Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Graham Corporation (NYSE:GHM)

F4Q 2011 Earnings Call

May 27, 2011 11:00 a.m. ET

Executives

Deborah Pawlowski - IR, Kei Advisors LLC

Jim Lines - President and CEO

Jeff Glajch - CFO

Analysts

Rick Hoss - Roth Capital Partners

Joe Mondillo – Sidoti & Co.

Dick Ryan - Dougherty & Company

Tim San Lucas [Gabe] – Rosetta Capital Markets

George Walsh – Gilford Securities

John Sturges – Oppenheimer

Operator

Greetings and welcome to the Graham Corporation fourth quarter 2011 quarterly results conference call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions). As a reminder, this conference is being recorded.

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

Deborah Pawlowski

Thank you, Christine, and good morning everyone. We appreciate your joining us today on Graham's fiscal 2011 fourth quarter conference call.

On the call I have with me today Jim Lines, President and CEO of Graham and Jeff Glajch, Chief Financial Officer. Jim and Jeff will be reviewing the results for the quarter, and also provide a review of the company's strategy and outlook. On our website at graham-mfg.com, you will find both the press release as well as supplemental slides that are posted there. Jim and Jeff will be referring to the slides during the following part of their discussion.

As you are aware, we may make some forward-looking statements during this 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 materially 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 at sec.gov.

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

Jim Lines

Thank you, Debbie. Please turn to Slide 4.

We feel the company performed very well during the quarter, and we also had the full benefit of Energy Steel in the quarter. I was very pleased with order development in the quarter, orders through the quarter were $26.8 million of which about 20% come from Energy Steel. We did win two Geothermal Power plant Vacuum system orders, both hare for Asia. Continuing with our focus on North American renewable power, we won two biomassed energy projects in the quarter.

Also, we had a very nice level of business, of new orders that we refer to as our short-cycle business. These are orders that typically come in and convert to shipments within one week to three months.

Compared to where we had been through the downturn, which averaged about 4 to $5 million in a quarter, this past quarter, the short-cycle bookings were about $7 million; so that was a nice upturn for us.

Also in the quarter we won new orders for two refining projects. One in North America and one in Asia. Both of these are not for transportation fuels, they are for lubricating oil products.

As you can see also that we had a geographic split of 50% of the bookings were domestic and 50% international.

For sales, we had a very strong quarter, I feel. Sales came in at $25.9 million, Energy Steel contributing just over $5 million. We continued to have sequential sales growth quarter over quarter. Again, because of the short-cycle bookings that we had in the quarter, we also had a lift to our sales from that segment of our business.

We also began production on the Navy contract, which lifted our sales above what our prior guidance was for the quarter.

Margins, we’re very pleased with the profitability in the quarter. Gross margin for the quarter came in at 30.5%, and EBITDA margin at 18.1%.

This is driven off of improvement in our capacity utilization for the Batavia operation. We’re becoming more loaded in our production area. Also the benefit of the short-cycle sales, those tend to have a higher margin than do our major orders.

And also, we’re beginning to work through the backlog that was won at a time that we refer to as the bottom of the cycle, where margins were lower and we’re starting to bleed in some of the higher margin work from our backlog into sales.

Turning to Slide 5, summarizing the full year; we saw progressive improvement in the market conditions throughout the year. Particularly with orders. You might recall the first half bookings – it was a rough first half for us, came in at $18.6 million. Second half was much better organically compared to the 18.6 million; organic bookings were 38.5 million plus an additional 6.1 million from Energy Steel. So that was a nice improvement between the first half and the second half of the year.

We also saw, compared to full year last year, organic bookings increased 10% year over year. We’re also adding because of our view towards improved market conditions, personnel into both Energy Steel and into the Batavia facility to drive growth through ’12 and beyond.

Financial performance for the year, I was very pleased by the way our company executed through the downturn, and as we exited the downturn in the second half of the year, and delivered what I feel is a fine level of performance considering all the factors that we were facing.

Sales for the year, $74.2 million with net income at $5.9 million. Both were a little bit about our guidance and that was because of the strength of the fourth quarter. Gross margin came in 29.4%, EBITDA margin 14.1%. If we do net out the acquisition expenses related to Energy Steel, the EBITDA margin would have been 15.1%. Also entering fiscal 2012, we have a very healthy backlog at $91 million.

On to Slide 6 please. Segmenting our sales. For the full year, 55% of our sales were for international end users and 45% domestic. As we have a full year of Energy Steel in fiscal 2012, we would expect this to move closer to 50% domestic, 50% international.

Sales by market, Oil Refining still was a key driver of our business at about one-third of our sales mix. Power with the addition of Energy Steel for the last quarter was just over 20%, Chemical Processing about 20%, and other markets, including the Navy contract comprised of 20%, 21%.

On to Slide 7; a quick update on the Energy Steel acquisition. I’ve been very pleased with the progress we’ve made in integrating Energy Steel into our business. We identified early as we were speaking with Energy Steel, their management, the employees, we saw a similar culture, a company that shares the same values we have with respect to service to our customers, pride in the company, excitement about the business. And subsequent to the acquisition we’ve seen no change, we have had no surprises. It’s been a wonderful acquisition through the first three and a half months. And I’m very positive about the outlook of Energy Steel as we work with them to grow the business.

We also have a very solid management team. The contribution of Energy Steel to our fiscal 2011 results; orders were just over 6 million, sales 5.8 million, and backlog on March 31, stood at $8.4 million.

