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Executives

Deborah Pawlowski – Investor Relations

Jim Lines – President and CEO

Jeff Glajch – Chief Financial Officer

Analysts

Gabe Birdsall – Brasada Capital Management

Mark Tobin from – Capital Partners

Joe Mondillo – Sidoti & Company

George Walsh – Gilford Securities

Graham Corporation (GHM) F3Q12 Earnings Call January 27, 2012 11:00 AM ET

Operator

Greetings. And welcome to the Graham Corporation Third Quarter Fiscal Year 2012 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, Deborah Pawlowski, Investor Relations for Graham Corporation. Thank you, Ms. Pawlowski. You may now begin.

Deborah Pawlowski

Thank you, [Shea], and good morning, everyone. We appreciate your time here today with the Graham Corporation’s third quarter fiscal year 2012 conference call. On the call, I have with me Jim Lines, President and CEO; and Jeff Glajch, Chief Financial Officer. Jim and Jeff will be reviewing the results of the quarter and also provide a review of the company’s strategic -- strategy and outlook.

Many of you -- you should have the website -- on the website there are slides that accompany the conversation today. If you don’t have them you can find them on the company’s website at graham-mfg.com.

As you may be 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?

Jim Lines

Thank you, Debbie. Good morning, everyone. And we appreciate your time today. Please turn your attention to slide four. I feel we had a solid quarter with revenue expanding year-on-year 27% to $24.3 million. Organic sales are up 13%, Energy Steel represented 14% of total sales.

An indicator to the market direction for us, one of them is our organic short cycle sales and we’ve seen that segment of our business improving year-on-year, it’s up 25% in revenue, while a lot of this is providing expanded margin due to price strategies we implemented earlier in the year.

The power market in whole that expanded about $2 million year-on-year. Petrochemical market, we’re continuing to see good activity there, primarily on the order intake side. Sales to the refining market were flat in the quarter. Our geographic sales mix was 57% domestic, 43% international.

Please turn to the slide five. Margin was in line with expectation for the third quarter. Gross margin came in at 27% and a 13% EBITDA margin. Organic production volume, as measured in total labor hours, was up 15%.

Tier 2, we believe this is an indication that our markets are improving, as one of our leading indicators to the direction are markets are moving in. We’re also nearing the end of producing a couple of large Middle Eastern refining projects and that did have an effect on sequential gross margin.

Please turn to slide six. Our strategy to diversify has had a positive impact. Our second quarter was a clear indication of what this can mean. As our traditional refining and petrochemical markets gain momentum, coupled with growth from power generation markets along with our work for the U.S. Navy. We anticipate stronger growth this coming expansion cycle than we enjoyed the last cycle. We also feel going forward our geographic sales mix will be roughly 50/50 domestic and international.

Slide seven. We do have a solid pipeline of good quality opportunities. Order growth was 23% year-on-year driven primarily by our strategy to be in the power market, principally Energy Steel win or new construction in the U.S., nuclear energy facilities. New orders in the quarter were $21.9 million. Energy Steel provided just under $10 million.

For the organic business order rate was down 28% to $12 million. As I look at that, while that was disappointing, we do believe that’s partly due to timing. Several orders that we’re expecting to close during the quarter for Asian applications moved out of the quarter.

To be candid, we actually thought a few of those orders would close in the second quarter, but as we’ve communicated on several calls, it’s been difficult to predict when orders will close. We do expect these orders to finally close in the fourth quarter.

Also in the quarter we did face stiff competition from South Korean competitors that took a few orders from us, to be direct there were price levels that that were unsatisfactory for us and coming out of a downturn into recovery, it’s not a time to be anxious and make decisions to take business off to street to low the business with inferior profitable orders. So we work smart in our decisions I feel. It’s tough to moves these orders at this point in time but I do feel they are the right decisions that we made at this point in the recovery.

Power market, that continues to be strong, the order level from the power market was just under $11 million. We had a terrific win for AP1000 new nuclear energy facilities being built in the U.S. Chem and Petrochem markets provided just under $5 million in new orders.

