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Executives

Deborah Pawlowski – Investor Relations

James R. Lines – President and Chief Executive Officer

Jeffrey F. Glajch – Vice President-Finance & Administration and Chief Financial Officer

Analysts

Jason Ursaner – CJS Securities, Inc.

Chase Jacobson – William Blair & Co. LLC

Brian G. Rafn – Morgan Dempsey Capital Management, LLC

Joe R. Bess – Roth Capital Partners LLC

Joe Mondillo – Sidoti & Company, LLC

Graham Corporation (GHM) F2Q13 Earnings Call October 26, 2012 11:00 AM ET

Operator

Greetings and welcome to the Graham Corporation Second Quarter Fiscal Year 2013 Financial 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, miss you may begin.

Deborah Pawlowski

Thank you, Dan, and good morning everyone. We appreciate you’re being joining us here today with the Graham Corporation second quarter fiscal 2013 conference call. On the call, we have Jim Lines, President and CEO, and Jeff Glajch, Chief Financial Officer. Jim and Jeff will be reviewing the results of the quarter in year-to-date period and will also provide a review of the Company’s strategy and outlook. There are slides on the Company website that accompany this conversation today. If you do not have them, you can find them and the press release 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 which 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 the call over to Jim to begin the discussion. Jim?

James R. Lines

Thank you, Debbie. And welcome everyone. Please refer to slide four, we had a solid quarter driven by very good execution, control of costs and being able to pull work into the quarter from our third quarter. It was a challenging year-on-year comparison this quarter due to the high-quality of orders converted during the second quarter last year that will not reflective of true market and business condition at that time.

Upon reaching the midpoint of the year we're tightening prior gross margin guidance by increasing the bottom into the range. However, it remains within the range as earlier stated for guidance, and we are projecting a 100 basis point increase to SG&A.

We were pleased with order activity in the quarter, quality and quantity of bidding activity, and we remain encouraged about market outlook over the next several years. Actions management has taken to be ready forward and anticipated strong recovery position us well to capitalize on increased demand.

Please turn to slide five; we had $25.9 million in sales during the second quarter. Sales to the chemical/petrochemical industries were up approximately 50% from $5.6 million a year earlier. This is due to conversion of orders for the ethylene market that for the U.S., Middle East and Indian installations. We also had a large order for China that contributed to the strong quarter, which is related to the ethylene market as well.

Refining and power market sales provided sequential growth, however year-on-year each was down due to an unusually strong quarter last year. Sales to the U.S. were 59% of the total, with international sales at 41%, we do project as we move forward that geographic sales mix were generally be 50-50 international and U.S.

Referring to slide six, using the midpoint for revenue guidance we're projecting 6.5% year-on-year growth. Representing 21% compound annual growth rate from the cycle bottom. Our businesses had capacity for greater level of revenue, however market conditions and order rates nine to 18 month backs were soft, which ultimately flows through as lower revenue levels during the past two quarters. What is encouraging is that we have the capacity to do more and the second half of this year we’ll begin to illustrate that.

Please turn to slide seven, we had a good bookings quarter with orders at $25.6 million, the difference between a good quarter and a very good quarter for orders was three days. We expect it to secure a large oil sands upgrader order in the second quarter; however it wasn't finalized until October 3.

The good news is, we’re off to a good start for the third quarter. It is noteworthy to mention in the quarter. They were $5 million in orders for the U.S. refining industry, including one for re-refining recycled lube oil. Total refining orders globally were $9.4 million including orders for Indonesia, Middle East and Canada. We secured $4 million in orders for biomass to energy products. We also secure roughly $2.3 million in orders for the U.S. Naval Nuclear Propulsion Program including its submarine program.

Referring to slide eight, the benefit of actions to diversify during the downturn are best shown, by the level of backlog today, with the addition of a strong power market segments, as well as the impact of the Naval Nuclear Propulsion work that appears in the other segment.

Backlog at the end of the last peak on March 31, 2009 was $48 million with approximately 80% being for refining and petrochemical markets. Today our backlog at the end of September stands at just under $92 million, with refining and petrochemical markets representing 47% of that backlog. The dollar value of refining and petrochemical backlog is similar at both points in time. This diversity will provide greater growth and lesser volatility from the cyclical nature of refining and petrochemical markets as we move forward. It is early to be thinking about the next downturn, but we are, and we also believe this diversity will enable us to have stronger earnings at the next bottom of the cycle.

