Graham Corp (GHM) 2009 Q1 法說會逐字稿

Greetings and welcome to the Graham Corporation 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.

Thank you 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 in 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 filings the Company has made with the Securities and Exchange Commission. With that let me turn it over to Jim to begin the review and discussion. Jim?

Thanks, Tammy. Good morning, everyone. As you have seen from our news release, we had a great first quarter to start off 2009. Sales were a new quarterly record of $27.6 million and were 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 doubled the first quarter of fiscal 2008, and earnings for the quarter were $1.11 per diluted share.

I would be remiss if I did not point out that this took a great deal of effort and team work by 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% topline 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. 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. For 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 (technical difficulty) [hiring] fabrication in China and in South Korea. North American subcontracting will continue to create added capacity as well.

Our productivity enhancement and selective outsourcing combined with the quality of the orders we shipped in the first quarter lead to the very strong gross margin of 44%. We have raised our gross margin expectations for the year to 39% to 42% with it being likely that we will be at the upper end of that range. That implies 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 where are we in this cycle and for how long can Graham sustain this level of growth and these strong margins. I continue to believe our markets are strong and support continued organic growth. Industry reports, indications by customers and our quotation activity all suggest there remains tremendous opportunity for Graham's products and services.

The refinery market outlook is strong. OpEx 2008 world Oil Outlook released recently provides a great perspective for the coming several years. Hydrocarbon Processing's Box Score report continues to add new refining and petrochemical projects each month. We are involved in a number of projects at various bidding stages that give us belief that we can achieve our growth targets. Examples include several major projects in India, Essar Oil, Mangalore Refining, Hindustan Petroleum, Oil & Natural Gas Corporation and IOCL.

China has several planned refinery projects on the horizon -- Sinopec Qilu, Sinochem Quanzhou and Tianjin Russia 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 significant refining investments; the Middle East continues to expand its refining infrastructure; Aramco and Conoco Philips have a joint venture at Yanbu. Aramco and Total have a joint venture at Rastanora in Saudi Arabia. KMPC in Kuwait has a massive project. Qatar Petroleum at Al Shaheen Refinery has a major investment under way.

Each major project is for the refining sector and that will require several million dollars of Graham equipment. We expect additional work in the US for revamping existing refineries to diversify feedstocks, increase capacity and improve bottom of the barrel conversion; that will represent very nice opportunities for us.

Significant investment in oil 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 Graham type products. We are continuing our watch 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 respected brand from the quality of our engineering and manufacturing, the level of service and high degree of responsiveness we provide our customers and the reliability of the equipment we deliver. Given the current outlook of our customers and the strength of the fundamentals of the industries we serve, we expect a solid continuation of growth through 2010 and we believe our strategy to be a world-class leader in the design and manufacture of engineered-to-order products for the process industries will derive further opportunities beyond that. Let me turn it over to Ron.

Thank you, Jim. Today we reported net sales of $27.6 million for the first quarter of fiscal '09, a 38% increase over sales of $20 million in the first quarter of fiscal '08. Aftermarket sales were particularly strong due to a couple of large capital spare orders for domestic refineries. Spare orders of this magnitude are infrequent.

As a result of these large orders aftermarket sales were $8.9 million or 32.2% of total sales in the quarter. Aftermarket profit margins are generally very good. We do expect that as our base of installed equipment continues to expand throughout the world aftermarket sales will continue to grow as a percentage of our overall revenue.

Sales of condensers were also strong in the quarter, at $5.8 million or 21% of total sales, up $3.8 million in the first quarter of fiscal 2008, while ejector system sales dropped slightly to $8.1 million or 29% of total sales compared with $10.5 million in the first quarter of fiscal '08. Domestic sales made up 67% of total sales in the quarter while international sales were 33% of our sales.

As we routinely mention quarter-to-quarter fluctuations in sales by product classification or destination are expected considering the size and timing of our orders as well as 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 were strong in this quarter, representing 31% of total orders compared with 14% in the same period the prior fiscal year.

We had a strong quarter of international orders which increased to 65% of total orders compared with 18% in the same quarter 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 million, a 28% increase compared with backlog of $59.2 million at the end of the first quarter of fiscal '08. We expect that 5% to 7% of this backlog would 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 last fiscal year. The large aftermarket sales pushed gross margin higher in the quarter as a higher percent of the mix was weighted to higher-margin sales. Additionally, our order selectivity and 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 cost were the primary reason for increases in SG&A cost. Of importance, we continue to gain 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% U.S. Treasuries six months back. Last year we were invested in US-sponsored agency notes which yielded greater returns 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.

We ended the first quarter with approximately $45 million in cash and investments, up from $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 there were 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 $163,000 in the first quarter of last year. We believe CapEx spending would be in the $2.1 million range in fiscal '09.

And finally, as many of you are aware of, my retirement as Graham's CFO is effective today. So in addition to reviewing the operating and financial results for the quarter, I have some closing remarks that I would like to share.

My 15 years at 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'm very proud of is that my departments are in excellent shape to carry on. They, as with all of Graham's departments, are rich and talent with dedicated and experienced people. For Graham I believe the best is yet to come. We have a strong three-year growth plan and the talent, financial resources and business opportunities to reach our goals.

