Graham Corporation (NYSE:GHM)
Q1 2009 Earnings Call
August 1, 2008 11:00 am ET
Tammy Poblete - Investor Relations
James Lines - President and Chief Executive Officer
Ron Hansen - Chief Financial Officer
James Bank - Sidoti & Company
Greg Garner - Singular Research
Greetings and welcome to the Graham Corporation's First Quarter 2009 Earnings Conference Call. At this time, all participants are in 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. Tammy Poblete, IR for Graham Corporation. Thank you, Ms. Poblete, you may begin.
Tammy Poblete - Investor Relations
Hello and good morning everyone. We appreciate your time with us today. You should have a copy of the news release that details Graham's financial results for the first quarter of fiscal 2009 that was released this morning. If not, you can obtain a copy from the website at www.graham-mfg.com.
With me here today are Graham's President and CEO, Jim Lines and Chief Financial Officer, Ron Hansen. Jim and Ron will provide their plan comments first and then we will open it up for questions.
As you are aware, we may make forward-looking statements both during the call and on the following question-and-answer period. These forward-looking statements are not guarantees of future performance and are subject to risks and uncertainties as well as other factors that could cause actual results to differ materially from what we discuss here today. These risks and uncertainties are available for you in the press release itself as well as with the filings the company had made with the Securities and Exchange Commission.
With that, let me turn it over to Jim to begin the review and discussions. Jim?
James Lines - President and Chief Executive Officer
Thanks Tammy and good morning everyone. As you have seen from our news release, we had a great first quarter to start off 2009. Sales were at new quarterly record of 27.6 million and was 38% higher than last year's first quarter. The quarter was up 21% sequentially from the fourth quarter. In addition, we surpassed all records of net income. Net income was $5.7 million in the quarter, which is more than double the first quarter of fiscal 2008 and earnings for the quarter were $1.11 per diluted share.
I would be of remiss if I did not point out that this took a great deal of effort and team work of all of Graham's employees to successfully achieve these new levels. I congratulate our employees for a tremendous start to 2009.
Bookings in the first quarter were 27.8 million, a 12% increase. As you know because of the magnitude of our orders, one quarter's results by product, industry and geography does not represent a trend. What is driving demand for our products is the continued expansion of the refinery, petrochemical and power generation industries. We have a solid backlog that stood at $76 million at the end of the quarter. This provides sufficient visibility to give us confidence in our expectation of 15 to 20% top line growth for this fiscal year.
We continue to make progress on efforts to expand capacity in our engineering and manufacturing processes, primarily through new equipment, automation and technology. The investments made in operations especially for new welding equipment such as two new submerged arc machines and various multi-process welding equipment have improved quality, weld deposition rates and increased capacity. Investment in engineering is holding to our timelines.
We subcontracted approximately 14% of our production hours in the first quarter and continue to expect that we will subcontract between 12 and 15% of our production in 2009. On the quarter, approximately 10% was subcontracted in North America and 4% in China. We are continuing to expand subcontracted fabrication in Asia and there are orders in backlog for hiring fabrication in China and in South Korea. North American subcontracting will continue to create vast capacity as well.
Our productivity enhancement and selective outsourcing combined with the quality of the orders we shipped in the first quarter led to the very strong gross margin of 44%. We have raised our gross margin expectations for the year to 39 to 42%, would have been likely that we will be at the upper end of that range. That implies that a more normalized margin of around 40 to 41% for the rest of the year. I am comfortable that given our backlog, we can achieve this level on average.
I believe we have proved that we can perform to our expectations. Nonetheless, the question in most people's minds is always while we’re in this cycle and for how long can grow and sustain in this level of growth and this growing margins. I continue to believe our markets are strong and support continue to our product growth. Industry reports indications by customers and our quotation activity all suggest remains tremendous opportunity for Graham products and services. The final market outlook is strong. Opex 2008 oil outlook released recently provides a great perspective for the coming several years.