Oil refining was down year-on-year, Q2 I do feel that’s timing, several of the orders that pushed out of this recent quarter into the fourth quarter that we hope to close in the fourth quarter are for the refining sector.

Our outlook is very strong. We see our pipeline continuing to expand with opportunities. It’s a fairly diverse pipeline going across refining, petrochem, power gen, within power gen, nuclear, renewable energy, such as biomass energy, geothermal, all areas where we’ve a very strong brand.

Well, near-term order levels may vary. Our conviction to the long-term remains very strong.

On slide eight. Just to provide some color on our key markets. For oil refining and petrochemical markets, we believe we’re in the early stages of the next wave of investment to expand capacity. I’ve said on prior calls that, it feels to us, it feels to be sales management that we are at point where we were in 2003 and 2004 today, the early stages of the next wave of substantial investment in this particular segment of our business.

In Asia, we are seeing a lot of activity for new refining capacity, petrochemical capacity and fertilizer additions throughout the region.

In Middle East, we are wrapping up a few large projects for Saudi Arabia. There were others in the pipeline of similar magnitude in particular Ras Tanura Jazan refining projects both 400,000 barrel per day projects, like the ones we won a few years back. Also throughout the rest of the Middle East, Kuwait, Qatar, UAE, a lot of activity is starting percolate. We are feeling very good about that.

In North America, we are seeing oil sands activity, our new extraction capacity, as well as upgrading capacity, both aspects of oil sands drives demand for our products.

In the U.S. refining space, we’re seeing investments being made, we’ve won a few orders. This last quarter, for smaller refinery re-ramps to expand capacity and to enable the refiner to diversify its feedstock.

Also with the shale gas activity and the current price of natural gas, we’re seeing investments being planned in the U.S. for new petrochemical capacity, revamping idle capacity, investment and fertilizer capacity.

Something we haven’t seen in about a decade and that’s very exciting for us, because those are types of projects that we have a high probability of winning as right in our wheelhouse and those projects cover all of our products, our vacuum systems, our condensers, our heat transfer products. So we’re feeling very encouraged about the direction of the U.S. petrochem market.

Also, in South America, we’re aware of very large multi-year investment plans in Columbia, Brazil, Venezuela, again areas where Graham has an extraordinarily strong brand.

In power generation, our strategy to move into the power gen market is on the mark, is delivering benefit to us very early. In the nuclear energy area, new-build, we won our first order for new-build activity in the U.S. Our teams identified opportunities in the new-build area outside of the U.S.

We’re also working with our team in Lapeer, Michigan to expand our addressable opportunities for the existing U.S. facilities. So that’s been a terrific acquisition. It’s integrated very well and we’re very excited about the topline growth that we see there over multiple year period.

Also in renewable energy, biomass energy is still active in North America and geothermal in Latin America, Southeast Asia and to a smaller extent in North America is still active.

The naval nuclear propulsion program that was another one of our diversification strategies during the downturn. The carrier program, the order that we have in-house that we won about two years back is progressive very well. There is additional work on that carrier that we will be bidding. Overtime, we hope to secure in the coming years.

Also with the submarine program, we’re continuing to make progress there to become a consistent supplier to the submarine program. That’s a long process. But is moving along very well. In other markets that we served, edible oils, general industrial, HVAC, that’s very active as well.

Another nice leading indicator that suggests the health of our markets are improving -- is improving as the aftermarket and the demand we’re seeing there has picked up quite a bit when we compare the first three quarters of fiscal ‘11 to the current three quarters of fiscal ‘12. Orders are up 33% as our margins in that segment and the aftermarket stands all of our markets refining, petrochem, edible oils and general industrials, so we’re seeing a nice lift there.

We are narrowing our guidance and outlook for fiscal 2012. Full year expectation for revenue is $105 million to $108 million. Energy Steel providing 16% to 20% of that total revenue. Organic growth rate 25% to 30%. Gross margin expectation for the full year is 32% to 33%. Full year SG&A about 15% of sales and the effective tax rate remains approximately 34%.