I’m also very pleased that after three and a half months when we include the expenses related to the acquisition and amortizing certain expenses related to the acquisition, Energy Steel did contribute to our earnings in fiscal 2011.

A question that might be on your mind is what’s the impact of what’s happened in Japan on the nuclear market and our strategy. You might recall when we discussed our strategy related to Energy Steel, we were focused primarily on the existing fleet of nuclear plants in the U.S. market, and we saw additional avenues of growth around new construction in North America, and new construction in the international markets.

With regard to the first driver, the key driver, existing plants in the U.S. we see no change and actually, we may benefit from that about 12 to 24 months from now as the impact of what occurred in Japan and changes that have to be incorporated into the U.S. plants because of that make their way through the supply chain toward Energy Steel. So we’re expecting some lift potentially from what happened in Japan as existing plants have to make investments.

What we have picked up though, with regard to new construction is for many of the plants that were on the table to be built, expect some delay. We’re hearing a couple of years of delay to be expected, depending upon how far along they were in the licensing process. We do feel, however, there are four plants that are progressing. We are involved in some bid activity. And should those projects continue to proceed as planned, there’s a great deal of opportunity for us there.

And also in the international market, from the customers we’ve spoken with there will be a pause, we think, in the investment for new construction. Although, we do feel long-term nuclear energy will be in the energy mix of many of these countries as well as the U.S. and this will be a timing delay found progressing of new capacity.

But all in all, I have no concerns with what’s occurred in Japan with respect to our modeling and our investment in Energy Steel. Quite to the contrary, I’m very excited about the growth potential that we have there and our ability to expand that business and generate profitability for the corporation.

On to Slide 8; our guidance for fiscal 2012, at this point we’re expecting our sales to expand 30 to 40% or to 95 to $105 million, up from $74.2 million last year. Of that, we’re projecting Energy Steel will be 16 to 20% of that total sales amount. The organic growth rate is 20 to 25% in that range. Gross margin, our guidance at this point is between 29 and 32%.

We do see upside. The market environment seems robust to us from the amount of bid activity that we have, and quotation that are in our pipeline. We’re uncertain as to the timing of when some of those will proceed, but we have capacity to execute and we have an aggressiveness to win the business and expand to beyond 105 million if order rates allow us too, both at Energy Steel and at Graham.

Some challenges that we face, right now we’re in a very good position for the first half of the year, actually, right where we want to be. Our Batavia operation is near fully loaded and we have a good amount of subcontracting for the first half of the year. So our first half of the year for all intents and purposes, has keyed up very well.

We have capacity in the second half of the year in the Batavia operations. I’ll would say our capacity utilization right now looks to be between 60 and 70%. We do have a good amount of subcontracting already in our backlog as well for the second half of the year, and it will come down to the order rate this quarter and next quarter to fill up the second half of the year.

We’re positive because of the amount of bid activity that we have, and the time that we have to fill in the rest of the year. And quite honestly, where we are right now looking at our second half of the year, 60 to 70% loaded, that’s pretty customary for first month of the fiscal year to be about loaded at that level. So we’re not worried about it, but we have a great first half and we have time to work on filling up the second half and pushing beyond this guidance that we’ve given today.

And as you might recall from the guidance that we’ve given in the past years, as the year develops, we adjust our guidance typically upward as we have a better view to the back half of the year.

Long term, we see our markets generally improving. We see a lot of activity in refining space. We’re beginning to see activity now in the Oil Sands area for upgraders. There’s also a fair amount of investment that’s planned for the extraction side in the Oil Sands. You might recall that we had won a very large order about six months ago. Our first order on the extraction side in the Oil Sands. So we think there’s a great opportunity there for us to expand our sales over the next few years.

Petrochemical markets are beginning to feel much better. Our Navy program, I’m very excited about that. That is a longer-term process for us. We will have contribution in fiscal 2012 from the Navy program but longer term as we get into fiscal ’13, ’14, or ’15, I’m very optimistic about our strategy with the Navy.

Turning to Slide 9, just recapping our actions to drive sustainable growth in Graham. We’re focused on the Naval Nuclear Propulsion Program, not just with carriers but with other vessels. I’m exceptionally pleased with our progress there. As the shipyards come through to evaluate Graham, as the Navy comes through to evaluate Graham, each and every time they’ve been very impressed by our personnel, our capacity to execute very complex projects, our focus and operations on work flow, quality control, safety. We get very high compliments every time they come through so we’re very excited about that.

And also with regards to Energy Steel, as I said earlier, I’m very excited about the growth potential there, around the existing plants in the U.S. market. Our Batavia operation is also undergoing certification to be able to fill the nuclear quality products in Batavia.

Our strategy to position our company and to win in the renewable energy market in North America has taken off very well. We continue to win business there. As I mentioned earlier, we won two orders in the last quarter for renewable energy in the North American markets.

We also are improving our flexible cost model by expanding our ability to build our products in other locations. We have [inaudible] now in place for building South Korea and China, and India. We have several subcontractors we work with the North America. That’s what enabled us to get through the downturn the way we did. That’s also allowed us to expand the way we did in fiscal 2009.

And I’m very excited about where our business is as our markets recover and our ability to grow, I think faster than we did last time, with the avenues of opportunities that we’ve put in place through the downturn and the addressable market expansion that we’ve focused on through the downturn.

We’ve also thought about the sales mix changing and becoming more internationally aligned. That has some margin compression. We’ve looked at strategies to improve productivity, reduce lead times, and minimize waste to hold our margins if not improve our margins in the face of marching compression from international sales mix.