With those remarks, let me pass it over to Jeff, for more details on the quarter. Jeff

Jeffrey F. Glajch

Thank you, Jim and good morning everyone. As Jim mentioned, we have some pretty tough comparables when looking at the second quarter of fiscal 2012, but you will see a nice step up from the last two sequential quarters.

Turning to slide 10, Q2 sales were $25.9 million, down 23% versus last year’s strong second quarter, but up 15% sequentially when compared with Q1 of this year. Sales in the second quarter were 59% domestic, 41% international, in last year's second quarter, the split was 53% domestic and 47% international. Graham’s historic commercial markets continue to be tilted toward the international arena, while Energy Steel is primarily exclusively domestic, and the U. S. Navy of course is 100% domestic.

EBITDA margins for Q2 was 15%, down from 26% last year, but up sequentially from 12% last quarter. Q2 net income was $2.6 million, or $0.26 per share, down from $5.5 million, or $0.55 per share, in Q2 last year, but nearly double sequentially from $1.4 million or $0.14 per share last quarter.

On Slide 11, you see the gross margin in the second quarter was 30.5%, down from 38.1% in Q2 last year, but up sequentially for the second straight quarter, and 25.6% in the fourth quarter of last fiscal year, and 27.7% in the first quarter of this fiscal year.

SG&A was $4.4 million in the second quarter, flat with Q2 of last year, but up sequentially from $4.1 million in the first quarter of this year. The increase compared to Q1 came through investments being made in our business to support future growth. Operating margin was 13.4% in the second quarter, down from 25% last year, but again up sequentially for the second straight quarter.

On slide 12, you can see that our orders in the second quarter were $25.6 million, up from $23.5 million in the same quarter last year and $19.7 million in Q1 of this year. Our order level in sales were essentially even with our book-to-bill ratio at 0.99. As we have discussed in the past, we expect this type of quarterly fluctuation that we have seen as the movement or timing of a couple of large projects as Jim mentioned, can dramatically impact these specific quarter. We continue to recommend that investors view a longer period of at least four quarters and perhaps longer, to better understand the direction of our business.

To that end, you can see that our orders over the past four quarters have averaged almost $27.5 million or a total of $109.5 million during that four quarter, period. Our backlog at the end of September was $91.8 million down slightly from $92 million at the end of June, as well as, down from our $94.9 million level at the end of March. We expect to convert 75% to 85% of this backlog to sales over the next 12 months.

As you may recall, we have three large projects, the U.S. Navy projects and two domestic new build nuclear projects, with multiyear lives, which make up approximately one-third of our backlog. Two of these projects, the Navy project and one of the nuclear projects are currently in production, with the third project expected to start production in the next couple of quarters, but since all three projects have multi-year convergence, we expect a good portion of these projects to remain in our backlog for the foreseeable future.

Our cash position remains strong and has increased by over $5 million in the first half of this fiscal year to $46.9 million. We continue to have a clean balance sheet with no bank debt. This allows us to focus on utilizing our cash, and if necessary, our uncapped line of credit for future acquisition activities, as well as the internal growth and investment opportunities.

Finally, on slide 15 this slide summarizes the first half of fiscal 2013. Sales gross profit and EBITDA are all down versus the first half of last year. Again, this was expected as the first half of last year was very strong and not an indication of where the market was in its cycle at that point in time. I would know however that we have generated $6.2 million of cash in the first half of this year.

With that, Jim will complete our presentation by discussing our full year guidance and providing some comments about our future growth opportunities.

James R. Lines

Thank you, Jeff. I am on slide 17. Our guidance for full year fiscal ‘13, revenue remaining in the range of $105 million to $115 million, gross margin tightened to be between 29% and 31%. SG&A expected to be between 16% and 17% of sales with an effective tax rate of 33% to 35%. We have a very strong view of how our markets may recover over this cycle due to the leading indicators that we see with a big work we’re doing, the conversations we have with our customers and should this cycle recovery unfold as we project? We believe that will be possible for Graham to exceed $200 million of revenue at the top of this cycle.