Slide 12, our priorities and challenges as we go forward. We viewed fiscal ‘12 and as we move into fiscal ‘13 as positioning years for the market recovery. We’ve taken directed action to prepare our business with a strong wave of work that are expecting to come in the coming quarters and in the coming years.

I don’t feel our business was fully prepared in our past to take advantage of a strong recovery cycle. We will be better prepared this time. We’re making investments in personnel and process improvement. Our capital is paying dividends and we will be ready to capture greater market share, and expand more rapidly in this coming cycle.

We also plan to advance our market share in oil refining and petrochemical -- and in petrochemical markets in Asia. We have a healthy share there but I believe there is more that we can do and there is more than we can capitalize on in that region. We also intend to maintain our strong brand and our strong market share throughout the Middle East and continue to dominate the North American markets.

We focus with our team at Energy Steel in Lapeer to exploit the synergies for Batavia and Lapeer’s capabilities, expand our addressable opportunities within the existing U.S. plans and also capitalize on new construction in the U.S and international markets, continue to develop our Naval Propulsion -- Naval Propulsion Program sales strategy and as I said, that’s moving along very well.

We are at a point where our balance sheets in very good shape. We have positive operating cash flow and we’re actively seeking additional acquisitions to diversify and expand our revenue growth and profitability.

We expect to be building backlog as we move into subsequent quarters. We do expect order rates to vary somewhat. But we’re quite convinced and we have a strong conviction that our very healthy pipeline will convert to orders in the coming quarters.

I’ll turn this over to Jeff now for greater detail on Q3. Jeff?

Jeff Glajch

Thank you, Jim, and good morning, everyone. As Jim mentioned, we had a good third quarter. Q3 sales were $24.3 million, up 27% from last year. Half of that growth was organic and half of that growth was Energy Steel and just to clarify we purchased Energy Steel late in the quarter -- third quarter of last year, so comparable results for last year have very limited amount of Energy Steel in them in the third quarter.

Sales in the quarter were 57% domestic and 43% international. When you compare that with last year, last year had 36% domestic sales and 64% international. If you look at Graham’s historical commercial markets, they do continue to be tilted toward the international arena, whereas as Energy Steel is almost exclusively domestic and the U.S. Navy related work of course is also 100% domestic. Therefore, looking forward we think a 50/50 mix is probably in the right range.

EBITDA margin is up slightly to 13%, compared with 12% last year, of that 12% and I will speak to this not only on the EBITDA but on other earnings related issues, that 12% backs out the acquisition-related costs that we encouraged in the third quarter of last year.

So the comparables will be slightly different then was reported, but we want it -- from an intellectual integrity standpoint we want to make sure you are looking at apples-and-apples, so, again, 13% versus 12% last year. Earnings per share were $1.6 million in the third quarter, up from $1.3 million or $0.13 a share last year.

For the first nine months of fiscal 2012 sales were $82.9 million, up from $48.3 million last year, organic growth was 44% or $20.9 million increase and Energy Steel contributed an increase of $13.8 million.

EBITDA in the first nine months for the year was $17 million or EBITDA margin of 21% and we do have the EBITDA reconciliation information in the backup slides. This is up from $6.4 million or 13% in the first nine months of last year.

Finally, net income in the first nine months of the fiscal year was $10.1 million or $1.01 per share, up from a $3.7 million or $0.37 a share.

On to the next slide, gross margin in the third quarter was 26.6%, up from 24.7% in the same quarter last year, but as expected down sequentially from 38.1% last year.

SG&A in the third quarter was $3.8 million, up from $2.9 million in last year’s third quarter. The increase came from both investments in our organic business, as well as the addition of Energy Steel.

Operating margin was 10.9% in the third quarter, up from 9.5% in last year’s third quarter.

If we move to slide 16, you see our cash position remained strong at $44.5 million, up slightly from $43.1 million at the end of the -- last fiscal year. What I think is important is look at the last quarter. As we talked about on the last call, we had the cash usage in the first half of fiscal 2012, primarily related to timing of some projects, as well as obviously outgoing spending around capital.