As I said earlier, we’re also investing ahead of demand in our business to be able to capitalize on the market recovery faster than we did last time. There’s one thing I was disappointed about the last growth cycle that became readily apparent in 2006 and 2007, is we weren’t ready. We were growing too slowly. The market demand was ahead of our execution capability. We spent the last four years focused on that, such that we’ll be able to grow in the up cycle, as I said, I believe faster than we grew last time.

With that, I’ll turn it over to Jeff, for a more detailed review of the quarter. Jeff?

Jeff Glajch

Thank you, Jim, and good morning, everyone. As Jim mentioned, we had a strong finish to fiscal 2011. Sales in the fourth quarter were $25.9 million, up $13.8 million or 88% compared with Q4 fiscal 2010. Organic growth was up 51% with the remaining $5.1 million coming from the Energy Steel acquisition.

Q4 sales were also $6.7 million sequentially up from Q3. Approximately one-third of that gain was organic and the rest was the increase of Energy Steel. Sales in the fourth quarter were 52% domestic and 48% international. While Graham’s historical markets continue to be tilted toward the international arena, Energy Steel is almost exclusively domestic. Organically, sales were 60% international in Q4.

Full-year sales were $74.2 million, organic sales were up 10% to 68.4 million with the remaining $5.8 million coming from Energy Steel. For the full year, 55% of sales were international, which is equivalent to fiscal 2010.

Q4 net income was $2.7 million or $0.27 a share, up from $600,000 or $0.06 a share in Q4 last year. For the full-year, net income was $5.9 million or $0.59 a share, and $6.4 million or $0.64 a share when excluding the acquisition transaction cost. The $6.4 million level was equal to fiscal 2010.

As Jim mentioned, we are pleased that in the three and a half month since Graham purchased Energy Steel, Energy Steel has performed above our expectation. Energy Steel has been accretive in fiscal 2011 earnings, even when including the $0.05 per share of transaction cost.

On to the next slide, orders in the fourth quarter were $26.8 million, up from $18.3 million in the fourth quarter last year and up sequentially from $17.8 million in the third quarter. Included in the Q4 orders were $5.3 million from Energy Steel.

Full-year orders were $63.2 million, down from the record 108.3 million in fiscal 2010. As Jim mentioned, fiscal 2011 was a tail of two halves for orders. Orders in the first half of the year were 18.6 million, where in the second half they were more than doubled at 44.6 million.

Backlog at the end of March 2011 was $91.1 million, up slightly from 90.5 million at the end of December. One note is we have no orders on hold by our customers. The last order, which was on hold, which was for just over $1 million, was reinitiated by the customer in April.

Gross margin in the fourth quarter was 30.5%, down slightly from 31.1% in Q4 last year, but up from 24.7% in the third – sequential third quarter.

SG&A was 15% of sales, down from 22.5% in last year’s fourth quarter and down slightly from 15.2% in Q3. Operating margin in the fourth quarter was 15.4%, up from 8.6% in last year’s fourth quarter and 9.5% sequentially.

Full-year gross profit was 29.4%, down from 35.7% last year as we converted orders received during the very competitive pricing at the bottom of our market 9 to 12 months ago.

As Jim mentioned, we expect 29 to 32% gross margins in fiscal ’12. In addition, we continue to expect at the peak of the next business cycle that margins will increase to the mid to upper 30s.

SG&A was 16.7% in fiscal 2011 when excluding the Energy Steel transaction cost; acquisition transaction cost. This was down from 19.4% in fiscal 2010. For fiscal 2012, we expect SG&A to be between 16.5 and $17.5 million as we have the full-year impact of Energy Steel into our cost space. Full-year operating margins were 12.7% excluding the acquisition transaction cost, down from 16.1% last year.

This next slide is a slide that was shown in the past. It shows the sales and EBITDA margin performance over the past couple of cycles. You can see the significant step up in EBITDA margins at both the top and the bottom of the recent cycle when compared with prior performance. We believe we’ve raised the bar on performance and expect to continue this higher level moving forward.

On to the last slide, our cash position continues strong with $43.1 million of cash and no debt. In fiscal 2011, cash was used to purchase Energy Steel as well as to lower our excess customer deposits, which we’ve talked about quite a bit over the past many quarters. Those deposits have come down, as they’ve been used to procure raw material for projects.

We believe with our balance sheet, and debt free, and with this $43 million of cash, we are well positioned to utilize the cash for future acquisition opportunities when they become available.

As Jim mentioned, we are very pleased with the acquisition of Energy Steel, its performance, the strength of its management team, and its nice culture fit into the Graham family. The smooth combination of Graham and Energy Steel is a testament to both organizations.

One additional comment on our cash position, at year end our customer deposits were still elevated above normal levels by about 4 to $6 million. However, on the asset side of the balance sheet we also had an offsetting increase in unbilled revenue, as projects which are in process now have yet to be shipped. We expect the unbilled revenue to convert to cash over the first half of fiscal 2012.

Finally, to reiterate Jim’s comments on fiscal 2012, we expect revenues to grow approximately 30 to 40% and to be between 95 and $105 million. Of this growth, it will be roughly equally split between organic growth and the full-year impact of Energy Steel. Energy Steel is expected to provide 16 to 20% of Graham’s overall revenue in fiscal 2012.

