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Graham Corp. (NYSE:GHM)

F2Q10 Earnings Call

October 30, 2009 11:00 am ET

Executives

Deborah Pawlowski – Investor Relations

Jim Lines – President and Chief Executive Officer

Jeff Glajch – Chief Financial Officer

Analysts

Rich Hoss – Roth Capital Partners

Tom Lewis – High Road Value Research

Chris McCampbell – Stifel Nicolaus & Co.

James Bank – Sidoti & Company

George Walsh – Gilford Securities

Operator

Welcome to the Graham Corporation Second Quarter 2010 Quarterly Results conference call. (Operator Instructions). It is now my pleasure to introduce your host, Ms. Deborah Pawlowski Investor Relations for Graham Corporation.

Deborah Pawlowski

We appreciate your joining us today on Graham's Fiscal 2010 Second Quarter Financial Results call. On the call with me today are Jim Lines, President and CEO of Graham and Jeff Glajch, Chief Financial Officer. Jim will briefly review the second quarter's performance and will discuss the company's strategy and outlook, as well as their perspective on the state of the industries we serve, while Jeff will be reviewing the company's performance in the recent quarter and first half of the fiscal year.

You should have a copy of the earnings release that was put out this morning. And if not, you can access it at the company's website, which is www.graham-mfg.com. In addition, we have posted supplemental slides on the website to provide a visual overview of our results.

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 both at the company's website and at www.sec.gov.

So with that, let me turn it over to Jim to begin the discussion.

Jim Lines

Welcome everyone to our conference call for the second quarter fiscal 2010. Sales in the quarter at $16 million were in line with our expectations. However, they were down sequentially 20% and down 32% year-over-year. Our margins held at relatively high levels for the amount of sales in the quarter. I believe that maintaining gross margin at 36.3% and operating margin at 17.5% demonstrates that our managers and the entire company have been able to control costs while sales have sharply declined.

Steps our employees took to improve the company during the upturn that resulted in record financial performance for fiscal years 2008 and 2009 are showing through in the downturn. The Graham team demonstrated that it could execute differently than it did during prior strong markets. Now equally importantly, they are demonstrating that Graham is also a different company in a sharp downturn, arguably the worst downturn since the 1930s.

I believe that the actions taken over the past few years have enabled Graham to grow during the past cycle have also been instrumental in allowing the company to execute well and remain profitable during the current downturn.

These actions include an ongoing company-wide commitment to continuous improvement, investments in IT and process improvement, investment in the low volume high mix Graham production system by investing in both process flow and equipment, policy deployment and performance management, value based selling and a renewed commitment to improving customer relations.

We intend to continue to invest in the company and its employees and process improvement in IT and production equipment, in eliminating waste and in becoming a faster company. We believe these steps are critical to Graham's ability to manage profitably across this sharp downturn and are essential to staying competitive in the future.

I believe we can remain profitable at the bottom of the cycle, which we expect to be in the next few quarters. Our strategy throughout the downturn has been to be ready for the market recovery. We expect that this strategy will allow us to take market share from our competitors, expand our markets and ultimately grow more quickly than we did during the past growths periods.

We implemented additional restructuring in September as a result of our outlook across the next several quarters, which we believe for Graham will represent the bottom of the downturn. In total, we have completed two restructurings, the first in the fourth quarter of fiscal 2009 and the second in the last quarter, which together lowered our annual costs by approximately $4.3 million.

Some of this cost reduction was in SG&A. However the majority, about 75% was in cost of goods. I expect that following these restructurings the company will have more than sufficient capacity to capitalize on opportunities in our markets, while at the same time maintain a cost structure that supports profitability during the remainder of the downturn.

New orders in the second quarter were just under $30 million. This represents an excellent improvement from the $8.8 million in bookings in the first quarter and is our highest bookings quarter since the fourth quarter of fiscal 2008, which was before the global recession set in.

In the second quarter, two major refining projects in the Middle East moved forward with equipment purchases that represented about half the bookings in the quarter. I believe that there is more opportunity for Graham on each of these major projects.