We turned that around and then some in this last quarter, and our cash position increased to nearly $7 million in the third quarter. We expect going forward to continue to generate cash. We believe we are well positioned to utilize this cash and if necessary our untapped line of credit for future acquisition activities, as well as internal growth opportunities.

On the acquisition side, we’ll be quite happy to find another company of the caliber of Energy Steel. As Jim mentioned, we continue to be pleased with Energy Steel, the expansion of their addressable market opportunities, the financial performance, the strength of the management team and its nice fit within Graham. In addition to the team that’s in place, we have been enhancing the management team with new additions to prepare for future growth.

On the slide 17. Backlog at the end of December was $72.6 million, down from $75.1 million at the end of September and $91.1 million at the end of March. We haven’t quite seen the book-to-bill ratio make it to 1.0, but we’re at 0.9 in the quarter so we’re getting closer and as Jim mentioned, we do expect to see that moving above 1 sometime in the next few quarters.

Slide 18. Orders in the second quarter were $21.9 million, up from $17.8 million in the third quarter last year. In the first nine months of fiscal 2012 orders were $64.4 million, up from $38.4 million in the first three quarters last year and actually slightly above the total for the full 12 months of fiscal 2011, which was $63.2 million.

In the quarter, strong order levels from Energy Steel of $9.7 million offset slightly lower -- offset lower order level from our traditional business -- traditional markets.

Finally on slide 19, just to reiterate Jim’s comment for the full fiscal year. We expect revenue to be between $105 million and $108 million, growth rate of over 40%, of this increase, organic growth is expected to be 25% to 30% with the full year impact of Energy Steel adding the rest.

Gross margins for the full year are expected between 32% and 33%. SG&A expected to be approximately 15% of sales and the tax rate approximately 34%. We also expect for the full year to spend between $3 million and $3.5 million in capital, and we spend a large portion of that in the first three quarters.

I’d like to thank you for your time and interest in Graham today, and open the line for questions. Thank you.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from Tien San Lucas from Brasada Capital Management.

Gabe Birdsall – Brasada Capital Management

Hi. It’s actually Gabe for Tien. How are you?

Jim Lines

Pretty well. How are you?

Gabe Birdsall – Brasada Capital Management

Real good. Thank you for your time. Just a few questions. Can you help us understand the size of the orders that were pushed out this quarter?

Jim Lines

Sure. That was between $5 million and $10 million, and that was across three or four projects.

Gabe Birdsall – Brasada Capital Management

Excellent. Thank you. Another question I had is regarding the cash, is the 100% of that available or is any of that include advanced payments from customers?

Jeff Glajch

No. 100% of that is available. The advanced payments which had spiked about two years ago have been consistently coming down now at a more normalized level.

Gabe Birdsall – Brasada Capital Management

Excellent. And is there anything that’s particular in the third quarter that’s seasonal from a cost standpoint, can you remind us there?

Jim Lines

No. Nothing in particular, no.

Gabe Birdsall – Brasada Capital Management

Okay. And then last question on the backlog. Can you just remind us on slide 17, you have the Navy project that was booked in 2009? You expect 50% of that to be remaining and set right at the end of fiscal ‘12, the size of the original Navy contract?

Jim Lines

Well, at the end of fiscal ‘12, there will be normally two-thirds of that project left.

Jeff Glajch

And the original size was greater than $25 million.

Gabe Birdsall – Brasada Capital Management

Excellent. Any comments for us, as we look out to fiscal ‘13?

Jim Lines

I think the important takeaway that that I would like to share, as I said in the earlier remarks is, the earlier stages of recovery, it’s difficult to predict the timing of orders. But what we can state with strong conviction is, our pipeline is extraordinarily strong and it’s more diverse than it was the last cycle. So we’re very encouraged by that.

And as we also look at some fundamental leading indicators of what actually has transpired over the last 12 months, we’re seeing order development improve for our larger orders. It’s up about 18% trailing 12 months versus the prior trailing 12 months. Particularly, importantly and indicative of the environment is the gross margin is superior in the trailing 12 months to the prior trailing 12 months. So we are seeing order development improve as, as is margin, so that’s a sign that things are getting better.