Gross margins are expected to be between 29 and 32%. The benefit seen from increased capacity utilization is partly dampened by increased personnel cost as we plan for further growth beyond fiscal 2012.

SG&A is expected to be 16.5 to $17.5 million as we incorporate Energy Steel for the full year as well as invest in personnel to grow moving forward.

[Inaudible] fiscal 2012 is expected to be between 33 and 35%. Also we expect to spend between 3 and $3.5 million in capital in fiscal 2012, which is above the $2 million we spent in fiscal 2011.

With that, I would like to thank you for your time today, and your interest in Graham. And would like to open the line for questions. Christine?

Question-and-Answer Session

Operator

Thank you. We will now be conducting a question-and-answer session. (Operator Instructions). Thank you. Our first question is from Rick Hoss with Roth Capital Partners. Please proceed with your question.

Rick Hoss - Roth Capital Partners

Hi, good morning.

Jim Lines

Good morning, Rick.

Rick Hoss - Roth Capital Partners

Good morning. As far as gross margin goes, and we’re only thinking about 2012, do you expect to see a – call it a 200-basis point split between first quarter and fourth quarter, or 100, or how do you think that progresses throughout the year as all the low margin business kind of works its way through and you start to improve – the improved bid work starts to show up in the P&L?

Jim Lines

One of the factors that I mentioned in the earlier remarks was how well loaded our first half of the year is. Part of our gross margin impact going into recovery is how much of our capacity we are utilizing and the absorption of those expenses. We have a great first half keyed up. Second half, we need the bookings in the first and second quarter to fill in our capacity for the second half.

I look at it as a general comment, and we’re going to win the orders to fill in the second half of the year, get up to 100% utilization and the same level of self-contracting we have in the first half – I would expect margins to be comparable.

Rick Hoss - Roth Capital Partners

Okay, so flattish throughout the four quarters then?

Jim Lines

Right.

Rick Hoss - Roth Capital Partners

Okay. And then, how much of that short-cycle business has continued into the first quarter?

Jim Lines

We had a very strong level in the fourth quarter, we thought, due to decisions by the customers to hold back on procurement. It does not seem to have carried with the same vigor into our first quarter.

Rick Hoss - Roth Capital Partners

Okay. And then, Jim, you talked about how when you look at the last cycle, that you’re disappointed in that you weren’t capturing everything and you felt that maybe you could of grown faster organically if you had the resources; sales reps and engineers, etcetera. Last – the last cycle that looks like you achieved about a 20 to 25% organic growth rate, do you think that has to achieve something similar in this next cycle, or even above that as you’re preparing to capture different business?

Jim Lines

There’s a potential for it to be at that level or a bit higher. What I didn’t like last time is the start of the recovery, we had needed growth because we couldn’t execute. And the market was turning more favorable and we weren’t able to do win the business because we knew we couldn’t execute it. So we had slow growth at the start. I don’t like turning business away. I don’t like giving it to the competition, and this time we’ve strategic decisions to bring personnel in ahead of the demand so we’re ready to grow as our markets do hit full stride into a recovery. We weren’t at that point last time.

Rick Hoss - Roth Capital Partners

Okay, and that explains the about 1 ½ million additional SG&A that you’re adding. If you annualize the fourth quarter you’re at a 15.6 million SG&A revenue rate, so you’re guiding to call it a 17 mid-point. That 1 ½ million would be purely setting yourself up in order to capture additional growth that you foresee as this next up cycle materializes?

Jim Lines

Yes, that’s right, with respect to, as an example, the Navy project. That’s a long-term investment and we need to have the personnel in our company way in advance of actually recognizing a revenue on the business we plan to win; say submarine work. But we’re bringing those resources in now because there’s some early activity that we’ll be involved in, but not commensurate with the expenses that we’re bringing in, but it’s to support growth a couple years out.

Rick Hoss - Roth Capital Partners

Okay. And then I guess probably it’s relevant to discuss the last peak gross margin was maybe a – as unrealistic, above the – or 40%-plus would probably be in the rare range, right, in thinking about setting expectations for this cycle? You peak out at upper 30s, does that seem reasonable?

Jim Lines

That’s been our comment in that regard. We felt the next peak for modeling purposes, mid-to-upper 30s. Is it inconceivable that we push beyond that and get into the 40s? I don’t think so. It depends really on market conditions and if it gets as white hot as the last cycle. But we’re not modeling our business around that happening again.

Rick Hoss - Roth Capital Partners

But your share of domestic versus international business also contributed to the higher margin as well, right? And thinking about the next cycle, it’s probably led by international markets?

Jim Lines

When you think about the refining of Petrochem space, now with Energy Steel, that’s largely North America, they provide a similar margin potential to our North American refining work. We also are expecting our Oil Sands to be a nice component in our growth two to three years out. That has a similar margin potential to typical North American work like we had enjoyed in 2007 and 2008, 2009. So I see our sales mix, as we said earlier, being around 50/50 now with the addition of Energy Steel domestic-international. And Energy Steel brings in nice margin work.

Rick Hoss - Roth Capital Partners

Okay. Thanks, guys.

Jim Lines

You’re welcome.

Operator

Our next question comes from Joe Mondillo with Sidoti and Company. Please proceed with your question.

Joe Mondillo – Sidoti & Co.

Good morning, guys.

Jim Lines

Hi, Joe.

Joe Mondillo – Sidoti & Co.

First question, just going back to the gross margin. I was wondering if you could comment on what Energy Steel’s gross margin looks like and how that’s affecting the guidance that you put out there for the gross margin?