We felt market recovery would be led by Asia and the Middle East, followed by South America and then by the North American market. That is what we believe we are seeing now. We are encouraged by the advancement of the projects in the second quarter. Our bookings in the quarter were strong and our perspective on the pipeline continues to improve.

We do not believe our markets are in full recovery. We expect that order rates in subsequent quarters will continue to be non-uniform and very significantly on a quarter-to-quarter basis. We intend to continue our aggressive, but disciplined approach to winning new orders.

We are tightening our revenue guidance for fiscal 2010 to $60 million to $65 million. This is due in part to the suspension of a large project that had been planned to be completed across the third and fourth quarters. Although this project has not been cancelled, it has moved into fiscal 2011. Jeff will update you on our margin guidance.

In summary, this downturn has been dramatic and fast. We intend to continue to be proactive in our response to the downturn, while at the same time keeping our commitment and focus on where we want to be in the next growth cycle from a cost by the breadth and operations perspective. We intend to be ready when our markets do recover.

Let me turn it over to Jeff for greater detail on the quarter.

Jeff Glajch

I will start with a review of sales and operations activity before moving on to our orders and backlog. Net sales in the second quarter of fiscal 2010 were $16.1 million, a $7.8 million decline compared with last year's second quarter and down $4 million from the trailing first quarter this fiscal year.

As expected, Graham's sales have begun to shift toward international and away from the U.S. market. Second quarter fiscal 2010 sales were split equally between the international and U.S. market compared with 63% of sales in the U.S. in last year's second quarter. U.S. sales declined $6.8 million or 46% to $8.1 million, while international sales declined just $900,000 or 10% to $8 million.

In the quarter, sales to Asia were $4 million, up from $1 million in last year's second quarter. This continues the trend from the first quarter. For the first half of this fiscal year, sales to Asia have tripled to $12.2 million up from $4 million in the first half of fiscal 2009. Sales in the Middle East in the second quarter were comparable to last year at $2.9 million off just 3% or $100,000. Sales in all other regions, South America, Europe and Canada offset the gains achieved in Asia in the second quarter.

For the first half of fiscal 2010, net sales were at $36.2 million nearly 30% below last year's first half sales of $51.6 million. In this period, U.S. sales made up 51% of total sales and international sales accounted for the remaining 49%. These percentages for the prior year's first half were 65% U.S. and 35% international. Again, the increase in sales to Asia and the slower U.S. market accounted for the majority of this trend toward an increase in international sales weighting.

As Jim mentioned, based on the geographic source of our orders and the activity of the various energy industries that we serve in those regions, we continue to expect to see our sales mix shifting toward Asia and the Middle East and away from the United States. By industry, while sales dollars have declined across all segments, as expected we continued to see a shift away from refining, especially in the United States.

Sales to refiners were down to 44% of total sales in the second quarter of this fiscal year compared with 47% the same period last year. Thirty-three percent of sales were to the petrochemical industry, up from 27% and 23% of sales were to the power and other industrial applications, down slightly from 26% last year.

For the first six months of fiscal 2010, refining industry sales accounted for 45% of total sales, down from 50% of total sales in last year's first half. Petrochemical sales in the first half of 2010 increased to 28%, up from 23% last year, while sales for power and other industrial applications stayed constant at 27% of total revenue.

Orders in the second quarter of fiscal 2010 were $29.6 million and were at the highest level since the fourth quarter of fiscal 2008, 18 months ago. International orders totaled $23.4 million and accounted for 79% of the second quarter orders.

This was driven largely by the Middle Eastern orders that Jim mentioned earlier which made up just over half the total for the quarter. As we have mentioned in the past, we expect quarterly orders during this disruptive period in the cycle to be quite erratic and we suggest using trailing 12-month information to understand our order trends.

At the end of September 2009, backlog was $50.5 million, a $13.5 million improvement from the backlog of $37 million at the end of June 2009. It is important to note that we expect only 65% of this existing backlog to ship within the next 12 months.

Our historical 12-month shipment expectation is usually 85% to 90% of backlog. However, because a significant portion of the $16 million in orders that we announced in a separate press release today are not expected to begin to ship until the latter half of fiscal 2011 and into fiscal 2012, our backlog has become more extended.