Also on the short cycle order slide, trailing 12 months we’re seeing that up about 13% to 15% and as well having margin expansion. So those are clear signs that we think the worst is behind us and the markets are just slow in their recovery, but our bidding activity is not slow. Growth of bidding activity is slow in 2003 and 2004 when we saw the wave in growth coming. And so we’re really excited and if I were to pass on a comment from our sales management side, its get ready.

Gabe Birdsall – Brasada Capital Management

We appreciate that color. And then I have one more question I could just throw it in there please. Your comments on the petrochemical cycle, you said you haven’t seen any projects like this in over a decade. So safe to assume this would be new, this cycle relative to your last one.

Jeff Glajch

The comments, the context of that comment related to the USA. Globally, the market was in the early stages of recovery similar to the last recover. But what’s different this time and beneficial to us is we’re expecting to see a stronger investment in the U.S. this coming cycle than we saw the cycle, because of the present natural gas. And just anecdotally, we have secured a couple of orders now for investing in additional ethylene capacity for U.S. petrochem plants and there is a number of those that are under consideration.

So that’s very encouraging to us because the ethylene plant to us is the surrogate for the overall health of the petrochemical market and as we see investments being made there, primarily drive our surface condenser product line, but downstream at the ethylene plant would, ethylene is a feedstock to the rest of the petrochemical industry, that drives demand for all of our products, all of our traditional products, condensers, ejectors, docking systems, heat transfer products. So we’re very excited about what we’re seeing there and we just need to allow some time for that to play out but we have secured a few orders already.

Gabe Birdsall – Brasada Capital Management

Thank you very much for the color. Great job, guys. Thank you.

Jim Lines

Welcome, Gabe.

Jeff Glajch

Thanks, Gabe.

Operator

Thank you. Our next question comes from Mark Tobin from Roth Capital Partners.

Mark Tobin from – Capital Partners

Hi, Jim, Jeff. Thanks for taking my questions. First on SG&A, I assume the $500,000 in transaction cost was included in that -- in backing that out it ticked down quite a bit sequentially. And then your guidance assumes that it does, I guess climb back up in Q4. Can you give us a feel for what the dynamics I guess on that line?

Jeff Glajch

Sure. Mark, this is Jeff. First off, the backing out of the $500,000 was in the third quarter of last year. So that’s when we were giving.

Deborah Pawlowski

2011, fiscal 2011.

Jeff Glajch

Yeah. For fiscal 2011. So, if you look at the second quarter and the third quarter of this year, we did actually see the SG&A drop a little bit in the third quarter and that’s really just some timing nothing out of the ordinary.

And in the fourth quarter, if you look at our guidance, it would drop up a little bit and part of that is as we’re looking to add resources to prepare for the market expansion, that’s where we’re seeing some of those costs coming in the fourth quarter.

Mark Tobin from – Capital Partners

Okay. Understood. My mistake on that. And I guess you talked about the pipeline looking rosy. Can you give us some insight into on the productive as far as the things you’re doing from a production capacity standpoint to prepare yourselves for this rebound?

Jim Lines

Sure. That’s a great question. We took advantage of this downturn to continue to invest in our business. Our capital plan still is targeted on capacity and throughput improvement focusing on productivity. Ideally, our strategies remain to get more out of our roofline, not having go spend our roofline to fulfill our growth and growth objectives.

So, we’ve been having targeted investment in welding equipment, machining equipment to reduce lead time and improve throughput, and that’s been paying off, and that’s been an ongoing program for the last four or five years.

With respect to our contract execution, we’ve been focusing on process improvement, again, to get that lead time reduction and also to drive areas out of the process. That’s an ongoing activity but that’s paying off as well.

And the IT solutions to create scale and create capacity have provided some benefit as well. So we’ve been focusing on a number of fronts to help our employees be more successful and more productive in the work that they’re doing and that’s had a big impact on our business.

And if we think about our company, just to give a comparison, in 2004 and 2005 we are about a $40 million company, the organic piece, in 2009 organically we were a $100 million with the same roof line. And if I think of where we are today in our productive capacity, I would state that that’s more like $135 million to $150 million as we go into the next cycle.