Auto Caribbean processings Bosco report continues to add new refining and petrochemical projects each month and offer a number of projects at various bidding stages that give us belief that we can achieve our growth targets. Grahams include several major projects in India as our oil, Mangalore refining, Hindustan Petroleum, Wilma Natural Gas Corporation and IOCL. China has several plan refinery projects on the horizon. China pet chi loo, China camp Glanchow and Sia chin Russia a joint venture project to name but a few. China has plans for 17 major investments in refining infrastructure over the next several years.
Vietnam is planning significantly finding investments and Middle East continues to expand its refining infrastructure, Aramco and ConcoPhillips have a joint venture in (Yamboo), Aramco and Total have a joint venture at (Inaudible) in Saudi Arabia. The MPC in Kuwait has a massive project. Qatar petroleum at Al Shaheen Refinery has a major investment underway. Each managerial project and therefore the refining sector are not well required several million dollars of Graham equipments. We expect additional work in the US for revamping existing refineries to diversify feedstocks increased capacity and improve bottom of the barrel conversion. That will represent greatest opportunities for us.
Significant investment in oil and sands processing and upgrading is expected to take place in Western Canada according to the Canadian association of Petroleum producers and energy resources conservation board of Alberta. Again there will be several million dollars of opportunity for grand type products. We are continuing our launch of the power generating markets, particularly nuclear power generation. The petrochemical markets remain active as well. We continue to win because we have earned a strong well respective brand from the quality of our engineer and the manufacturing, and level of service and high degree of responsiveness we provide our customers, and the reliability of the equipment we deliver.
Even the current outlooks of our customers and the strength of the fundamentals of the industry we serve, we expect a solid continuation of growth through 2010, and we believe our strategy to be a world class leader in the designed and manufacture engineer to order products for the process industries will drive further opportunities beyond that.
Let me turn it over to Alan.
Ron Hansen – Chief Financial Officer
Thank you, Jim. Today we reported net sales of $27.6 million with first quarter of fiscal ’09. A 38%percent increase over sales of $30 million in the first quarter fiscal ’08. After market sales were particularly strong due to a couple of light capital spend orders for domestic refineries. The spell orders at this magnitude have high input. As a result of these large orders aftermarket sales were $8.9 million or 32.2% of total sales in the quarter.
After market profit margins are generally very good. We do expect that ever things of installed equipment continues to expand throughout the world. Aftermarket sales will continue to grow as a percentage of our overall revenue. Surface condensers were also strong in the quarter, a $5.8 million for 21% of total sales, up in $3.8 million in first quarter at fiscal 2008. Our ejector system sales dropped slightly to $8.1 million or 29% of total sales of $10.5 million in the first quarter of fiscal '08. Domestic sales were up 67% of total sales in the quarter and international sales were 33% of sales. As we repeatedly mentioned, quarter-to-quarter fluctuations in sales are product classification or destination expected considering the size and timing of our orders as well as for the fact that we sell globally and can service all process markets.
Orders were $27.8 million in the first quarter, a 12% increase compared with the first quarter of fiscal '08. Orders for surface condensers for the refinery, petrochemical and electrical power industries was strong this quarter, representing 31% of total orders compared with 14% in the same period the prior fiscal year.
We had strong quarter of international orders, which increased to 65% of total orders compared with 18% in the same quarter of last fiscal year. Again quarter-to-quarter comparisons will vary. We do not believe these reported numbers represent trends.
At the end of the first quarter, backlog was $76.0 million, 28% increase compared with backlog of $59.2 million at the end of the first quarter of fiscal '08. We expect a 5 to 7% of this backlog will not be converted to sales over the next 12 months.
Gross margins were strong in the first quarter at 44.2% compared to 33.4% in the same quarter of last fiscal year. The large aftermarket sales pushed gross margin higher in the quarter and a higher percent of the mix was weighted to higher margin sales. Additionally, efficiency gains in engineering and manufacturing continue to contribute to profitability improvements.