Jeff Glajch

Joe, this is Jeff. The margins at Energy Steel are comparable to Grahams.

Joe Mondillo – Sidoti & Co.

So it’s primarily just the improvement on the volume and pricing?

Jeff Glajch

Right.

Joe Mondillo – Sidoti & Co.

Okay. What is the pricing look like in the orders that you’re bringing in today? Are you seeing, you know, on a quarter-to-quarter basis are you seeing a nice improvement there or where are we in terms of the cycle in terms of pricing?

Jim Lines

Joe, we’re in the very early stages of recovery and it can be spotty. There’s going to be some very nice wins and there’s going to be some rough wins. We’ll defend our market position, we’ll make a strategic decision to win that particular order to keep a competitor out of our space. But in general, the early stage of recovery is tough to comment on margins because it can be quite varied. But in general, we feel more positive about it than I felt 12 months ago.

Joe Mondillo – Sidoti & Co.

Okay. Looking at the Energy Steel business, how much of that backlog is related to construction?

Jim Lines

Related to new construction, as an umbrella comment, none.

Joe Mondillo – Sidoti & Co.

Okay. So you’re outlook is based on existing plants and the outlook still looks pretty positive going forward. Does that – does the 18 to 20 million of sales that they generated over the last 12 months or so, did they see any new construction benefits?

Jim Lines

No. Not in their sales.

Joe Mondillo – Sidoti & Co.

Okay. And then in terms of the SG&A guidance, how much of that guidance is related to the Energy Steel?

Jim Lines

If you look at the increase in year over year from roughly – the majority of it is Energy Steel because we only had Energy Steel in for just over one quarter of the year. So the majority of the increase is Energy Steel, probably about 2/3s-1/3, Energy Steel versus additional resources.

Joe Mondillo – Sidoti & Co.

Okay. And then just to – I know I’m all over the place, but the U.S. Navy shipments, how do you sort of expect those to hit the P&L throughout the 2012-13 period? Is it going to be more weighted in 2012 or sort of end of 2012, beginning of 2013? How does that sort of look?

Jim Lines

Sure. The contract that we have, the order that was won back in December of ’09, over $25 million, that has a revenue recognition cycle of roughly three years. We had a piece of it in fiscal 2011. The majority lands in ’12 and ’13, fairly equally across both those years, and a similar piece in fiscal 2014 through the fourth quarter piece we saw this past year.

Joe Mondillo – Sidoti & Co.

Okay, and you sort of mentioned that business being strong, and you mentioned ’14-’15, meaning, the way I took it was that you’re expecting to possibly continue business with them and continue to see more orders in the future. Is that correct? And are we looking at more orders like the one that you saw last year? You know, could you just comment a little more color on that?

Jim Lines

The Navy work, the order we won and the one I just made remarks about, that’s for an aircraft carrier. There’s additional work to win for that particular aircraft carrier. We hope to be bidding that work over the next six months, hopefully will win the order between six and nine months after now. Revenue would be out in ’14 – I’m sorry, ’13 and ’14. The longer-term remarks that I was making refer really to submarine work, adding to our capabilities of providing not just to the carrier fleet our equipment, but also to additional vessels.

Right now, we’re winning initial concept engineering work from the shipyards for the next generation of submarines, the Ohio-Class submarine. Ultimately, that would lead, we hope, to procurement of equipment. But that, we believe, is out in the fiscal years that I said earlier, ’14 or ’15 before those sizable orders would be.

Joe Mondillo – Sidoti & Co.

Okay.

Jim Lines

So a mixture of vessels, a mixture of timing. Longer term, projecting out five years, we expect to have a more steady flow of Navel work for submarines and carriers that’s more uniform. But now the early stages of this strategy is going to have periods of time between winning significant orders. But we’re laying some very important ground work on getting our business in position to win additional work. And I'm very encouraged by what I see, by the interaction our team is having with the shipyards and with the Navy.

Joe Mondillo – Sidoti & Co.

Okay. And then last question I just have is, I was wondering if you could comment on sort of the competitive landscape, the competitive placing out there within the three or four sort of markets that you serve?

Jim Lines

Sure. As I mentioned earlier, for the large projects, at this early stage of recovery in Refining and Petrochem, there’s going to be some very good work that we’ll win and we have won, for example, in the last quarter. But because the order flow is rather spotty, I would say, versus 2008 and 2007 when there was a heck of a lot of order activity, the margins can be rougher, certainly in the international markets for Refining or Petrochem; again, because of frequency of orders is more spotty. And the Power Generation market, Renewable Energy, that tends to have a lower margin potential than refining and Petrochem, but they’re easy – they’re less transaction costs, easier orders to process through our business.

So there’s a little bit different margins, different types of execution model with that work. And for Energy Steel, we haven’t seen a great deal of variability in their margins. It’s fairly consistent.

Joe Mondillo – Sidoti & Co.

Okay. And then – so the chemical business is the reason why that’s been sort of light even up until this quarter, are the sales to the chemical markets? Is that just due to low activity or not being able to win orders?

Jim Lines

My view is it’s the low level of activity, you know, the population of opportunity is still relatively small at this point in time. So all of us can’t be aggressively going after those and that tends to have an effect on margin.

Joe Mondillo – Sidoti & Co.

Okay. All right, thank you very much.

Jim Lines

Thanks, Joe.

Operator

Our next question comes from Dick Ryan with Dougherty and Company. Please proceed with your question.