Please turn to slide 18, with our good pipeline; we are expecting orders to continue to expand as we go into the remainder of fiscal 2013, and then to fiscal 2014 and beyond. As we said previously, we weren’t waiting for this demand, we’ve made investments ahead of the demand that is affecting near-term profitability, but that has been the right decision for management to make and we will be able to capitalize on a strong recovery that we anticipate will occur as the recovery unfolds.

We do intend to advance our market share in our traditional markets of oil, refining and petrochemicals, primarily in the emerging economies in Asia and South America. We will maintain a strong market position in the Middle East, and we believe we will continue to dominate the North American market for refining of petrochemical projects.

With the team at our side will appear. We will continue to expand their market reach whilst within the existing utilities in North America and also moving into international markets. We’re focused on the Naval Nuclear Propulsion Program and developing that channel to be a more steady level of business for us. Japanese team are building the acquisition pipeline, because we remain very positive on the outlook while there is some uncertainty in the near-term. We will maintain our patience and discipline for order selection and price management.

With that, Dan, please open the lines for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Jason Ursaner of CJS Securities. Caller, please proceed with your question.

Jason Ursaner – CJS Securities, Inc.

Good morning.

James R. Lines

Good morning, Jason.

Jason Ursaner – CJS Securities, Inc.

Congratulations on the nice quarter.

James R. Lines

Thank you.

Jason Ursaner – CJS Securities, Inc.

I just have a couple of questions, within the guidance on the SG&A, part of it kind of up in the range to 16% to 17% of sales. Jim, last quarter, you’ve talked a lot about the addition to the middle of the company. on this call, you talk more about the strategy that you offer to international work, the engineering and kind of that build to design opportunity. Can you just talk about what that is doing to your SG&A versus, you also moved up your gross margin and I know that your sales guys are partially benchmarked to that as a component in competition. so just what’s driving the SG&A increase in that outlook, considering that it’s a pretty big range?

James R. Lines

To a degree, Jason, it comes down to order selection, and whether the orders are for company account where no commission is paid or where there is representative involved and commission is paid. What we’re seeing in the second half is a sales mix that has a little stronger percentage of orders that have commissions being paid to our representatives around the world versus company account. And we also had a shift as we got into the Navy project, it has begun to slow down, not caused by Graham, but caused by our customers. and the Navy project has a lower commission level than we ordinarily would see. So as the mix changed primarily around commissionable and non-commissionable orders that has lifted a little bit SG&A that can vary from time to time. we do expect that as we hopefully drive revenue higher, we would be able to get the lower end of the SG&A range. hopefully, that explains a little bit better for you.

Jason Ursaner – CJS Securities, Inc.

Yeah. I understand that, I appreciate the details. And then just second question from me, you mentioned in the orders you got for the quarter that I think you said 2 million of it was related to the Navy submarine work. I just want to make sure I heard that right.

James R. Lines

Sure. I mentioned that the business has secured just over 2.3 million of orders for the Naval Nuclear Propulsion Program including orders for the submarine program. In rough terms, it was 50-50. we had received orders for replacement parts for the equipment we provided quite sometime ago for carriers. and then we have secured a couple of orders for subwork still in the engineering aspect of those programs, not for build. but they are very important orders, the important stepping stones to get to that point where we begin building equipment for the submarine programs.

Jason Ursaner – CJS Securities, Inc.

Got it. And in terms of what’s still out there on the CVN-79. Has there been obviously, you’re united to your orders, but has there been any decision on the addressable content that you guys have still out there?

James R. Lines

There was an order that we were pursuing that we did not win. we did lose it during the quarter, we did aggressively pursue it. but it was a build-to-sprint and the award was placed with the incumbent.

Jason Ursaner – CJS Securities, Inc.

And relative size of that piece related to the other ones that are still out there?

James R. Lines

Relative to the size of the one we had secured, it was a couple of million dollars to the March $25 million order that we have for the CVN-79 project. there’s a couple more items that could be available of a similar couple of million dollars size range.

Jason Ursaner – CJS Securities, Inc.

Okay I appreciate the commentary, and I’ll let others have a chance to ask questions. Thanks.

James R. Lines

Thanks, Jason.