The measurably improved backlog is net of a cancelled $500,000 that had been on hold. In total our backlog includes $7 million in orders on hold for later and suspended projects. This number was $4.2 million at the end of June but along with cancelling the $500,000 order just mentioned, we added a $3.3 million project to the on-hold status in this most recent quarter.

This $3.3 million project was originally expected to ship this fiscal year. However, it is now expected to ship in fiscal 2011. Given our backlog and general business conditions, we are projecting revenue for the full fiscal 2010 to be between $60 million and $65 million.

Our gross margin continued to be relatively strong in the second quarter given our level of sales. Gross profit was $5.9 million or 36.3% of sales compared with $10.5 million or 43.9% of sales in last year's second quarter.

For the first half of fiscal 2010, our gross profit was $14.1 million or 39% of sales compared with $22.7 million or 44.1% of sales in last year's first half. Based on the strength of our gross margin in the first half, we have increased our full year gross margin guidance as a percentage of sales to be in the range of 33% to 35%.

And yes, when you do the math you will find that the second half gross margin will be measurably lower than the first half in the mid-to-high 20s. This is due to the expected level of revenue in the second half as well as we don't believe we'll have as much opportunity on the purchasing side to expand those margins as we had in the first half of fiscal 2010.

For the second quarter of fiscal 2010 SG&A expenses were $3 million or 18.1% of sales compared with $3.9 million or 16.4% of sales in the second quarter of last year. For the six-month period, SG&A expenses were $6.3 million or 17.3% of sales compared with $7.8 million or 15% of sales in last year's comparable period.

The restructuring initiatives we've undertaken both at the end of fiscal 2009 and more recently in the second quarter of fiscal 2010, combined with lower commission costs related to the decline in sales account for the reduction in SG&A dollars in the current fiscal year. We expect SG&A for the fiscal 2010 will be in the $12.5 million to $13.0 million range, down from our previous estimate.

Keep in mind that while our two restructurings are expected to yield a total of $4.3 million in savings, $2.7 million from the initial measures we undertook in the fourth quarter of fiscal 2009 and an additional $1.6 million from this most recent quarter's initiatives, most of the benefits, around 75%, have been and will continue to impact manufacturing cost instead of SG&A.

Interest income in the second quarter of fiscal 2010 declined to $15,000 compared with $172,000 in the same period last year as a result of the significant decline in U.S. Treasury yields. Our investments are in U.S. Treasury securities with maturities up to 180 days.

Our effective tax rate in the second quarter was unusually high at nearly 46% due to a $435,000 charge related to income tax credits that Graham claimed for their 2006 to 2008 tax years. This charge is our best estimate of the potential credit reversal from these claims.

In addition, there was a $32,000 interest charge related to the incremental tax estimate. We are currently in discussions with the IRS over this issue and believe our tax position is correct as originally filed. Without the charge our effective tax rate would have been slightly under 30% in the quarter. Excluding the charge we estimate our effective tax rates for fiscal 2010 will be between 30% and 31%.

Net income in the second quarter of fiscal 2010 was $1.5 million or 67% below last year's second quarter. On a per diluted share basis, earnings were $0.15 compared with $0.43 last year. Excluding the charge associated with the prior R&D credits which netted to $0.05 per diluted share, net income was $1.9 million or $0.19 per diluted share.

For the six months period GAAP net income was $5 million compared with the first half of last year's net income of $10.1 million. Excluding the charge for the tax credits, first half net income was $5.5 million or $0.54 per share.

Graham's balance sheet remains strong with cash, cash equivalents and investments totaling $54.7 million at the end of September, up from $45.3 million at the end of June and $46.2 million at the end of fiscal 2009.

For the first half of fiscal 2010 we generated $9.3 million from operating activities and increased our cash and investments position by $8.5 million. The cash generation in the first half of fiscal 2010 resulted from a combination of strong operating income despite the market downturn and continued improvements in working capital.

