there too that creates demand for our products, our ejector systems and our condensers. The need for or the drive for a less environmental footprint from the transportation fuel that moves globally with a timeframe in each region, but that does create demand for our products.

Operator

Your next question comes from Tim [Edmond] – Individual Investor.

Tim [Edmond] – Individual Investor

Thank you. A couple of my questions have been asked. I’ll ask them perhaps in a slightly different fashion so I appreciate your patience. On the after market business, how closely is it tied to capacity? Is it more capacity utilization or time for your clients in the sense of, you know, how much of it is deferrable and how much of it is tied to how fast they’re running their factories and facilities?

James R. Lines

Under normal circumstances, it’s normally time based. A refinery when they’re started up and running, their desire is to run continuously for five years without an unscheduled shutdown. And they plan the shutdown one or two years in advance of the actual planned turnaround. And that’s when they begin to inquire for spare parts. If there’s an erosion or a corrosion problem that means an unscheduled shutdown that’s hard for the refiner to plan and it’s hard for us to plan. But that happens as well. The equipment may have a performance problem due to damage from corrosion or erosion or just mal-operation of the equipment.

Tim [Edmond] – Individual Investor

So again it’s known other than unscheduled, which is a substantially smaller portion.

James R. Lines

Right.

Tim [Edmond] – Individual Investor

On the balance sheet, could you, obviously your buyback as I understand it was quite strategic and at excellent prices. Could you just give some further color to your thinking about share repurchase, completing the authorization and, you know, versus acquisition and how you balance those two and think about the returns that you demand on putting that money to work?

Jeffrey Glajch

Sure. I think there were a couple of questions there. First of all with regard to our share repurchase, we did authorize up to 1 million shares to be purchased between the end of January and late July of 2009. As you noted, we repurchased in the fourth quarter of fiscal 2009 277,000 shares so we have gone partway down that path and that repurchase does remain open through the end of July, through late July. With regard to the conflicting utilization of the cash between the share repurchase and acquisitions, when we laid the share repurchase out back in January, we did it with the understanding that it was a good utilization of our cash at the time but it would not impede us in any way to making acquisitions. So, you know, to date we’ve spent a portion of the funds, slightly over $2 million, about $2.3 million repurchasing shares through the end of March. We certainly have the opportunity to utilize more cash if we so choose to repurchase shares, but in no way will that impede our ability to make acquisitions.

I think your last question was around.

Tim [Edmond] – Individual Investor

If I could just, so order of preference for the business would be and I don’t put words in your mouth, so if you’re perspective of potential return acquisitions first, share repurchase second?

Jeffrey Glajch

Yes. And I think your last question of the original set of questions was on our return criteria for acquisitions. We clearly want to generate a return in excess of our cost of capital so we’re not, you know, to make an acquisition accretive for us would be relatively straightforward given the returns that we’re currently getting on that cash and investment sitting on our balance sheet. That’s not our target. I mean obviously we want to be accretive but our real target is to insure that the short and long term we’re generating a return in excess of our cost of capital.

Tim [Edmond] – Individual Investor

Just last on, you know, large scale desalination or large scale water treatment, do you have any exposure there?

James R. Lines

We have provided equipment for desalination projects over the years. They require our ejector systems and at times our vacuum pump packages.

Operator

Your next question comes from George Walsh - Gilford Securities.

George Walsh - Gilford Securities

I just had a couple of follow up questions relating to earlier questions. One, Jim related to raw material costs, obviously there are a lot of factors impacting things around the world with projects, but would you say that is probably the top decision factor in terms of delays and projects or even cancellations?

James R. Lines

Yes, I believe so, George. Yes.

George Walsh - Gilford Securities

So given that do you think it’s a matter of if these types of prices stabilize that these projects would, you know, go from pipeline to orders or be revitalized forward? That maybe prices have to reverse trends until they feel like they won’t get caught on the other end?

James R. Lines

I think it has to result in the raw material prices stabilizing at a level around where they are, perhaps a little bit lower. Again I don’t necessarily think it’s the price of oil per se, because when this wave of business took off in 2005, 2004 or 2005, oil was $30ish dollars a barrel. And there was tremendous demand for our products 5, 6, 7 and 8, well 5 and 6 when oil was less expensive than it was the last two years. So it comes down to the cost of the facilities and how that’s aligned with the raw material costs.

George Walsh - Gilford Securities

Yes, because I would think the dynamics and profitability are still very strong in these, even if, you know, particularly it would be, you know, a drop off in raw material costs.

James R. Lines

I tend to agree with what you’re saying.

George Walsh - Gilford Securities

And just to clarify on the SG&A, if I understood correctly the, you said there were $2.7 million in cost savings you would be getting? Is that correct?

James R. Lines

That’s correct. That’s both in SG&A and in operations.

George Walsh - Gilford Securities

Okay, because I was just matching that up to the SG&A number versus this year. So.

James R. Lines

A significant portion of the savings is in operations also.

George Walsh - Gilford Securities

And you went through the M&A which was good relative to the, you know, great strength of your balance sheet. Is there anything on the organic side you could expand upon in terms of investments that you’ll be thinking about in taking advantage of the slowdown in the cycle? Meaning, you know, would you want to make investments in marketing or new offices around the world or, you know, anything else or other types of investments?

James R. Lines

That’s a great question and one of the factors that is leading to our SG&A being where it is in proportion to sales during this downturn is we’ve chosen to use this downturn to increase our emphasis on sales and marketing to prepare the business to grow organically or take greater market share as the markets recover. We chose not to strip away in our SG&A area to effect negatively our potential for growth when the market recovers.

George Walsh - Gilford Securities

Yes, and it seems you’re still somewhat, even as you’ve had to ramp up for a good part of this cycle you’re still somewhat modular with your costs. You’ve been able to adjust.

Jeffrey Glajch

George, absolutely. In fact if you look at how Graham grew through this up cycle, we invested in variable costs. And what I mean by that is instead of running two shifts we ran three shifts. If we had a situation where we had excess demand compared to our capacity we would outsource some of our production. We did not invest and expand our roof line, so we did not add buildings. We did improve our facility but we did not expand our capacity by, you know, putting in extra building and an extra facility. And so we expanded using variable costs and when the demand is coming back down a little bit we’re able to contract those variable costs.

George Walsh - Gilford Securities

And during that period you did great increases in efficiency and productivity.

James R. Lines

Absolutely. And we’ve spent a lot of effort improving the speed of our entire work process, our work flow, before manufacturing and during the entire manufacturing process. And we expect to continue to focus on that during this weaker time period so as we come out of this we’ll be even faster and stronger.

George Walsh - Gilford Securities

Well you’ve done a good job in the up cycle and, you know, you’ve got a great [fortress] balance sheet there so you should be in good shape.

Operator

At this time we appear to have no further questions. I’d like to turn the call back over to Mr. Lines for any closing comments.

James R. Lines

Thank you. Again we appreciate your time and interest in Graham. As we’ve discussed although the near term is challenging, we feel extremely comfortable with our financial strength, the strength of our brands, the capability of our company, do relatively well all things considered during this contraction in our markets. We also know that we are better positioned for the up turn in our industries when it does come, and we believe we can capture even larger share than we had this last cycle. Thank you for your time and enjoy the weekend.

Operator

Thank you. This does conclude today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.

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Source: Graham Corporation F4Q09 (Qtr End 03/31/09) Earnings Call Transcript
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