Dick Ryan - Dougherty & Company

Hi. Good morning, guys.

Jim Lines

Hi, Dick.

Jeff Glajch

Good morning, Dick.

Dick Ryan - Dougherty & Company

Say, Jim, the initial work you’re involved with on the submarine side, is that being won on a bid basis, or – I didn’t know if you were done with the certification process yet either.

Jim Lines

It is bid. We have competition. But this early type of engineering work for the next generation of sub that we’re working on, it’s not uncommon that multiple companies, Graham plus others, will bid on the concept designs for our types of products. So that’s how the early work does. And as you move to the more progressive and detailed engineering work, the suppliers get narrowed and then one, in the end, builds the prototype, the first production unit.

Dick Ryan - Dougherty & Company

Okay. And on the certification, is that complete yet?

Jim Lines

With regard to having security clearance and going through the process, we’re at a point now where we can actually expand the avenue – our avenues into the Navy for the work that we work on, we can bid on, sorry. So we have some clearances that allow us to gain access to information we didn’t have before.

Dick Ryan - Dougherty & Company

Okay, good. You know, you’ve got a very good batting average with the Refinery business over in china. Are you seeing any opportunities to kind of get a toe hold or perhaps better than that with the chemical side of the business in China and India?

Jim Lines

With regard to China, I’ll go there first. We have hired a sales manager in our

Suzhou office, focused on expanding our opportunities in the Petrochem area. A focus point that he has right now, we’re seeing some very strong opportunities coming from here, is coal to chemicals, the Petrochemical arena and positioning our company like we did in the refining space to become a preferred supplier to that industry. So the missionary work is being done now, but we are seeing a lot of activity coming up for that particular segment of the Petrochem market.

And we’re also expanding toward the fertilizer market as well, which we’ve always had a strong brand there, but we didn’t pay enough attention, I think, in trying not to maximize our opportunities there. So we’re moving outside of refining, still sticking focused on refining but adding coal to chemicals and Petrochemical along with fertilizer into our areas of focus.

Dick Ryan - Dougherty & Company

Okay.

Jim Lines

And those are very strong growth areas in China.

Dick Ryan - Dougherty & Company

When you look at Energy Steel, you know, I think when you made the acquisition you talked about some international opportunities with your global footprint by you. Is it too early to start expecting you guys to be taking those services internationally?

Jim Lines

As a general remark, yes. We have a lot of upside potential here in North America with existing plants and with the couple that are planned to go through to construction. We want to execute extraordinary well on those opportunities and just capitalize on those. I would say tertiary would be the international side at this point in time.

Dick Ryan - Dougherty & Company

Okay. Is it too early for the Japanese situation to start impacting business yet? What’s kind of the commentary from the existing customers? What are you hearing there?

Jim Lines

The commentary with respect to the North American Utilities and what might occur is the new regulations that may come about as a result of what occurred in Japan tend to take about 12-18, maybe as long as 24 months to get pushed into the utility and then out to the supply chain. That was the timeframe after 9/11 before demand, or opportunities presented themselves because of what happened on 9/11. So we’re expecting over the next one-to-two years to see some pickup in North American Utility opportunities related to the Japan incident.

The Japan incident, as it relates to new construction though, I think that’s more right in front of us with regard to some plants have slowed down, some plants have moved to the side in terms of their planning process. Four that we are aware of and we believe are going ahead are the Vogel site and the Sumner site. That’s who we [inaudible] North America and those appear to be proceeding. But several others have indicated to us to expect a two-year delay, that order of magnitude as a result of what’s occurred in Japan.

We’ve also picked up internationally that there’s going to be some delay as well in new construction as they review the design specifications for these plans to ensure the safety and the controls are in place to avoid what happened in Japan from happening again.

Dick Ryan - Dougherty & Company

If you look at that market after 9/11, I mean, is there a way to kind of put your finger on what kind of the incremental spend occurred after 9/11 to kind of maybe draw parallel to what’s happened now? I mean, is there any figures out there that say normally it’s X, but with the 9/11 impact it was X plus Y?

Jim Lines

There may very well be. I don’t have those figures.

Dick Ryan - Dougherty & Company

Okay. Good, thanks, guys.

Jim Lines

You’re Welcome.

Operator

Our next question comes from Tim San Lucas with Rosetta Capital Markets. Please proceed with your question.

Tim San Lucas [Gabe] – Rosetta Capital Markets

Hi, guys. Thank you. It’s actually Gabe for Tim. Can you hear me?

Jim Lines

Yeah. Good morning, Gabe.

Tim San Lucas [Gabe] – Rosetta Capital Markets

Thank you. We just had a few questions for you. Could you please remind us of the percentage of backlog that you expect to recognize over the next 12 months?

Jim Lines

We expect 80 to 85% to convert over the next 12 months.

Tim San Lucas [Gabe] – Rosetta Capital Markets

Excellent. Can you also remind us on the increase for CapEx, or actually just comment on the entire piece that you’re raising for this next year. Can you break it down in buckets for us; how much is going to Energy Steel, how much is considered maintenance CapEx and how much is considered growth CapEx?

Tim Lines

The majority of the CapEx is for the Batavia operation at this point in time. And the majority of that is for productivity and capacity expansion. There will be a component for maintenance, of course, but our investments have been targeted in expanding our capacity and getting productivity through new equipment investments.

Tim San Lucas [Gabe] – Rosetta Capital Markets

Okay. So should we think about this as sort of the surge in the next 12 months, and then back down to your sort of long-term trend after that?