Excluding cash, cash equivalents and investment, our net assets less net live – net of current assets less current liabilities is minus $162,000. We have no borrowings on our $30 million bank line and are utilizing it solely for outstanding letters of credit which totaled $9.9 million at the end of the second quarter.

Capital expenditures were $202,000 in the second quarter of fiscal 2010 and $394,000 in the first six months of this fiscal year. We continue to pursue our capital plan which is an important part of our internal development activities and estimate that total capital expenditures for fiscal 2010 will be approximately $1 million and half of that investment is planned for productivity improvement.

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

Jim Lines

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

Question-and-Answer Session

Operator

(Operator instructions). Our first question comes from Rich Hoss – Roth Capital Partners.

Rich Hoss – Roth Capital Partners

I'm trying to get a little bit more detail on the $16 million of that $29.3 million in bookings that you have discussed. You talked about the majority being two projects in the Middle East. Are you able to comment if one of those is associated with Jubail and/or Yanbu?

Jim Lines

It's associated with both projects. Have a little piece of business in both projects, and more importantly, we think there's more opportunity for us on each project.

Rich Hoss – Roth Capital Partners

And are you able to comment on what you think the total potential from each of these projects could be?

Jim Lines

Each is about 400,000 barrel per day refinery in total, across both refineries. We would think in terms of $25 million to $35 million of total opportunity for us.

Rich Hoss – Roth Capital Partners

Twenty-five to 30 per refinery?

Jim Lines

No, total.

Rich Hoss – Roth Capital Partners

At what revenues would you have to start adding to SG&A? I'm viewing this quarter's SG&A as probably your bottom or close to bottom. Where would you have to start adding people?

Jim Lines

We've tried to keep in mind that we want to build this company to take advantage of the opportunities in the future. We didn't scale back appreciably in the SG&A area. There are some variable expenses in SG&A tied to the level of sales, so without personnel additions, SG&A could increase as revenue increases. There's a proportionate increase in our commission sales as revenue goes up. We think we're adequately staffed to take advantage of the opportunities that would be in front of us over the next one to two years with our staffing in the sales area.

Rich Hoss – Roth Capital Partners

So expect some pretty decent leverage then on revenue growth.

Jim Lines

We believe so, yes.

Rich Hoss – Roth Capital Partners

And then, third question, can you describe the phasing of your projects, the recognition of your projects today compared to, say, a year-and-a-half ago? And what I'm trying to get at is, it seems like you're able to ship projects earlier than the last several years, and does that go from, say, a 9- to 12-month target to maybe a six- to nine-month? And this excludes that 16.9 that we've already talked about.

Jim Lines

We segment our business a number of ways, but two key ways would be larger projects and smaller projects. We've indicated that around 40% of our sales in a given year would be smaller projects, which tend to convert within one month to three months after the order.

And then for the larger projects, those that have order announcements that really will depend upon the type of project. If it is a refining project, Rich, we are still seeing schedules being between 12 and 18 months on average, for order to complete shipment, bearing in mind that revenue could occur over the last six to eight months of that timeframe.

For a power generation job or a petrochemical project, that could be in the 10- to 14-months timeframe. So it really will depend on the type of order that we're winning and the value of that order with regard to how quickly it begins to convert to revenue.

Rich Hoss – Roth Capital Partners

That's fair. And then last question: For Jeff, do you have any updates on the acquisition search? How are valuations looking and any change to the strategy there?

Jeff Glajch

Rich, let me answer your last question first. No, there is no change to the strategy. We certainly have been spending a good deal of time looking at opportunities, and at this point we've also certainly valued a number of opportunities. We haven't come to what we've felt was the right opportunity at the right value yet.

With regard to valuation, we seem to be stabilizing a little bit. Certainly in the private markets we saw a – took a little longer for the valuations to come down than in the public markets, but I think we're at a pretty good base right now. But at this point we have not identified an opportunity that strategically is the correct thing for us at a value that we're comfortable with. But we are certainly very busy.

Operator

Our next question comes from Tom Lewis – High Road Value Research.

