Graham Corp. Q2 2010 Earnings Call Transcript

| About: Graham Corporation (GHM)
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Graham Corp (NYSEMKT:GHM) Q2 2010 Earnings Call July 29, 2010 2:00 PM ET


Deborah Pawlowski, IR

Jim Lines - President & CEO

Jeff Glajch - VP-Finance & Administration & CFO


Rick Hult - ROTH Capital Partners

Chris McCampbell - Stifel Nicolaus

George Walsh - Gilford Securities


Greeting and welcome to the Graham Corporation first quarter 2011 quarterly results conference call. (Operator Instructions). As a reminder this conference is being recorded. It is now my pleasure to introduce your host, Ms. Deborah Pawlowski, IR for Graham Corporation. Thank you, Ms. Pawlowski. You may now begin.

Deborah Pawlowski

Thank you, and good afternoon, everyone. We appreciate your joining us today on Graham's fiscal 2011 first quarter financial results call.

On the call I have with me today Jim Lines, President and CEO of Graham and Jeff Glajch, Chief Financial Officer. Jim and Jeff will be reviewing the results for the quarter and also provide a review of the company's strategy and outlook during this contraction in the business cycle.

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

As you are aware, we may make some forward-looking statements during the formal discussion as well as during the Q&A. These statements apply to future events and are subject to risks and uncertainties as well as other factors that could cause actual results to differ from what was stated here today. These risks and uncertainties and other factors are provided in the earnings release as well as other documents filed by the company with the Securities and Exchange Commission. These documents can be found at the company's website or at

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

Jim Lines

Thank you, Debbie and good afternoon everyone. I am pleased by our operating performance in the quarter. Our team continues to execute well and profitably across the trough of this downturn. We have seen a low level of revenue across the past three quarters, down 30% to 40% from the same quarters twelve months earlier. We continue to maintain a cost structure that is in line with this lower revenue level to realize the benefit of productivity gains from prior investments and people, equipment and processes and most importantly to invest in internal development so we are ready when our market is recovering.

We believe we are nearing the end of the tunnel with respect to low quarterly revenue levels. It can be expected that the second quarter will be in a similar range as the prior three but nearer to the upper end of the range. Moreover, there is opportunity to exceed that level. This will depend on the number of smaller, short cycle orders one in the quarter along with our ability to pull forward and convert existing backlog to revenue.

In keeping with our full-year expectations of revenue in the $65 million to $72 million range, we therefore expect higher revenue levels commencing in the second half of the year. We've had a strong level of new orders over the past four quarters with trailing twelve month bookings at $107 million and approximately $80 million if the navy aircraft carrier order is excluded.

New orders in the first quarter were down and came in at $8.1 million. We have projected a light quarter for new orders because much of the immediately available major project work was awarded previously as is evidenced by our exceptionally high multi-year backlog level.

Backlog remains elevated and is just over $89 million. Graham is fortunate to have such a high level of good quality backlog during this period of immediate near-term uncertainty. While our markets flutter across what we believe is an early stage of recovery where erratic quarterly order levels are expected. Our backlog provides an exceptional base of business to work from and to build on to.

We expect new quarterly orders to vary quarter to quarter just as they have over the past two years. And looking at the pipeline of available opportunities, we are encouraged by how strong it appears. Understanding when orders will ultimately be awarded for projects in the pipeline remains difficult, but that is simply a timing issue. Macroeconomic drivers that spur demand for our products have not fundamentally changed.

We have identified opportunities in power generation, while alternative energy projects such as a biomass to energy and geothermal power generation. There was considerable refining activity planned for emerging economies in Asia and South America along with investments planned for the Middle East.

Moreover, we have North American refining opportunities albeit not to the 2007 to 2009 levels. Petrochemical project work appears to be picking up as we are involved in early bidding work for ethylene, fertilizer and other petrochemical processes.