So, I think we’ve done a lot to address productivity and capacity here at Graham. And then in addition to that, we’ve added diversity through focusing on the navy and our attention to the power sector with the addition of our team in Lapeer, it’s a great story.

Mark Tobin from – Capital Partners

That’s helpful. Thank you very much. I appreciate it.

Operator

Thank you. (Operator Instructions) Our next question comes from Joe Mondillo from Sidoti & Company.

Joe Mondillo – Sidoti & Company

Good morning, everyone.

Jeff Glajch

Good morning, Joe.

Jim Lines

Hi, Joe.

Joe Mondillo – Sidoti & Company

My first question, just sort of trying to get a better feel what’s going on. So, last four quarters have been sort of flattish on the sales and orders basis. But it seems like compared to three months ago that you guys are feeling a little more positive on the cycle on the business. So with orders and sales sort of flattish still sort of what are you seeing differently that makes you little more optimistic and I know you’ve said that the timing is tough, when does this sort of come into play in terms of heading the P&L or heading your business?

Jeff Glajch

Well. The leading indicator there, Joe, is going to be bookings, and quarterly order rates and backlog expansion. What we can only remark to you is qualitatively and quantitatively the size and diversity of our potential bookings pipeline continues to look very good to us. We feel this is simply a matter of timing.

What’s really important is the discipline that we have to exercise in order selection. What would be wrong is to become too anxious and too nervous to move too quickly to full backlog when we could fill it with backlogs that would undervalue our productive capacity. So, we’re making, I believe the right decisions on order selection and our margin appetite, while we give the bookings pipeline a chance to move forward to procurement.

We think as the next couple of quarters, I’m not calling it Q4, but it’s going to happen. We saw it happen in 2004, 2005. The longer the downturn is with underlying demand still expanding, which is happening. The wave of work will be that much higher. So we’re really excited and we’re making investments to-date before demand comes to be ready.

Joe Mondillo – Sidoti & Company

In terms of the actual projects on the world that you guys track and eventually hope to bid on or are bidding on right now, how is that sort of timing when you look at all these projects around the world over the last couple of quarters, are you seeing any significant increase in products?

Jeff Glajch

To a degree certainly and we’re also seeing which is more important we’re seeing the projects move through their ordinary sales stage from concept to feed, which is a more detailed engineering analysis from feed to EPC bid, and then from EPC bid to contractor award and former acquisitions to purchase. So we’re seeing things move directionally to the right to our procurement.

Those are notes that we want to see and that’s what we’re seeing happening. So while we’re seeing movement around the sales cycle which is great and we’re also seeing additional projects come into the pipeline which is also very important.

Joe Mondillo – Sidoti & Company

Okay. And then I guess more in particular, in terms of your oil refining business is actually down year-over-year with a little on to me I guess, if you could talk about that? And then also oil drilling in the U.S. is as strong as it’s been in 20 years in terms of drilling?

Do you foresee any opportunities there within the U.S. refining business or is it just there is oil reserves within the U.S. with such a small percentage of overall U.S. demand that you’re not going to see a huge significant upturn there?

Jim Lines

We’re anticipating to see a very nice upturn there. We’re not expecting it necessarily to be as strong as it was the last cycle. And we have to bear in mind there was a huge investment in North American refining capacity the last cycle which is coming on stream now. So the market is absorbing that, there is a little of bit excess capacity.

But bearing in mind that, new refining capacity whether it would be a retrofit or revamp or an expansion at an existing site those construction cycles are two or three years. So what they would start up today -- start working on today comes on stream in calendar ‘15.

So we are seeing that activity now with some of the independent refiners in the U.S., some of the large integrated refiners are looking at expansion projects and equally importantly we are seeing again workup in the oil sands that we haven’t seen in three years.

Joe Mondillo – Sidoti & Company

Okay. And then, last question in terms of pricing, what is your backlog in terms of the orders that you are receiving today. What does that margin look like compared to the margin that you are realizing on the P&L right now? Thank you.