Tom Lewis – High Road Value Research

Good morning. First question, as the company gets – been through a few cycles, what can you tell us about the – you've had some orders postponed. You mentioned one that was canceled. Is this something I would think would be normal during a cyclical downturn? Is it happening at sort of a normal rate, or is it in line with your comment about a worst downturn in a very long time?

Jim Lines

The downturns when you're in them, Tom] they always feel brutal. They tend to, from my experience – and I've been through three – seem to be pretty similar. This time around though, some of the refining work actually was canceled or put on suspension, which we would get a little bit of it, if I recall correctly, in the prior downturns, but because of the extensiveness and the swiftness of this contraction, some projects were canceled that we didn't expect to be canceled based on our historical perspective of going into a downturn.

Tom Lewis – High Road Value Research

When a project canceled, do you tend to have anything in there other than some sales-type consultation, or do you book any revenues at all early on in the design process? Can you –

Jim Lines

Our revenue cycle begins when we begin production. Negotiating contracts, we tend to negotiate cancellation schedules that protect the company, that in the event that a project is canceled we have our costs covered that we've put into the project and perhaps some opportunity cost on the future profits that we would have earned. But that really depends on the situation.

Invariably, those are negotiations between us and our customer. When we look to maximize a given opportunity, we look to maximize the relationship over the long term, so we are a flexible company when we're talking about cancellations with our customers. We want them to be [long term].

Tom Lewis – High Road Value Research

And last question, you mentioned that in referring to your order pipeline activity that your perspective had improved. Were you just speaking with respect to how clear your perspective was, or were you speaking to improvement in the long-term likelihood of opportunities, or both?

Jim Lines

Our customer-facing groups, our sales team and our application engineering group, they've been very, very pleased with the level of activity and the quality of the activity that they're seeing coming from our customers. Now, we have remained very busy over the last 12, 18, 24 months, not too different from how busy we were in those areas two years ago and beyond.

But the quality of the work, the perception that the projects are beginning to advance, our customer-facing groups feel the quality of that work is improving, and they're very optimistic about the nearer term than they were, say, six to nine months ago.

Tom Lewis – High Road Value Research

So based on that, if we think about your sense of the business over the next five or so years, two years ago it was probably well above normal. The next – right in here, the next few quarters as well, below normal. Do you think that however normal ends up over five years is closer to the one or to the other?

Jim Lines

Inherently, being a provider of equipment to the energy markets, we will be a cyclical business. What we're projecting, and it's our belief, that our company can grow. We believe we can grow more rapidly than we did during the last up cycle and our expectation, Tom, is that we can grow beyond where we reached last cycle.

But we're not saying that we won't have this cyclical pattern. Hopefully not as extreme as what we just went through but we will be cyclical so it's hard to give you a comment on what is a normal level of business.

But I can state that it's our expectation that our company is prepared to grow when the markets recover. We believe we can grow more quickly than we grew in the last cycle and it's our expectation that we'll grow beyond where we grew in the last cycle.

Operator

Your next question comes from the line of Chris McCampbell – Stifel Nicolaus & Co.

Chris McCampbell – Stifel Nicolaus & Co.

Congrats on managing the business in this environment guys, it's really impressive. Rich answered or Rich asked a lot of the questions I wanted to ask, but should cash generation be I guess more muted for the remainder of the year in comparison to the second half or would that be similar?

Jeff Glajch

We would expect that cash generation will be more muted in the second half of the year. If you look at our cash generation the first half it was driven primarily by our earnings in the first half as well as some improvements in working capital.

We would think the improvements in working capital probably will not be repeated. But on the earnings side if you run out the guidance that we provided you'd see that our second half earnings would be significantly lower than the first half earnings. So we don't expect a lot of cash to be generated in the second half of the year, although we also do not expect to be using cash for operations.

Chris McCampbell – Stifel Nicolaus & Co.

And could you give any additional color on acquisition candidates out there? I mean are you looking at, are you leaning more towards things that would diversify a little bit away from the business that you have going on now or are we looking to focus on adding to what we have already?

Jeff Glajch

We are looking really at two avenues. One avenue is looking at expanding our product line and potentially expanding into some markets that we currently play in but maybe aren't as strong in as we are in say refining in petrochemical.