There certainly has been a rough downturn, but I am pleased with how we are operating and how well we are positioned for when our markets recover. Our sales team has identified a number of areas that provide potential for organic growth including additional work for the navy, the expanding investment in the domestic market for alternative energy, nuclear power generation and there is of course additional market expansion in Asia and in South America.

Our proven ability to generate strong operating cash flow as markets recover along with existing funds available from our exceptionally strong balance sheet are allowing us to seek additional growth via acquisitions. Acquisition strategy is centered on geographic expansion and market expansion.

We are considering engineer to order products that fit our sales model. I believe Graham will be ready when our markets recover and that it will expand more quickly than during the last cycle. Internal development continues to occur. We are investing to strengthen our team with additional personnel and employee training. Our commitment to continuous improvement and operational excellence shined during this downturn period and we continue to improve the business in areas of lead time, ontime delivery, quality safety and customer satisfaction.

Lastly, I confirm the prior guidance of our full year revenue in margin is not changing. We expect 5% to 15% topline growth and gross margins in the 27% to 31% range. We will turn it over to Jeff for a detailed review of the quarter. Jeff?

Jeff Glajch

Thank you Jim and good afternoon everyone. I would like to preface my remarks by commenting on how the entire Graham team has continued to perform admirably during this challenging downturn in our market, ensure that we would remain committed to our customers, generated profitable results each and every quarter and more than doubled our backlog from a slow point a mere 12 months ago.

We are the near the end of the bottom of this cycle with perhaps one quarter left. We expect to see sequential quarterly growth and growth over prior year quarters commencing in the third quarter.

Let me hit on the key results in the quarter to give you some additional insight from what you read in the press release. Net sales in the first quarter of fiscal 2011 were $13.4 million, a $6.8 million decline compared with last year's first quarter, but in line with the guidance we provided on our May call.

As expected, Graham sales have continued to be more international in nature. First quarter fiscal 2011 sales were 59% international and 41% domestic compared with an even split at this time last year. Compared with last year's first quarter, international sales decreased by $2 million, a large decline in Asia offset by increases in all other international markets.

The decline in Asia was tied to an unusually strong billing level in the first quarter last year. US sales declined to $5.5 million, down $4.7 million. By industry sales dollars in chemical and petrochemical increased to $5.3 million or 40% of total sales, up from 23% of sales in last year's first quarter. Sales from refineries declined to 25%, down from 46% last year while power and other commercial and industrial markets increased to 35% from 31%.

As Jim mentioned orders in the first quarter of fiscal 2011 were $8.1 million, down 8% from last year's first quarter. As we've discussed for the past couple of years we encourage investors to look at our order level, not in one quartet of isolation, rather using a trailing twelve month view to best understand our order trends.

Backlog on June 30 2010 was $89.1 million, down from a record of $94.3 million on March 31, but up dramatically from this time last year when the backlog was a cycle low $37 million. Orders in the first quarter were 47% international and 53% domestic.

Despite slightly lean for domestic quarters this part quarter, looking forward we continue to believe that our sales and order mix international in nature specifically shifting to growing markets in Asia, Middle East and South America.

As we discussed in May it is important to note we expect only 50 to 60% of our current backlog to shift over the next 12 months conversion of backlog is 85-90%. However our few projects in our backlog have a longer than usual conversion period. For example the US navy project makes up approximately 30% of our backlog is not expected to begin to meaningfully convert to sales till early fiscal 2012.

Our backlog is put as follows 38% in refining, 13% in chemical and petrochemical and 49% for power and other markets, included in the later category is the navy project. On June 30 2010 we had 3 projects valued at 5.2 million in our backlog which are currently on hold.

Did have one project for 1.6 million cancelled in the first quarter at fiscal 2011 which we discussed on the May call. Our gross profit in the quarter was $3.9 million or 29% of sales compared with $8.3 million or 41% of sales in lat years first quarter. SG&A expenses in the quarter were $2.6 million or 19% of sales compared with 3.2 million or 16% of sales for this quarter last year. The restructuring initiatives we undertook over the past 15 months combined with lower costs related to the declines in sales and favorable timing of expenses accounted for the reduction of SG&A this quarter.