Jeff Glajch

Consistent with the last call that we had in October, if we reflect it on Q1 and Q2 sales, sales converted -- backlog converted to the sales in those two quarters had superior margins on the average of the backlog. But we were winning new work that was also above the average margin of the backlog.

So we have Q3 and Q4 to contend with. But we are adding to our backlog business that’s on a superior margin to the average of the backlog. So we have to get through the trough. We have to deal with the backlog that was one, 12, 15 months ago.

But what we are doing to address that margin headwind, again we are focused on productivity, we are focused on error reduction. We have very aggressive strategies to control our costs and actually improve margin after the order and we’ve been realizing that margin improvement after the order through the steps that we have been taking.

So, I didn’t want to sound as though we are held hostage to the margin that we booked, we’re actually taking action to improve that and we’ve been realizing the benefit there. But to answer your question, what we’re winning new business on average is at a higher margin than we average of the backlog.

Joe Mondillo – Sidoti & Company

Okay. So in terms of the back log compared to, right now you realize 27% gross margin in this past quarter, I imagine that’s from bookings from a year ago. Is your backlog and the orders that you’re winning today much considerably higher than 300 basis points or more or higher than that.

Jeff Glajch

I’m not going to comment quantitatively I can say directionally its better.

Joe Mondillo – Sidoti & Company

Okay. All right. Thank you.

Jeff Glajch

You’re welcome.

Operator

Thank you. Our next question comes from George Walsh from Gilford Securities.

George Walsh – Gilford Securities

All right. Jim, is there any comments on the or any issues with the integration of Energy Steel or is that pretty much done and how are those margins out of that division comparing to your overall margins?

Jim Lines

As we anticipate, well, there’s two questions there. The simulation of Energy Steel the team in Lapeer into our and our team is going extraordinarily well. A part of our due diligence was to assess the culture, assess the management team, assess the operating practices to feel confident that it could simulate into our business well and there has – has not been any appreciable surprises or nothing that we didn’t anticipate.

So from that standpoint, it’s got extraordinarily well. I’m extremely pleased with that and the credit goes to the Lapeer team and to our managers that have overseen the simulation of Energy Steel into our team. Great job.

With respect to the margin, their business quite honestly, while gross margin and SG&A can be a little different. The operating margin is fairly similar to our overall business. It blends in quite well and it’s not appreciably different.

George Walsh – Gilford Securities

Okay. Is the SG&A, are there things that you’re still integrating some of that overhead with SG&A or anything else?

Jim Lines

With respect to our strategies to capitalize more fully on the power market we will be making investments that will both hit COGS and SG&A to capitalize on what we see as a strong growth opportunity at that company, in that market.

George Walsh – Gilford Securities

Okay.

Jim Lines

Nothing dramatically different but there will be some investments that hit COGS and hit SG&A.

George Walsh – Gilford Securities

Okay. And as you go forward and you talked about which is a great story, the increase to the capacity there, you mentioned that $135 million. With this cycle, could you just review again, I think you’ve done it before, but your perception of how margins would change as you come to the better parts in this cycle?

Jim Lines

Sure. I think a real great quarter to look at was Q2. Q2 was about $33 million of revenue, 38% gross margin. It had the diversity we were looking for. Power was a very good percentage of our overall sales that quarter and a good component from Navy, nice revenue from refining also reflective of because it was a delayed conversion of backlog to revenue, pricing that was similar to the last peak.

So that was indicative of where we thought margins will get to. We’ve indicated many times that while we eclipsed 40% gross margin last cycle, we’re going to work real hard to do that again. We feel upper 30s similar to Q2 is an expectation for the next peak.

We’re not dismissing that we won’t go above 40% and we know how to do that. But we think realistically and sustainably into the next growth cycle as we hit full striving recovery that’s what we’re expecting and that’s what you should expect.

George Walsh – Gilford Securities

Okay. And obviously that, you’re including the Energy Steel in its full integration, et cetera?

Jeff Glajch

George, this is Jeff. Just a quick follow-on from what Jim said. If you look at the second quarter and certainly don’t want to extrapolate anything, but I think if you just looked at it on the surface instead, if you took that quarter and made a full year out of it during the full recovery, what does that quarter look like.