So in that avenue would be really expanding the breadth of our product line and giving us some additional opportunities and potentially being less cyclical or somewhat countercyclical to our existing business.

The second opportunity is looking at geographic expansion which would be to have fabrication and engineering capabilities somewhere outside the U.S., and that's really to take advantage of some specific markets that are out there.

So that would be more in line with our existing business but it would also by focusing on other markets and potentially being able to get deeper into some of those other markets that could also help with the cyclicality a little bit, too.

Chris McCampbell – Stifel Nicolaus & Co.

From the geographic perspective would you say that domestically things are – are you having any conversations with your customers in regards to cap and trade and potential environment that that would have here? I mean are people actually postponing decisions based on the regulatory rhetoric or is that having any effect at all?

Jeff Glajch

Well, I think the domestic market we have viewed even without the cap and trade legislation have viewed the domestic market as being slow certainly in the next couple of years. It was very strong for a number of years.

We believe it's slowed down now and I think the cap and trade legislation is putting a level of uncertainty right now into the process because it's not clear exactly where that's going to land. But we don't think it's really affecting near term decisions but it certainly could have an impact on longer term decisions.

Operator

Our next question comes from the line James Bank – Sidoti & Company.

James Bank – Sidoti & Company

The first is did that cancelled project I'm sorry that was just $500,000, $700,000?

Jeff Glajch

Correct it was $500,000.

James Bank – Sidoti & Company

And then the one that's on hold was there a particular reason for that, maybe pricing? Are they trying to renegotiate the contract or anything like that?

Jim Lines

No, it has to do with some engineering activity that they have to complete. [Site] engineering and it's working with the EPC contractor to finalize that. An important point I want to make there is that it's not a project for transportation. It is a refining project, not for transportation fuel but for high quality lubricating oils for improving engine efficiency. So it's not a project tied to supply and demand per se.

James Bank – Sidoti & Company

Now with raw material inching up a little bit 33%, 35% gross margin is that sustainable as we kind of get into next year or are we going to need to see a big uptick in volume do you think?

Jeff Glajch

The 33% to 35% which is our full year number and includes the year-to-date gross margin which is at a higher level than that. So if you were to do the math you'd get into somewhere in mid to high 20s for a gross margin in the second half of the year. And recognize that's also on a lower level of sales in the second half of the year to the first half of the year.

We would think at that level of quarterly or half year sales the mid to high 20s is probably the price that we would be if and when we get to the point or when we get to the point where the revenue number starts increasing, there's a significant amount of leverage there from the margin standpoint and we would thing that we would start seeing the margin going up from that mid to high 20s range.

We think the mid to high 20s is the trough margin at this point in time. And again, we expect that to be the range we're in in the second half of this fiscal year.

James Bank – Sidoti & Company

And then on the backlog side it looks like some shipment of some higher margin stuff's helped just a little bit more I guess here in the quarter. Not so much from the – we're down a lot from what had helped in the first quarter. Is that pretty much it for those price-inflated projects from last cycle?

Jeff Glajch

Yes, that pretty much, James, works through the backlogs. Going back to what we mentioned on the last conference call an appreciable portion of the margin lift that we saw in Q1 and the margin we had in Q2 I would say has been attributed to lower cost materials and being able to take advantage in how we procured materials during this downturn. That appreciably lifted our margins.

James Bank – Sidoti & Company

Well, why wouldn't we see that same type of success in the back half here? Has raw material moved I guess too quickly at this point to continue to take advantage?

Jeff Glajch

We'll continue to be as disciplined as we were in Q1 and Q2. It's hard to suggest that you should model the business around continuing to have those savings because it really will depend on how the market recovers and how the supply chain tightens up.

Our team has been able to find opportunities where there's been available capacity, aggressive negotiations and flexible suppliers. That really we would attribute to where the supply chain is at that point in time.

James Bank – Sidoti & Company

Now on the cost savings on the COGS side I – Jeff I'm sorry I think you said 3.4 but 2.7 and 1.6 is 4.3?