Operator

Our next question comes from Chase Jacobson of William Blair. Caller, please proceed with your question.

Chase Jacobson – William Blair & Co. LLC

Hi, good morning, nice quarter.

James R. Lines

Good morning, Chase.

Chase Jacobson – William Blair & Co. LLC

Jim, first question for you. So, it sounds like this oil sands award that you mentioned, could be pretty meaningful. is there any other detail that you can give us there in terms of what project is going to or maybe what the size of it is and does it kind of speak to your confidence, and being able to reach the $30 million level of awards that you’ve talked about in the third quarter?

James R. Lines

Well, again for the sake of three days, we would have been above $30 million, as that order closed in September like we had envisioned. but regrettably, it didn’t, we could not control the timing any better than we did. There is only two upgraders that are currently active, up in the Alberta area right now, in terms of EPC work and RFPs, request for proposals. This is one of the two. the other one is that actively being pursued by us. The timing is not yet clear. but our team has been working honestly to be candid. We’ve been working on these projects since 2007. They fell off the table when the downturn occurred. They became active again about 12 to 18 months ago. One finally move to procurement, and we landed it early in October, but it does give us a positive sense that it’s picking up again in Alberta and we have really good brand there, we have very good market share for this particular application, and what really is comforting is our people have been involved in these projects since late 2007, early 2008. And we feel pretty good about being able to pull in the future work.

Chase Jacobson – William Blair & Co. LLC

Okay. That’s helpful. And then another question on the SG&A, I mean you guys have been talking further while that potential for SG&A to go higher on an absolute basis, it’s trended up the last few quarters, and the guidance assumes that has been a trend closer to about $5 million a quarter, second half of the year. looking forward, should we expect is there a kind of stay around that level on an absolute basis? And do you think that’s the appropriate level or do you think that there is still a change that let me feel a little bit higher, if you want to take advantage of the market as best as possible?

Jeffrey F. Glajch

Chase, this is Jeff. With regard to the second half of the year, I’m not sure the $5 million level certainly averaging at the next two quarters is likely, I think if you look at the range we gave and the revenue range. we’re not going to be at the top of the revenue range and the top of the SG&A range of this bulk order occur. But certainly if we were at the lower end of the revenue range, it might be more likely to be at the top of the SG&A range from percentage basis.

So that $5 million is probably pushing in for the second half of the year. And your question looking forward beyond that, we’ve talked about we in the neighborhood of around 16% of sales annually going forward. And I think certainly in the near-term, next couple of years, we would expect that to be our reasonable thought process and whether 15% or 16% while there is a difference there, it gives us enough of the difference to dramatically just bring out our profitability. But somewhere in that, the midteens, it is the place for us to be, for SG&A at least in the next couple of years. And we’ll see if beyond on that, if there is any kind of as that function half of that.

Chase Jacobson – William Blair & Co. LLC

Okay. And then the last question I’ll ask you is, given we’re getting from all the –a few companies about all the opportunities for petrochemical work in the U.S. Have you seen any change in that competitive environment on those projects that there were fewer products?

James R. Lines

Chase, this is Jim. No, we haven’t yet, primarily because those have not moved through the sales stages to get to firm RFPs. We are in thought and some concept works with the ethylene projects, fertilizer projects, but I would characterize those as early stages, not yet at formal EPC or certainly not yet at RFP stage. We’re expecting decent margin potential from this opportunity in the North American market for petrochemical works.

Chase Jacobson – William Blair & Co. LLC

Okay, appreciate it. Thanks.

James R. Lines

You’re welcome.

Jeffrey F. Glajch

Thanks, Chase.

Operator

Our next question comes from Brian Rafn with Morgan Dempsey Capital Management. Caller, please proceed with your question.

Brian G. Rafn – Morgan Dempsey Capital Management, LLC

Good morning, guys.

James R. Lines

Good morning.

Brian G. Rafn – Morgan Dempsey Capital Management, LLC

Just give me a sense on the Ford Class, the CVN-79. is that works specifically just condensers or are you guys going other things on that shift?

James R. Lines

Right now, the order we have is for steam surface condensers. the order that we had lost was for ejector systems. And there are some others smarter items that we could pursue that our four vessels or heat exchangers or small evaporation type ejector systems.