Jim Lines

I think that’s a fair way to consider it right now. We felt our capital plan, as a more normalized spend would be in the range of 1.5 to $2 million with the addition of Energy Steel. Before it was 1 to 1.5 million. We have points in time, say for the Navy project as an example, where we need to invest more to fully capitalize on those opportunities. But thinking of it as a more normalized level, I think in terms of 1.5 to 2 million but there could be surges or spikes where we invest more.

Tim San Lucas [Gabe] – Rosetta Capital Markets

And then could you comment if there’s some opportunity on your tax rate going forward with as much business as you have coming from overseas?

Jim Lines

Sure, Gabe. At this point we would not expect a significant change there. But that’s obviously something we would continue to pay attention to. But I would not expect that that will change dramatically in the near term.

Tim San Lucas [Gabe] – Rosetta Capital Markets

Excellent. And our final question, can you just remind us the dividend strategy for the company?

Jim Lines

Yeah, dividend, as you probably know, we pay an annual dividend of $0.08 a share and reality is, you can look at our cash position, we believe the best use of our cash is for future growth via acquisition as we did with Energy Steel. We do it a pace as noted and we also have a stock buyback program in place right now through the end of July. It’s been in place for about the last two-plus years. But if I had to characterize our cash usage expectation, acquisitions would be probably first, second, third on the list and the others would be quite a bit behind it.

Tim San Lucas [Gabe] – Rosetta Capital Markets

Okay. Okay, guys, great. Great job. We appreciate it.

Jim Lines

Thanks, Gabe.

Tim San Lucas [Gabe] – Rosetta Capital Markets

Thank you.

Operator

Our next question is from George Walsh with Gilford Securities. Please proceed with your question.

George Walsh – Gilford Securities

Jim, could you expand again a little bit on the idea that you want to be ahead of demand versus the previous cycle in ’06, ’07. Just from pulling together the comment, is it a matter of, you know, increasing your staffing versus how you were previously plus these CAP expenditures that you’re doing in terms of production capacity?

Jim Lines

Exactly. It’s increasing our personnel to be able to execute a higher level of orders and we didn’t grow very well initially at the start of the recovery in 2005 to ’06, 2006 to ’07. Then we again hit full stride in ’08 and ’09. That was disappointing. We don’t want to do that again. It’s more of an infrastructure build around personnel and focusing on productivity and IT solutions to allow us to execute at a higher level.

George Walsh – Gilford Securities

And is that engineer hires or in other areas?

Jim Lines

It’s engineering, it’s drafting, there’ll be some quality, there’ll be hires in manufacturing and in production.

George Walsh – Gilford Securities

But pretty much across the board expect administrative.

Jim Lines

Yes.

George Walsh – Gilford Securities

Okay. As far as the Oil Sands is concerned, does the pace of activity pick up as the price of oil moves up? Is that something that there’s a correlation there for you?

Jim Lines

I would say there is, certainly. As – well, as oil price dropped, they began to pull back very significantly on investments and that was around 2007 or ’08. We had heard that they were going to go into about a three-year pause and that’s pretty much what they’ve done, and we’re seeing the early signs of new upgrading investments. We’re aware of two that are planned to go ahead right now. And these are very large opportunities for us. We don’t expect to win that business until the latter part of ’12. So it’s revenue in ’13.

But where investment is going on now in the Oil Sands is on the extraction side, developing the field to extract the oil sands that ultimately goes to an upgrader. We hadn’t really planned on the extraction side historically and we did recently win a very nice order on the extraction side, a couple million dollars, so we are developing strategies to try to be a more consistent provider of products on the extraction side of the Oil Sands business.

George Walsh – Gilford Securities

Okay. Is there a price of oil where it just seems to be that’s the level where it’s more economical or is that – does that become something of a moving target?

Jim Lines

I think it becomes somewhat of a moving target tied to the cost of materials. When I say materials; carbon steel, nickel-based alloys, copper-based alloys. But the general comment, what we’re hearing from the Oil Sands developers is a price point in the 75 to $85 a barrel range within today’s cost basis is about right.

George Walsh – Gilford Securities

Okay. Also, on the M&A front, could you just, as much as you can, just describe what’s in the pipeline and how you, you know, what’s there and what are you looking at in terms of deals? And also, in terms of doing the deals, are they looking more like all cash, or maybe cash and getting stock in there too?

Jim Lines

Sure.

Jeff Glajch

George, this is Jeff. You know, we’ve continued to keep the pipeline, looking at the pipeline even subsequent to acquiring Energy Steel. But to be honest with you, we’ve a little more focused on the integration and a little less focused on the acquisition process in the short term. But there’s certainly opportunities out there. As we saw with Energy Steel, there’s a pretty significant timeframe from when you identify the right opportunity too when you open and reclose a deal. So you know, we’re expecting, when we find the right opportunity, that there’ll be that same type of a timeframe.

With regard to funding, our preference would be to fund it with cash. You know, certainly there would be a scenario if a seller had an interest in some stock, we might be willing to utilize some stock. But our intent really is to use cash because we do not want to dilute our existing shareholder base.

George Walsh – Gilford Securities

Can you just, in a general way of speaking, industrial or market areas you’re thinking about in terms of acquisition?

Jim Lines

Sure. I think our strategy is where it’s been for the last couple of years looking at it in that geographically we'd certainly consider domestic and North American opportunities, but we’re also looking over, you know, to be closer to our customers, whether that’s in Asia or the Middle East, or in South America. So there is some interest, we’re interested in looking at both arenas.