Please note that we do not expect to achieve this low level of SG&A dollar spending going forward and we have not seen our full year guidance on SG&A. interest income in the first quarter of 2011 was 16%. Effective tax rate 32% both items similar to last year.

Net income in the first quarter of fiscal 2011 was $878,000 down 75% below last years first quarter. On a per diluted share basis earnings were $0.09 compared with $0.35 last year. Continue to put these we have achieved solid financial results given the significant effect that de-leveraging has on our business with lower volume.

We structure the business to be profitable through the drop in our markets and we have to be ready for the upturn when it occurs. Grahams balance sheet remains strong with cash, cash equivalents and investments totaling $71.1 million at the end of June, now its 74.6 million at the end of March up 57% from 45.3 at this time last year. While we are very pleased with this level of cash it is important to note as we did in the May call still have an exceptionally high balance in customer advances which declined by $200,000 in the first quarter to $21.8 million but it is still well above the normal range of $ 5 to 7 million.

We expect the customer deposits to remain higher than normal throughout fiscal 2011 but we do believe the level will generally reduce over the period hence using rather than generating cash in this category. We used $2.8 million of cash for operations in the first quarter primarily from changes in working capital and the payout of deferred compensation which was earned in fiscal 2010.

Our working capital position net of cash and investment is negative. Even if one backs up the excess in customer deposits mentioned previously working capital net of cash on investments is still below 5% of sales.

We have no borrowing on our $30 million bank line and are utilizing it solely for outstanding letters of credit which totals $13.1 million on June 30. Capital expenditures were $525,000 in the first quarter as we began work on the capital project to support the US navy order.

As we look at the rest of 2011 our due remains the same the second quarter will look a lot like the past three quarters similarly lower sales levels $12 to $14 per quarter with as Jim mentioned potential for upside above $14 million expected gross margins in the mid upper 20s.

In the second half of fiscal 2011 we expect to see significant improvements in sales and gross profit. As Jim mentioned we are confirming the guidance provided in May for the full year fiscal 2011 we expect to see sales 5 to 15% above 2010 with 65 to 72 million with gross margins of 27 to 31%.

SG&A for fiscal 2011 should be in the range of $12.5 to $13 million and we expected an effective tax rate of 30 to 33%. From a cash standpoint we expect the operating cash flow may likely be negative in some periods primarily due to the unwinding of the high balance of customer deposits that I mentioned earlier.

The operating cash flow beyond the customer deposit line will continue to be strong as it has been even in the debt of this downturn. We expect our capital spending in fiscal 2011 to be between $2.8 and $3.3 million approximately half of this capital is for the equipment to support the US navy project.

We believe order level over the upcoming quarters will continue to be erratic and of all we generally expect the book to bill ratio to exceed 1.0 and our backlog to grow. We live to see some quarter where the book to bill is below 1.0 as we did this past quarter.

In closing we believe the first quarter was successful and in line with our expectation. Let the lower level of sales over the past few quarters we continue to remain profitable and manage our cash and working capital effectively. You have seen our backlog dramatically stand over the past 12 months by staying close to our customers.

The markets are still rough and we see top and bottom line growth occurring in the second half of this fiscal year based on converting a strong backlog. We believe we remain profitable in the second quarter as we did in each quarter of this downturn and expect to see a noticeable sequential improvement in sales and earnings in the second half of fiscal 2011.

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

Jim Lines

Thank you Jeff. Operator, please turn it over for questions at this time.

Question-and-Answer Session


Thank you we will now be conducting a question and answer session. (Operator Instructions) one moment please while we poll for questions. Our first question comes from the line of Rick Hult with ROTH Capital Partners, please proceed with your question.

Rick Hult - ROTH Capital Partners

Jim this is going to be more of a difficult question you been through couple of these up cycle down cycle periods and do you have an initial read on the potential trajectory of the next up cycle, (inaudible) trough year does it feel like its going to be may be down speed to the last one average, below average anything you can give us here?