Brian G. Rafn – Morgan Dempsey Capital Management, LLC

Okay. So there are other things. Have you guys had any preliminary discussions on CVN-80 yet with the Navy?

James R. Lines

No, we have not. We still think that’s a couple of years out.

Brian G. Rafn – Morgan Dempsey Capital Management, LLC

Yeah. So I thought just late in the Q1 the other one. What about, go back to the Nimitz Class fleet carriers, when they come in for kind of their 18-month overhaul. is there any in some of the legacy super carriers, is there any work to go back into, because certainly, enterprise is coming off, but there certainly are going to be for the next at least 20, 20 plus years, Nimitz carriers [doing] a fleet. Is there any other work, ejectors, condensers of that in overhaul that you guys can do?

James R. Lines

Sure, Brian. The orders that I mentioned in Q2 of about $2.3 million, partly for the subprogram, partly for the carrier program, we did receive an order, which happens about every couple of years for replacement ejector systems for an earlier CVN carrier that we’ve supplied to 10, 15 years ago.

Brian G. Rafn – Morgan Dempsey Capital Management, LLC

Okay, okay, okay. And then the same question on a legacy base, you guys were up at your Analyst Day; you’ve talked about certainly the Virginia’s Fast Attack class. So how about some of the legacy you like, you see well from the Los Angeles’ Fast Attack sub, you’re doing work there?

James R. Lines

We have not. No.

Brian G. Rafn – Morgan Dempsey Capital Management, LLC

Okay. Is that something that potentially, is there or is it just not big enough or is that something that’s where there are legacy OEMs that really have that locked up?

James R. Lines

At this point, I would say the legacy OEMs have good position. and we’ve not really broken in, Brian, into the subprograms. once we’re into the subprograms, the Virginia Class, the Ohio class worked. hopefully, we’ll be able to be considered for this type of repair replacement.

Brian G. Rafn – Morgan Dempsey Capital Management, LLC

Okay, okay. Once you get it Jim, as you get to penetrate the Virginia Fast Attack class sub. once you put in, I think we said there were two condensers per sub, once you have the original OEM on that, when those subs come back in for overhaul, is there any sense that you’d get up, maybe a priority or you have some benefit of being the original versus having that give the legacy suppliers that when it goes to overhaul. Do you have some follow-on annuity?

James R. Lines

We do view that there is opportunity there like on the carrier programs. There will be some rare parts.

Brian G. Rafn – Morgan Dempsey Capital Management, LLC

Okay.

James R. Lines

But hopefully, we’ll be able to enjoy replacement work. there is a difference that our carrier has a life of 50 years.

Brian G. Rafn – Morgan Dempsey Capital Management, LLC

Right.

James R. Lines

Subs don’t have that life. Look there are not…

Brian G. Rafn – Morgan Dempsey Capital Management, LLC

Give me…

James R. Lines

In services as long as a carrier.

Brian G. Rafn – Morgan Dempsey Capital Management, LLC

Right, right, right. give me a sense of in, you guys constantly are on the petrochemical side in the different projects, I’m assuming that most of that new build and it’s also capacity expansion type stuff. if you look at some of the heavier industries not specifically petrochemical, but steel or cement films, they’ll do a lot of maintenance work when their industries cycle down. When you have – be it condensers or ejectors or heat exchanger or vacuum pumps installed some of these petrochemical plants. is there large maintenance work at all or is most of that petrochemical work primarily new build, new expansion capacity?

James R. Lines

As we think about the North American petrochem market and what excites us is around the new build. however, as the industry gears up to again be a producer in North America at petrochemicals, we have enjoyed some work around repair, replacement and upgrades of existing facilities to get on stream faster to take advantage of the lower cost natural gas. we have some work in our backlog right now that I would associate with that, which is revamped, restarted upgrades. But the real exciting part is the new builds.

Brian G. Rafn – Morgan Dempsey Capital Management, LLC

The new builds, yes. but what are you working at relatively as you build up, you have kind of the $200 million sales relative to the next cycle. how do you see kind of incremental increase, Jim in headcount, weather it’d be engineering or sales or where do you maybe have some fall in excess if you moved from $115 million up that sales curve, $200 million.