And then, we’ve got a couple of just different alternatives there. One is to look at our existing business space and expand that and get a bigger share of our existing customer base. And then, you know, additionally we’re looking at opportunities to expand our market presence such as in Energy Steel where we moved into a market where we weren’t playing before.

It’s a pretty open strategy. We want to make sure and find the right opportunity. There’s good opportunities, we believe, in each of those areas and at the end of the day it comes down to having a willing buyer, which of course we are, and willing seller. So we’re not – we’re not necessarily tied to one specific strategy but rather there’s opportunities across multiple arenas.

George Walsh – Gilford Securities

Okay, and size?

Jim Lines

We’ve consistently said that between 20 and $60 million worth of revenue would be our target. Energy Steel was right at the lower end of that, near the lower end of that. That being said, we will look outside that range. We have and will continue to look above or below that range. Again, it’s really a function of the right opportunity. I think we’re very happy that we ended up going at the lower end with the first acquisition of Energy Steel. You know, to get ourselves, and quite frankly, to build some credibility that we would be able to execute well on an acquisition and we believe we’ve certainly done that. We’re certainly a little more willing to step to a higher level going forward. But that’s no guarantee it’s – it’s really function of what the right opportunity is. It could be 20 million, it could be 60 million, or it could be even outside that range.

George Walsh – Gilford Securities

Okay. All right, thank you very much, gentlemen.

Jim Lines

Thanks, George.

Operator

Our next question is from John Struges with Oppenheimer. Please proceed with your question.

John Sturges – Oppenheimer

Congratulations, gentlemen. Nice job.

Jim Lines

Thanks, John.

John Sturges – Oppenheimer

I’m just curious, all the other questions have been pretty well answered. You’ve had a great series of questions asked. On Batavia, is the capacity expectation or vision here to be about 125 million? I think you mentioned that at one point, without having to push out or up or whatever?

Jim Lines

Without having to expand our roofline, I feel it’s in that 120 to 140 range.

John Sturges – Oppenheimer

Okay. And when do you think you might be at that level of capacity because the changes you’re making, you know, they are proceeding, but I’m curious when you think you might have that capability?

Jim Lines

Just to give you – I’m going to answer this a little differently. When we were exiting fiscal 2009, when we did 101, we were teed up to execute 120 to 125. Then the markets turned down on us. So as our markets recover, we know we can execute at that level. The business can execute under the roofline. And actually, we’re further ahead today with our investments, and productivity, and lead time reduction, and just gaining capacity through the roofline.

It really depends, John, on recovery and the pace of how the markets come back. I just wanted to strike a comparison to where we were at the last peak. We weren’t done, the facility wasn’t exhausted yet, we had more gas in the tank to expand our capacity and we were ready, but the markets turned down. So I would think that that’s a couple years out, tied more to market.

John Sturges – Oppenheimer

Right, of course. How about Energy Steel, you picked up 18 million of revenue, it’s probably what, running around at the moment, 20?

Jim Lines

The Energy Steel’s capacity, I think they have a lot of runway through their facility. They thought well about their investment to – the facility is only four years old. I think the management team thought long-term about the investment and they put a facility in place that I feel is running below half capacity.

John Sturges – Oppenheimer

So lots of room there, basically.

Jim Lines

I believe so. Yes.

John Sturges – Oppenheimer

And of course, the last item is – I told you I would ask you this question. Stuff sitting on the side that hasn’t been billed yet, I assume that’s what you call your increase in on-build revenue?

Jim Lines

John, that’s actually things that we’re in the process of building and it’s just a matter of if they haven’t shipped or if there’s a certain stage in the process. We haven’t billed to the customer. So those are projects that are in process and the percent completion is ahead of the billing in this particular case.

John Sturges – Oppenheimer

Okay, in that case.

Jim Lines

I think, if you look back a couple of years to see the exact same kind of spike to years ago where we went from 4 to $5 million up to 10 million and then dropped right back down.

John Sturges – Oppenheimer

Right. Is there anything on – I’m just curious, is there anything on siding outside just by somebody getting the right shipper that could have been in the quarter that wasn’t in the quarter? I’m just curious what the variation would be in the quarter had that occurred?

Jim Lines

No. I don’t see no significance, John.

John Sturges – Oppenheimer

Okay. Good enough. I’m all set. Thank you.

Jim Lines

Thank you.

Operator

Mr. Lines, there are no further questions at this time. I would now like to turn the floor back to you for closing comments.

Jim Lines

Thank you, Christine. And thank you, everyone, this morning, for your time and your questions. I hope we explained well Graham’s performance through fiscal ’11 and how we’re positioned to perform in fiscal 12 and beyond. I’m very pleased with the way our company performed through the downturn and as we exited the downturn the second half of fiscal 2011. And more importantly, I’m really pleased with the actions that we took as a company, that, Energy Steel, focus on the Navy products, to build capacity inside our business, to be able to expand more quickly as our markets recover. [Inaudible] in mind, we’re bringing those investments in ahead of demand and I believe they are the right things for us to do such that in ’13, ’14 and ’15 we’re expanding more quickly than we did in 2005, ’06 and ’07.

Thank you for your time, we look forward to updating you again in July. Good bye.

Operator

Ladies and gentlemen, this does conclude today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Graham CEO Discusses F4Q 2011 Results - Earnings Call Transcript
This Transcript
All Transcripts