SG&A expenses were $3.8 million or 13.8% of sales in the first quarter of fiscal '09, up slightly on an absolute basis with $3.1 million in the first quarter of fiscal '08 but down from 15.4% as a percentage of sales. Higher sales commissions and variable compensation of cost were the primary reasons for increases in SG&A cost. Of importance, we continue to gain the leverage on our SG&A expense as sales continue to grow.
Interest income was $131,000 in the quarter compared to $230,000 in the first quarter of fiscal '08, primarily due to the fall in general interest rates. Concerned about the bond market, we adjusted our investment portfolio to 100% US treasuries six months back. Last year we were investing in US sponsored agency notes, which yielded rate of return than US treasuries.
Our effective tax rate in the first quarter of fiscal '09 was 33% and represents our estimated annual effective tax rate for fiscal 2009. Net income in the current quarter was $5.7 million, more than double the net income of $2.7 million in the first quarter of fiscal '08. Diluted EPS was $1.11 compared with $0.53 per diluted share in the first quarter of fiscal '08.
At the end of the first quarter, we had approximately $45 million in cash and investments compared with $36.8 million at March '08 and $19.3 million at June 30, '07 one year ago. We have a $30 million revolving bank line of credit, of which that we are outstanding letters of credit of $8.9 million and no borrowings at the end of the quarter.
Net cash provided by operating activities was $6.9 million in the first quarter of fiscal '09 compared with $5 million in the same period the prior fiscal year. The increase was due to higher net income and our continued efforts to reduce our working capital requirements.
Capital expenditures were $219,000 in the quarter up from a $163,000 in the first quarter of last year. We believe CapEx spending would be in the $10.1 million range in fiscal ’09.
And finally as many of you are aware of, my retirement as Graham CFO is effective today. So in addition to reviewing the operating and the financial results for the quarter, I have some closing remarks I would like to share. My 15 years in Graham have been a pleasure. I want to assure you that I believe I leave Graham in good hands. Our future looks extremely bright. Business conditions are exceptional. As we have said before our customers are telling us we have not seen busy yet. One accomplishment I am very proud of is that our departments are at excellent to clearly as with all Grahams department, a rich impairment is dedicated and experienced in total. So Graham I believe your best is yet to come. We have a three growth plan, and a talent financial resources and business opportunities to reach our goals. Thank you.
Operator, please open the line now for questions.
Question and Answer Session
(Operator Instruction). Our first question comes from line of (Inaudible).
Hi guys, just fantastic quarter congratulation. I guess the one think I wanted to start out is I am just trying to model the – I am trying to model the financial statement here, based on your guidance I guess you may miss seasonal pattern and be a very strong Q4. So is it fair to say that you know Q2 and Q3 are both going to have, there is about in our $20,000 a quarter may be related little module of Q2?
Our guidance for the year for top line is 15 to 20% top line in growth and we’ve had $27.6 million first quarter. If there is seasonality in our business, it is our third quarter which typically has a slight downturn in top line revenue.
Okay, okay. And I guess from an earnings perspective obviously you guys have that big jump in Q1. So if I would to sort of look at the earnings, do you guys think that you would be able, is a dollar can sort of the best quarterly EPS number you’re going to see – where do you think you can get out of the barrel 10 given that you expect margins to be little lower over the last year?
And again from a guidance perspective we have updated our gross margin guidance from after 30s which was 37 to 40% gross margin to now we’re saying for the full year on average 39 to 42% gross margin. We expect to drive the business hard, we’re going to push this business to improve this performance, but we’re sticking to our guidance that we have given thus far, and we will update you quarterly as we go forward with this improvement that we can make.
Okay, thanks guys.
You are welcome.
Our next question comes from line of James Bank with Sidoti & Company.
Hi, good afternoon.