James R. Lines

Sure. as we think about head count today, which is roughly 350, 360 employees, at all of our sites combined with a run rate as you said of $105 million to $115 million as we move towards the $200 million, which would comprise subwork, carrier work, our strong refining and petrochem activity, nuclear work, I would see our headcount having to expand by about a 100 to 150 people. The good amount of that is in the direct cost, the direct labor area.

Brian G. Rafn – Morgan Dempsey Capital Management, LLC

Okay.

James R. Lines

We've taken some steps to build the middle of the company. We’re ahead of the demand; there is some building that still needs to be done. but the large expansion of the workforce is on the production side, the direct labor side.

Brian G. Rafn – Morgan Dempsey Capital Management, LLC

Okay. and then the footprint that we saw at Batavia, where you guys are, anything as far as buildings, you showed us the brand new [paint standing] area, what’s kind of the physical structure for $200 million in sales?

James R. Lines

We believe our rooflines both in the Lapeer and Batavia, you saw Batavia. we believe these rooflines will be stretched, but they can get near to that $200 million. We think of the Batavia roofline with the outsourcing that we do that we’ll continue to do and perhaps expand a little bit. we think the run rate through what we call the Batavia operations including outsourcing is somewhere between $125 million and $150 million, with some CapEx around equipment. That’s so much roofline and at Energy Steel when we bought the business, Lapeer, they had upper teens run rate, we view that business is having physical plan assets good for $40 million to $50 million.

Brian G. Rafn – Morgan Dempsey Capital Management, LLC

Okay, okay. All right, that’s fair, good, good. And one more [Audio Gap] given the massive size of some of this stock that certainly we saw, what are your freight costs like, they negotiated. Is that something you bear, you put that in the contract and maybe what are you seeing freight cost moving some of these massive things around the world.

James R. Lines

Primarily for the international work, our freight term will be part of export and that’s talking about $100 million run rate, we’re talking about 1% or 2% of sales for that type of freight. on the smaller short cycle works, its freight prepaying at or that works.

Brian G. Rafn – Morgan Dempsey Capital Management, LLC

I appreciate. thanks.

James R. Lines

You’re welcome.

Operator

Our next question comes from Joe Bess of Roth Capital Partners. Caller, please proceed with your question.

Joe R. Bess – Roth Capital Partners LLC

Good morning, guys.

James R. Lines

Good morning.

Joe R. Bess – Roth Capital Partners LLC

Jim, I have a question on about the conversation that you’ve even having with your customers lately. you talked about some of them having their actions a little bit more tentative, and also having customers to the projects or kind of passing that conception stage. Can we talk a little bit about, do you think this is the order activity is kind of increase at a quicker rate, given that these orders are kind of coming closer together and what your outlook is for the growth cycle? is it going to be a little bit quicker than you would expect than a longer process?

James R. Lines

It’s a great question, the same question you asked me about a month ago. I think it’s still too early, what excites us is the fact that we’re fitting these projects that we’re seeing they move through their different stages. It’s hard for us to say what the next one or two quarters looks like, just because as we said this last quarter was $25 million, but for the cycle three days, it could have been $31 million and that’s meaningful.

But by and large, we’re looking beyond the next couple of quarters and remaining excited, we have less certainty around what’s happening, believe it or not what’s happening next week, next month, because of the tentativeness of our customers. We’ve been chasing some of these orders for quarters and years and it seems like each quarter they’re telling us it’s going to close this quarter, get ready. And then we’re talking about at the next quarter.

Joe, I’m not really giving you answer simply, because it’s not clear to me just yet. But I’m looking beyond the next couple of quarters, and we are remaining very optimistic when we’re taking action to get our businesses ready to capitalize that with the investments that we’ve made, but near-term visibility is tough right now.

Joe R. Bess – Roth Capital Partners LLC

Okay, thanks. I know you expect geographically for revenue would be kind of split 50-50 long-term. are you expecting maybe international order rates to increase in the near-term compared to U.S. orders or do you expect demand to kind of pick up in one market versus the other kind of at the start of the growth cycle?