Jeff Glajch

That's correct. If I misspoke I apologize.

James Bank – Sidoti & Company

So and I'm sorry 75% of that has been realized and you would say most of that is going to be in the manufacturing cost end?

Jeff Glajch

No ,of the 4.3 about 75% will be in the cost of goods sold side. And what has been realized is that of the 2.7 million annualized number that we did in the restructuring that we did in the fourth quarter of fiscal 2009 were certainly, that has been realized on an annualized basis.

The 1.6 million which was related to the restructuring that we just did within the last fiscal quarter, we're just starting to realize that now. So we really did not realize any of that 1.6 million in the second fiscal quarter but you'll start seeing it in the third fiscal quarter.

James Bank – Sidoti & Company

Now moving to the SG&A, I think earlier in the year there was some marketing for some international inroads and some other costs in the SG&A line that might have bumped up this year a little bit more than it might have or should have been I guess. So with everything going forward and looking on the out year, let me stop.

Jim let me ask you this, if you did $100 million in sales what do you think your SG&A would be?

Jim Lines

Comparable to what it was when we did $100 million last time.

Jeff Glajch

Which was around $15 million.

James Bank – Sidoti & Company

So no leverage benefit in the SG&A?

Jim Lines

We actually, to be candid, we have a little more SG&A expense now but that's necessary to take advantage of where the sales will come which would be the emerging markets. We need it to strengthen our sales organization to take advantage of those opportunities, not appreciable change, but there is more cost in our SG&A to go after the business where it is going to come from in the future.

James Bank – Sidoti & Company

Okay so for modeling purposes we should drive it with whatever hypothetical sales number would be and just assume okay it's up commission dollars up and if it's down commission dollars are down and just run it through that way.

Jim Lines

That's a good way to model it.

James Bank – Sidoti & Company

And last question, $30 million in orders I understand it's volatile, but that's quite a big number. You can almost assume a $38 million run rate the first half which could give you a pretty good run rate full year. Are you guys not issuing press releases for these orders anymore into quarter?

Jim Lines

No we – excuse me. Yes we are. The orders came in at the end of the quarter near the last half of September a good amount of them came in. And it was timing of wrapping up the quarter and getting ready to release the announcements.

Jeff Glajch

Typically those larger orders came in late in the quarter.

Jim Lines

But to be clear we haven't changed our philosophy on announcing larger projects.

James Bank – Sidoti & Company

Right. And I think on the last conference call at the end of July I think you gave us a rough aggregate of the orders that you had booked. Could you do that for us for October, the month of October?

Jim Lines

The orders that have been won in October are between $5 million and $6 million.

Operator

Our next question comes from the line of George Walsh – Gilford Securities.

George Walsh – Gilford Securities

I'd like to add my congratulations to you, Jim, and the whole team for doing a very good job of marketing during the entire business cycle. It's quite a feat in a very, very volatile market you've had to deal with.

But I'd also like to look forward a little bit and you touched on it there in the last question. It really looks like it would be a foreign sales-led recovery that you're looking at. And you partially touched on the idea that there would be some more sales and marketing type of investment you'd need for those type to fully exploit that.

I wonder if you could just go into other expenses or how that cycle might be different for you because I think this would be the first that I've notice a really foreign-led sales cycle potentially in terms of dominate in revenues for Graham.

So would that mean that you'd be outsourcing more in Batavia, some Batavia versus doing the manufacturing there as you would other type of investment you do in ramping up your sales in marketing or any other factors you might see?

Jim Lines

Good question to a large extent the same EPC contractors that we work with for domestic work are pursing the international work and we'll get orders from for example [FLOR] or KBR just as we did in the past cycle that were for the U.S. market, but now it's for the international market. So managing that same sales channel hasn't really changed.

As international contractors begin to take more of the market share, Japanese contractors, Korean contractors even some Chinese contractors then that changes how we have to manage those relationships.

But within our cost structure that we have now I think to a large extent we thought this was going to occur. We could see it coming in our future and we've organized our sales team both from a headcount and a structure perspective to be prepared for this.