Jim Lines

Your right that is a tough question, but as I sit here and look at our pipeline of opportunities which is expanding this is a number of high quality opportunities in the pipeline and refining in petrochem, power generation some floating L&G work as I sit here today and reflect on where it was in 2003 or 2004 as we saw a building wave of opportunity coming into the pipeline I feel fairly similar to how it was back then.

It's not to say though that that will necessarily translate into similar strength that we saw the last cycle but qualitatively and somewhat quantitatively as I look at our pipeline it feels fairly similar to how I felt back then.

Rick Hult - ROTH Capital Partners

Are you looks like begun to some of the its nearing (inaudible) recently like yesterday or day before and saw that [FK] had won the installation fees. Are you able to give any information if you are on that or any contract wins there?

Jim Lines

That is the type of project where Graham has great opportunities for those products. So we have two large projects in our backlog for Saudi Arabia in refining projects, already one is associated with that project, but there is additional work that we potentially could win from that project.

Rick Hult - ROTH Capital Partners

Jeff, M&A it is something that we talk about every quarter. It hurts to see the interest income such a small piece of that cash balance and can you give us a schedule, an expectation when do you think some M&A, is it going to close?

Jeff Glajch

Rick, I agree it does hurt to get that miniscule level of interest on our cash. We are continuing as we talked about. We are continuing to work through what is a pretty significant pipeline of opportunities and narrowing down to smaller number and we have been pretty active in discussions and from a timeframe standpoint I really can't give you any further direction there. As we move forward obviously there is a buyer and a seller in any transaction and plus to successful there we need to find a seller who is in line with our view and both from a dollar standpoint as well as from a timing standpoint.

So suffice it to say we continue to be quite active in that arena and there are a good number of opportunities out there that we are pursuing

Rick Hult - ROTH Capital Partners

And buyers and sellers, it sounds like broadly speaking are coming closer together these days than they were say a few years ago.

Jeff Glajch

That's an accurate statement.


Our next question comes from the line of Chris McCampbell with Stifel Nicolaus.

Chris McCampbell - Stifel Nicolaus

Can you talk about where you are in the certification process for more nuclear business, how far long you are and how far away we would be from booking additional revenue there?

Jim Lines

For a nuclear certification that's a lengthy process that spends 12 to 18 months in terms of it showing up as revenue, I wouldn't expect revenue to flow through our books for nuclear projects or at least 24 months.

Chris McCampbell - Stifel Nicolaus

And talk a little bit about the opportunity for more military business?

Jim Lines

Sure we were pretty encouraged by that we have engaged with the navy and stated clearly what our intent was with respect to supporting their program, the nuclear propulsion program. There is more carrier work that we are able to do, we believe. There is also work for our products on submarines and destroyers and other surface vessels.

And there is a lengthy qualification process outside of the carrier work. We don't see [subworks] immediately in front of us, but we are into the qualification process. We have a very receptive customer that we are dealing with in terms of wanting to work with Graham in the future. So we see great upside potential from the naval nuclear propulsion program.


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

George Walsh - Gilford Securities

Jim, could you elaborate a little bit on the M&A activities of the type of companies you are looking at no more or less the size in the industries and what you are looking to accomplish there or just an overview of the candidates you are looking at?

Jim Lines

Sure George, what we are looking at would be companies that have engineered to order products or products that fit our type of sales model, our type of business model where there is a long sales cycle where the design of the equipment is specialized, the integration of the equipment into the customers process is very complicated. The reliability and the risk of failure is very expensive for the end user.

So we are looking for those types of products which could include heat transfer products other vacuum producing equipment, (inaudible) heat transfer, mass transfer as well as packaging or systemizing some of these products into a larger scope of supply.

So we are looking for that type of product that's engineered to order. We are also looking at where decisions again because of the engineer to order and the cost of failure is high, decisions tend to be more value based than price based and we are looking at businesses that provide either geographic expansion or allow us to enter into additional markets with additional products or could leverage our existing sales channel by selling more products through our existing customers, the way we are selling our current products.