James R. Lines

Sure. If we put aside for the moment, what may happen in North America around the petrochem and again, we’re very bullish on that, but we don’t believe that’s the next couple of quarters. We would say the growth rate from Graham’s traditional markets, oil refining and petrochem will be stronger internationally than domestically. Once we have more confidence in the timing in the pace of North American Petrochem Renaissance. We could see the sales mix pull back toward more domestic, less international for our traditional business, we’ll be finding in petrochem. But it’s too early to tell you when that’s going to happen and how that looks.

Joe R. Bess – Roth Capital Partners LLC

Okay. And just a housekeeping item, Jeff, can you talk a little bit about the benefit that you had on the interest expense line this quarter?

Jeffrey F. Glajch

Sure. we had a couple of items around some tax issues with the IRS that were resolved. one of which was the R&D credit that we’ve discussed in the last couple of quarters. And finally, there was final closure on that. And then there was another one just around in accounting tax, accounting change. A couple of things where we had accrued interest and ultimately, the IRS did not charge us the level of interest that we had expected to be charged or they decided on a – to give us some credit or not credit, but not to hold us accountable, if they’ve decided to audit previous year with regard to that one accounting change. So it’s really around IRS interest that we had accrued, properly accrued and the IRS had decided not to charge us or gave us relief.

Joe R. Bess – Roth Capital Partners LLC

Okay, that’s right. And then that’s going to done now, we should expect interest expense in the level we figure out?

James R. Lines

Exactly, and they should be above our levels and you’re seeing the last number of quarters, last six, seven quarters, because those couple of items are no longer accruing interest. so we had a reversal of some of those accruals, and then going forward, the interest expense level should be significantly lower than what you see in the last two quarters, should be a very small number.

Joe R. Bess – Roth Capital Partners LLC

Okay, great. Thank you, guys.

James R. Lines

Thank you.

Operator

(Operator Instructions) Our next question comes from Joe Mondillo of Sidoti & Company. Caller, please proceed with your question.

Joe Mondillo – Sidoti & Company, LLC

Good morning, guys.

James R. Lines

Hi, Joe.

Jeffrey F. Glajch

Hey, Joe.

Joe Mondillo – Sidoti & Company, LLC

My first question, just wondering how the gross margin in the orders has been tracking, are we still sort of flattish around that 30, 31-ish range?

James R. Lines

I think that’s fair. Just to look at it that way.

Joe Mondillo – Sidoti & Company, LLC

Okay. and then also does the margin differ at all between any of the three or four different sort of main end markets that you sell into?

James R. Lines

For refining in general that provides the best margin potential with North America and the Middle East having the highest margin potential where rest of the world being down a little bit from South America and the Middle East, where petrochem that’s noted below refining, the same comments hold geographically. our power generation, primarily nuclear, which is mainly domestic that has a margin potential that’s comparable to our petrochem business and the Naval work is right in the middle of that mix between refining and petrochem, around petrochem.

Joe Mondillo – Sidoti & Company, LLC

Okay. Thanks for the color.

Deborah Pawlowski

And Jim you would add also, wouldn’t you there some, it will vary a lot project by project as well.

James R. Lines

Yes, that’s correct, Debbie.

Joe R. Bess – Roth Capital Partners LLC

Okay, great. And then I guess in terms of actually just going back to the last question in terms of the U.S. versus international, how sort of that 50-50 or how you look at the business long term, has that shifted at all over the last say 12, 18 months?

James R. Lines

It really hasn’t, Joe that wildcard is, in our mind, is how the petrochem market in the U.S. or North America begins to unfold and the pace of that. To us that’s pretty exciting, to us that could shift the sales mix to the – or heavily-weighted toward domestic. I do think that’s a year or two out still, because of where these projects are. but everyone is pretty excited about it as are we – we’re ready for it, but we just need to see a little more traction.

Joe R. Bess – Roth Capital Partners LLC

And that’s same on the refining side?

James R. Lines

Yes, we’re seeing, our team is pretty active on refining bid work around revamps still referring for alternative feedstocks or pushing the refineries to produce more diesel or transportation fuels. We had a very good level of order intake last quarter; about $5 million came from the U.S. refining industry, it’s great business for us and we’re seeing a good amount of opportunities in the repair and replacement of equipment that we have supplied 10, 15, 20 years ago as I think the refineries prepared for our stronger economy.