Congratulation to you both double 11, and you first quarter when you are able to do at $0.09 material not only two years ago for full year 07, great accomplishment. Really not so many questions, the first is being SG&A, to me with the sales you put up it seemed a bit light. Clearly on absolute dollar basis it increased, and in terms of the profit sharing plan you have I think bit in the G&A the selling expense, did that just Ron impact you much in the first quarter or Ron is it sort of the comment you made the leverage you have on the SG&A is just coming in the quarter?
It’s the latter.
Okay, fair enough. And with the new updated gross margin guidance that I guess was on the comments you have made in terms of, you haven’t seen busy yet If we will be able to see that, there is no reasonable gross margin this year to fall from year anticipating in `09 and I am tract you might be able to assume that they could improve.
First of all we are gaining the concerning into work on improving our leverage of our cost both cut payable and fixed payable, as well as available, and we are continuing to make good gains and improving the efficiencies in the company, I think we’ve said many times that we felt the call really have clearly to the identified improvements we can make. We will continue to work on order selection and gross profit. But a real estate is our cost for improving – it’s continuing to grow the top line aggressively and continuing to improving earnings per share. So as we see good orders out there that’s going to have a good drop down and give us good leverage, that’s going to be more important to us then continuing just to try to drive up gross profit margin per se. For us it’s all about improving our earnings per share and continuing to get a better sales expansion and position ourselves better with our larger customer base.
Alright. Thank you, I appreciate that color. And then lastly on the aftermarket business, you know, historically cutting it from a model, there is a bit more lumpy than maybe a core business, but it got some of your remarks assumes its stabilizing in year-over-year but we have higher visibility on it and its going to trend as long as you had a core products or trending?
Well, my point was this particular quarter over 8% of our sales increase was due to the, lets put ourselves, this particular quarter we had two large after market order which were unusual for us. And aftermarket orders has a good profit building to the after market business. So the overall rate helped the gross profit margin through this quarter to 44, whereas trend for the year is making reference to after 42%.
As we continue a large portion of our after market business comes from our adjuster sales, its bit of strong for the last couple of years, we continue to think they’re going to be stronger going forward, but that’s not our only product in todays after market business, but the more we grow our sales and the more we grow particular products within our sales, the more inspirations we’re going to get out there which will lead to a continued growth in after market business. Other areas that are taking place right now is refineries and businesses put ourselves busy where they can, they have a tendency to go in and prepare and fix their processes to keep them going versus brand new installations. So we are also seeing a growth at our aftermarket business just because its – in some cases it’s quicker fix than a longer term fix.
Okay. Just little then slightly now pay has come forward. And I have Ron just individual congratulations to you and best of luck gentlemen.
(Operator Instruction). Your next question comes from the line of Greg Garner with Singular Research.
First of all congratulations on a fabulous quarter. My question have primary been answered, but just push them little clarity on some of the after market order, if you could characterize them more normal quarter or after market orders in the first quarter where you have been approximately with 4 million less about half of what was there, are you trying to get a short for an ongoing, how much of a big boost it was the first quarter versus it would have been perhaps normalized view of it?
If you look at our after market business on an annualized basis it has been between 16% and 18% of overall sales and I will project going forward on a more normalized basis lets go whole through.
Okay, okay. And with cash buildup is there any sense that what might be a good use of this cash?