From a company size, we have talked in the past George about revenue range between $20 million and $60 million, not to say that we won't look above that range because we have and not to say that we won't look below that range because we have, but we think that's the switchbox for us and as we do the evaluation for this businesses, we're not looking for simply an accretive acquisition to add a little bit to earnings per share, we're looking at it on a cash flow basis and its even a return that's above our targeted cost to capital that we have internally. Has that answered your question?


Thank you. Our next question comes from the line of Dick Ryan with Dougherty. Please proceed with your question. Your mike is now live.

Dick Ryan - Dougherty

Thank you. Say Jim, could you refresh my memory. You said there's three projects on hold in backlog? When was that? I mean going back to quarter or two I believe it was higher than that but what did it get to at that point?

Jim Lines

One point when it was at its highest level, we have five to six quarters on hold. I think the value was around $7.5 million. We had a recent cancellation in this last quarter that we recognized some revenue on as well as a cancellation fee. There is three other orders in backlog now on extended delay. We believe one of the three will be coming off shortly and we may expect revenue in the latter part of fiscal '11 and a bit into fiscal '12. The other two which are about $2 million of the $5 million on suspension or hold, are likely to be released in fiscal 2012.

Dick Ryan - Dougherty

Okay. Can you talk about what industries they are related to, either the hold projects or the camp foundation?

Jim Lines

Sure. For the three that are on suspension, they are all four refining markets. One is for US refining installation, not for transportation fuels but for advanced lubricating oils to improve the efficiency of a gasoline engine. The other two are for refining projects in international markets and our quarterly follow-up or a period follow-up with our customers. Two projects for the international markets are still viable. It's believed that is a timing issue as to when they get released and our best estimate at this point is they will be released in fiscal 2012.

Dick Ryan - Dougherty

Okay and you said there's an opportunity for some upside in the current quarter, either from turns on your business or pulling something forward. Can you kind of characterize what that was until now?

Jim Lines

In terms of the upside potential, we've given a range of $12 million to $14 million for our quarterly run rates through these four quarters that are the current downturn. Upside beyond above the upper range or as you said come from short cycle orders that come in and go out in a quarter and a level of work that we're able to go through to win and convert during the quarter and really getting some of that backlog moving. If then customer releases and our ability to get it into production for revenue recognition. Just to give it a upper range, that's within a $1 million of the upper range we've already given you.


Thank you. Our next question comes from the line of George Walsh with Gilford Securities.

George Walsh - Gilford Securities

Jim, could you describe, just going against your view of the improvement in the cycle, could you describe it in terms of what you're seeing from some of the larger engineering or architectural design and engineering firms that you've worked with in the past and the activity they are seeing and how that's passing on to you and how that compares with other cycles or the previous ones?

Jim Lines

If we look at the opportunities that we're working on and our interaction with the contractors, they are become more encouraged about the timing of when projects will move ahead. You maybe aware that [Florr] had an announcement of a record bookings in the last quarter and their backlog is at fairly high level at this point, Jacob's was bullish as well.

The international contractors in North Korea, they've been winning a good amount of work. The Japanese contractors are beginning to get encouraged. But all around the world, with the exception of I'd say refining in the North American market, we're seeing more optimism from the contractors that we're interacting with and the engineers that we interact with along with the triple machinery OEMs. We just believed that now it's a matter of timing as to when we actually start to move through the pipeline to purchase.

George Walsh - Gilford Securities

So really, it seems like it's everything except Lawrence, America as you stated that there?

Jim Lines

Well let me just qualify. Asia, Middle East and South America.


Mr. Lines, there are no further questions at this time. I would like to turn the call back over to you for any closing comments you may have.

Jim Lines

Thank you. I thank you for your time this afternoon. We appreciated your questions and your interest in our company and we look forward to updating you on our progress during the next call in October. Thank you.


Ladies and gentlemen, this does conclude today's conference. You may disconnect your lines at this time and we thank you all for your participation. Good day.

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