Joe R. Bess – Roth Capital Partners LLC

Okay. And are we at the very initial stages of these projects and how long do these projects take and sort of where do you guys fit in, in terms of that hold time period between certain finished?

James R. Lines

Sure. when we’re doing that job right and I think we do it most of the time correctly. We’re involved very early. We defined the sales cycles having four distinct phases. We’d like to get involved in the very initial stage, which we call concept, project concept. And that moves on to front-end engineering design. we’re seeing a lot of projects right now in that Phase 1 or Phase 2. But that moves from the feed work front-end engineering design to the EPC work. We have some projects in that stage right now. and then ultimately, an EPC is awarded to the work and we received the request for purchase, final sales stage that cycle can vary between normally or narrowly, Phase 1 through Phase 4, six months to 18 months. As I mentioned earlier on the call though some of these projects we’ve been tracking since 2007, 2008.

Joe R. Bess – Roth Capital Partners LLC

So it’s not just 6 to 18 months, it can vary amongst a longer time period?

James R. Lines

Right. But (inaudible) sales guys have shortened it, but they haven’t been able to.

Joe R. Bess – Roth Capital Partners LLC

What's the volume of these in the project planning and new projects coming on board that you’re hearing about like how is that trending?

James R. Lines

I would say, generally Joe its trending up, we see an expanding of our pipeline a bit work, which again gives the confidence that the decisions we made and are making today 12 months go, and are still making today about investing in our business ahead of demand have been the right decisions, we missed it last time 2004, 2005 we weren’t ready, we’re more ready this time, because…

Joe R. Bess – Roth Capital Partners LLC

So, I mean production of oil in the U.S. right now is at a 15 year high, it’s really growing tremendously, given the fracing and other methods of drilling, you haven't seen though a big jump or a big acceleration in these type projects yet. Is that correct?

Jeffrey F. Glajch

From a 30,000 foot level probably not, we’ve seen an acceleration of good work for what we call smaller projects very, very important, $0.5 million to $1.5 million. Those are great we need quite a few of those to get a $5 million aggregate order value, which is what it might be a custom to seen from us, but what we’re seeing is the good amount of traction on that smaller end of the work, which is transactionally simpler, order ship cycle is faster, margin is good, so we’re seeing more on that

Joe R. Bess – Roth Capital Partners LLC

Okay and then last question just regarding the chemical segment, and I guess the chemical/petrochemical, it's been roughly sort of flattish, I mean its seems like it's been improving over the last couple of quarters slowly, I'm really wondering if I know that ag industry in the U.S. has been booming over the last couple of years and there is tons of projects and tons of fertilizer capacity expansions in the U.S. I just wondering what the opportunity is there and why may be we haven't seen a bigger jump in that segment yet.

James R. Lines

I just don't think Joe, it’s moved through the sales stage yet, we are aware of all of those projects, half a dozen or so, I'm talking about fertilizer projects; ammonia, urea plants. Our team, they are involved in discussions with the process licensors, with the companies that we think we'll get the EPC work, it just has not moved yet, in general, to what we would call the very active stage of getting ready to buy equipment.

Joe R. Bess – Roth Capital Partners LLC

Okay, okay. So just below early until benefits come?

James R. Lines

We think so, we think so. And this is a market that we hope to do well in. In the 70s and the 80s our company did very well with our mortgage expansion in North America. We have a great brand here, we’re connected well to the process license source and I’m expecting that will in a fair position to win a good amount of that work.

Joe R. Bess – Roth Capital Partners LLC

Okay, great. Thanks a lot guys.

James R. Lines

You’re welcome Joe.

Operator

It appears there are no further questions at this time I would now like to turn the stage back to management for closing comments.

James R. Lines

We appreciate your time this morning and for your questions, as you can tell we are very pleased with where we are at the mid point of the year, and the optimism we see with the second being stronger than the first half of the year. And ultimately we’re looking very positive toward next several years as our markets begin to recover. And if they recover as we anticipate, looking at a very strong growth cycle, one that we believe is possible to reach over $200 million of revenue, across our businesses. And we will keep you updated quarterly on our progress. Thank you.

Operator

This concludes today’s teleconference. You may now disconnect your lines at this time. And thank you for your participation.

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