We felt the recovery would be coming from the emerging markets which would be China, Middle East, South America. Our proposal activity for the last 12, 18, 24 months has been largely for those areas and I think our channel management and our opportunity management we prepared the company well I believe to be in a position to take advantage of those opportunities when our customers are ready to place orders.

George Walsh – Gilford Securities

And Jim, just to clarify for my own mind, if I understand it correctly, a lot of your domestic sales anyway will end up with overseas customers so is the difference with foreign sales that, as you explained, that you're dealing more with a foreign contract as opposed to a Jacobs Engineering a domestic contractor?

Jim Lines

The way we define an international sale it's based on the end use location.

George Walsh – Gilford Securities

Oh it is? Okay.

Jim Lines

Not necessarily order origin.

George Walsh – Gilford Securities

And the other would be a question regarding cap and trade which you addressed earlier but the other side would be is this something that would be potentially good for your business in that it could create demand because of regulatory emission issues with your customers?

Jim Lines

Yes there have been in the past when legislation came down from the government whether it be [HM TBE] or ultra low sulfur diesel that created mandatory CapEx for the refiners to comply with those requirements, that then created demand for Graham's products whether it be our heat transfer products or ejector systems or our surface condensers so here, too, cap and trade could provide an opportunity for us depending upon what processes have to added to the refinery to comply or to try to manage their costs under that new legislation.

George Walsh – Gilford Securities

And anything that would affect you personally or just in any way that you could think of so far that any these carbon credit would have an impact on Graham either for your customers or your customers dealing with you or for Graham itself?

Jim Lines

Nothing that jumps out at us, as Jeff indicated, there is some uncertainly around the how this is going to be applied what the actual carbon tax will be, what the amount of it will be, how it's actually going to be applied. You couple that with the reduction in the consumer demand in the U.S. market, utilization rate for the refiners being down appreciably and then the differential between sweet and sour crude closing. These have all had an impact on near term investment decisions in the U.S.

When we look beyond the U.S. there's still investment going on clearly in the Middle East, in China and then we think there will be investments coming out of South America shortly that will be for new refining capacity. And as I said earlier we've been managing that sales opportunity for 12, 18 months in anticipation of when those opportunities would move toward purchase.

Operator

(Operator Instructions) Our next question comes from the line of James Bank – Sidoti & Company.

James Bank – Sidoti & Company

Just a quick follow-up, I think I think in the first series of questions. Jim, you mentioned Jubail I'm sorry what was the other refinery?

Jim Lines

Yanbu.

James Bank – Sidoti & Company

Yanbu?

Jim Lines

Yes, Y-A-N-B-U.

James Bank – Sidoti & Company

Okay and I think Jubail had been a $12 billion contract and it's now 9.6 due to some raw material stuff. Do you know what the total aggregate of the Yanbu project is?

Jim Lines

I do not offhand. Both are 400,000 barrel per day refineries. I would assume it's in that $10 billion to $12 billion range. I don't know for certain but both are 400,000 barrel per day refineries.

James Bank – Sidoti & Company

And, Jim, you mentioned there are $30 million to $35 million in total opportunity?

Jim Lines

[Forty-five] to 35 million.

James Bank – Sidoti & Company

And then also South American markets you mentioned I had written down here I think that's the first I've heard you guys talk about South America unless I'm mistaken. What type of work are you seeing down there?

Jim Lines

It would be refining and petrochemical work we've had a long history with the state-owned refiners in Colombia, Ecopetrol; Brazil, Petrobraz; PDVSA in Venezuela. We have equipment in those refineries for decades and we have actually our sales team – some of our sales guys are in South America this week interacting with our state-owned refining customers.

Operator

Thank you ladies and gentleman we have no more questions at this time. I'd like to turn the floor back to management.

Jim Lines

Well, thank you for your time this morning and we look forward to updating you after the end of the third quarter in January. Have a good weekend.

Operator

Ladies and gentleman this concludes today's teleconference and you may disconnect your lines at this time. Thank you for your participation.

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Source: Graham Corp. F2Q10 (Qtr End 09/30/09) Earnings Call Transcript
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