We don’t have revenue for the historic Graham business annualize about $105 million, revenue for Energy Steel annualize at just about $30 million, so you’re kind of in the mid 130s from a revenue standpoint, again gross margin of 38%, EBITDA margins in the mid 20s, that’s we -- as Jim said, that’s what we believe in the middle of a full recovery, we can look like at that size.

And also, as Jim said, we have capacity of $135 million to $150 million that’s in the base business that does not include Energy Steel, on top of that we believe we have great deal of available capacity of Energy Steel. So the $135 million well certainly a nice target, but it’s certainly not the peak we’re looking for.

George Walsh – Gilford Securities

Yeah. What is the capacity of Energy Steel? Is there general number you have with that?

Jim Lines

We believe it’s more than double and if you look at where we’re at right now. We’re running at the annualized rate in the high teens. We believe it’s more than double what it’s at right now. So, we think $40 plus million is certainly not out of the question.

And where we need to add some resources people wise to get there absolutely, but do we -- and it’s really just giving us more capabilities in both the front office, as well as in the manufacturing facility, but the facility itself has a lot of run rate.

George Walsh – Gilford Securities

Okay. That’s great. Well, that’s a great picture. Thank you very much.

Jim Lines

Thanks George.

Jeff Glajch

Thanks George.

Operator

Thank you. (Operator Instructions) Our next question is a follow-up from Joe Mondillo.

Joe Mondillo – Sidoti & Company

Hey, guys. I just have a one quick follow-up question. I was just wondering, I don’t have the numbers in front of me, but if you could comment how the Energy Steel sales have been flooding over the last couple of quarters, and if you could sort of give your sort of updated outlook on the nuclear market overall in the U.S.?

Jim Lines

Sure. Joe, if you look at Energy Steel, they are, as we are a bit lumpy. They have quarters of -- if you would look at the calendar year, so the fourth quarter of last fiscal year was around $5 million. First quarter this fiscal year the second -- the quarter that ended in June was around $4 million. The next quarter, the quarter ended September was a little more than $7 million and this quarter was around $3.5 million.

So there is some lumpiness in there really due to timing of projects and how things flow through the facility, through the business. We will kind of look at that business and again, on an annualized basis, we’ve been running up in the upper teens.

With regard to the nuclear market itself, obviously the win in Westinghouse we were very pleased of our about the facilities down in Georgia and in South Carolina. That was a big project for them, a big win for them and there is some more opportunities we believe to support those new facilities. So on the new facility side, at the new reactor side, there is definitely opportunities.

And then in their historic business, which has been supporting the existing plans we continue to see very good opportunities there. We think we’ve enhanced their capacities to go after some opportunities that might have been more challenging for them in the past.

And so we think that the addressable market at their historic business, which is the existing plants has improved and then on top of that there is some new build opportunities. So we’re very encouraged about what we see at Energy Steel both currently, as well as in the opportunities going forward.

Joe Mondillo – Sidoti & Company

Okay. Following the sort of the Japanese crisis, there were sort of talks with the NRC that increased safety regulation was going to occur when they came out with a bunch of stuff that they were talking about and that could benefit. Have you guys heard anything further from that? Has anything sort of come about from that and?

Jim Lines

Sure. Nothing that we could point to directly and if we reflect that to 9/11 we thought it would take 12 to 18 months like it did last time before it got into the supply chain. So the NRC has drafted certain regulations or recommendations for what utility should be looking at. Some of it involves heat transfer which is, excuse me, what we’re involved in and other controls. So we’re expecting to see some of that flow into the supply chain in the coming quarters, but I can’t point to anything specifically.

Joe Mondillo – Sidoti & Company

Okay. All right. Thank you.

Jim Lines

You’re welcome.

Operator

Thank you. At this time, we have no further questions. I’d like to turn the call back over to our speakers for any closing comments.

Jim Lines

We appreciate your time this morning and we look forward to updating you during the June conference call, end of the year conference call. Thank you.

Operator

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

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