Yes. We are pretty well on accumulating cash of course, it’s not helping with the amount of free cash flow or P&L we saw accelerating. But to continue our growth which is absolutely our plan, we read acquisition that other business combination is going forward. We believe our balance sheet is underleveraged, so we believe that it can take on more debt as well as with the cash that we’re building up, we believe that we will be able to use our balance sheet strength on our cash to help continue to grow the business through our acquisition and other business combination which could have great joint ventures of whatever make sense as we go to on the road. We saw that we did have a stock split, I mean, a stock split and a dividend increase as well announced. So we certainly might fall of our shareholders, additional level and then subsequently just say that we did have additional shares optimize at the last annual meeting and we do not believe – really our turns for those shares at this time whereas stocks that is now announced, we had no additional plans at this time, got further shares, one of those shares approve so that we can get a meaningful authorized shares and a potential link for authorized announced that one time and not have to continue to go on, but we really have those specific claims for a share offering that I already think that would deliver earnings for our shareholders a very sensitive team, our shareholders and dilution, so I think that’s gotten a long run answer but in case really – in case I am really more into your question and the cost per se, we would not activation through cash.
That’s good. Because you know great cash generating little right now and always a nice plan that have but that needs to be addressed?
Absolutely. We are absolutely a 100% inline with what you’re saying, and the way we want to organically as well as other great plan it will require utilizing that cash, it’s not just going to sit there.
And just a quick followup on the previous question where you answered about the margin improvement, the gross margin improvement only about half way of the year to, you’ve identified other improvement that you feel you’re only halfway to the total gain there, was that quarterly 8 on a gross margin basis there were few percentage in the coming years given the same kind of mix in the sales if that were the case?
What we are looking at Greg to expand our capacity and improve our productivity, a number of strategies that are taking in our operation plant as well as in the engineer office to make better use other scripture there is greater demand then we have capacity across the business, we can’t fulfill all the demand. Our strategy is to continue to grow the business as Ron appropriately said continue to increase our earnings per share and that will come by increasing our productivity, becoming a more efficient company, becoming a faster company, and these are the strategies that we have in place and we’re executing well on to take greater advantage of the strong economy for our products. The gross margin will comedown to the sales mix and the, I think that we can improve the leverage across the infrastructure. We do expect that we said this on this last call to have very good quarters going forward and an early quarters that are below the 44% and are below the 42% gross margin that we spoke about earlier, and our objective is to drive the business, but not make decision solely that center around optimizing gross margin, we center around expanding our earnings and building sustainability into the business.
Okay. Again I appreciate that call and congratulations again on a good quarter and I wish you best in your retirement.
We shipped in good shape.
Our next question comes from line of (Brandon Austin) with (Inaudible).
Hi guys just a one quick follow up and I know you guys have your total growth target on the base that you hold organic and our positions. And you guys kind of see a very good cycle for at least the next three years which is great, can you give me a sense on the organic side, what kind of growth do you – when you say that the cycle is going to remain strong for three years, what kind of growth you foresee over those three year just an organic expense, is it sort of continuation of 20% is it most sort of mid teens, I am just trying to get a sense of what you guys characterize this as strong organic growth?
Well it’s a tough – we expect the target rich environment across our markets as well as other markets we’re looking to penetrate. The compound annual growth rate as you know has been above 20% from the last four years, it’s around 23%. I would expect going forward aside from the 2009 guidance which is good can be 20% top line growth that’s new to the mid teens.
Great, that’s often. Thanks a lot guys.
(Operator Instructions). There are no further questions. I will turn the call back to management for closing remarks.
Thank you. Thank you for your question and for listening to our earnings call. I am proud of the work our employees are doing to make Graham a better company. Our financial performance and improvements to operating statistics has become their commitment to put our customers first and to our continued success as a company. Our employees continue to concentrate on delivering solid financial results was going focused on building toward a better future for the company. Ron, I thank you for you years as a Senior Executive of Graham, our company and I personally was proportionate to have a financial executive of your caliber on the team. You have prepared the company well for your retirement. I wish you well for long and healthy retirement.
Thank very much Jim.
In closing I continue to be optimistic about our future. We are executing well on our improvement and capacity expansion strategies. Our brand continues to become stronger and we are using our engineering and manufacturing low how to expand market share and win in our markets. I look forward to updating you on the next quarter results. Thank you.
Ladies and gentlemen this concludes today’s call conference thank you for your participation.
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