Thank you, Ron. Operator, please open the line now for questions.

(OPERATOR INSTRUCTIONS). Brandon Osten, Venator.

Hi, guys. Just fantastic quarter. Congratulations. I guess the one thing I wanted to start out is I'm just trying to model the annual financial statements here. And based on your guidance I guess your normal seasonal patterns would be a really strong Q4. So is it fair to say that Q2 and Q3 are both going to average about $25 million a quarter, maybe weighted a little more towards Q2?

Our guidance for the year for topline is 15% to 20% topline growth and we've had a $27.6 million first quarter. If there is a seasonality in our business it is our third quarter which typically has a slight downturn in topline revenue -- in revenue.

Okay. And I guess from an earnings perspective, obviously you guys had that big jump in Q1. So if I were to sort of look at the earnings do you guys think that you'll be able -- is $1.10 sort of the best quarterly EPS number you're going to throw up this year or do you think you can get ahead of $1.10 given that you expect margins to be a little lower over the rest of the year?

And again, from a guidance perspective we have updated our gross margin guidance from upper 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 its performance, but we're sticking to our guidance that we've given thus far and we'll update you quarterly as we go forward if there are improvements that we can make.

Okay. Thanks, guys.

James Bank, Sidoti & Co.

Good afternoon. Congratulations to you both, $1.11 in your first quarter when you only did $0.89 not only two years ago for the full-year '07, quite an accomplishment. Really not too many questions; the first just being SG&A. To me with the sales you've put up it seemed a bit light. Clearly on an absolute dollar basis it increased, but in terms of the profit sharing plan you have I think baked into your G&A or the selling expense -- did that just not impact you much in the first quarter? Or Ron, is it sort of that comment you make that the leverage you have on the SG&A is just coming into play here?

It's the latter.

Okay, fair enough. And with the new updated gross margin guidance and I guess with, again, the comments you have made in terms of you haven't seen busy yet, one would safely be able to assume that there's no reason why gross margins would fall from where you're anticipating in '09. In fact, you might even be able to assume that they could improve?

Certainly we're gaining. We're continuing to work on improving our leverage over our cost, both step variable and fixed variable as well as a variable. And we're continuing to make good gains in improving the efficiencies in the Company. I think we've said many times that we think we're probably only halfway to the identified improvements we can make. We'll continue to work on order selection and gross profit, but our real statement is -- our model calls for improving -- continuing to grow the topline 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 than continuing just to try to drive up gross profit margins per se. For us it's all about improving our earnings-per-share and continuing to get a better sales expansion globally and position ourselves better with our larger customer base.

Thank you, I appreciate that color. And then lastly on the aftermarket business, historically -- correct me if I'm wrong -- that was a bit more lumpy than maybe your core business. But again, from your remarks it seems as though it's stabilizing and/or you're able to have higher visibility on it and it's going to trend as long as your other core products are trending?

Well, my point was this particular quarter, over 8% of our sales increase was due to the -- let's put it this way. This particular quarter we had two large aftermarket orders, which were unusual for us, and aftermarket orders has a good profit built into the aftermarket business. So the overall weight helped the gross profit margins for this quarter to 44 whereas Jim, for the year, is making reference to up to 42%.

Okay.

As we continue -- a large portion of our aftermarket business comes from our ejector sales which have been strong for the last couple of years and we continue to think they're going to be strong to stronger going forward. But that's not our only product that has aftermarket business. But the more we grow our sales and the more we grow particular products within our sales the more installations we're going to get out there which will lead to a continued growth in aftermarket business.

Other areas that are taking place right now is refineries and businesses because they're so busy, where they can they'll have a tendency to go in and repair and fix their processes to keep them going versus brand-new installations. So we are also seeing growth in our aftermarket business just because in some cases it's a quicker fix than a longer-term fix.

Okay. So still then slightly lumpy I guess coming forward? The next one I would have, Ron, just an individual congratulations to you and best of luck in your retirement.

Thank you.

(OPERATOR INSTRUCTIONS). Greg Garner, Singular Research.

First of all, congratulations on a fabulous quarter. My questions have primarily been addressed, but just for some clarity on some of the aftermarket orders, if you could characterize a more normal quarter for aftermarket orders in the first quarter. Would it have been approximately what, $4 million less, about half of what was there? I'm just trying to get a (multiple speakers) ongoing how much of a big boost this was for the first quarter versus what would have been perhaps normalized view of it?

If we look at our aftermarket business on an annualized basis, it has been between 16% and 18% of overall sales. And I would project going forward on a more normalized basis that will still hold true.

Okay. And with all this cash buildup is there any sense on what might be a good use of this cash?

Yes. Right now we're accumulating cash of course; we can't help it with the amount of free cash flow our P&L is generating. But to continue our growth, which is absolutely our plan, we'll need acquisitions and other business combinations going forward. We believe our balance sheet is under leveraged; so we believe that it can take on more debt as well as with the cash that we are building up. We believe that we would be able to use our balance sheet strength and our cash to help continue to grow the business through acquisitions and other business combinations which could include joint ventures or whatever makes sense as we go down the road.

You saw that we did have a stock split -- I mean, a stock split and a dividend increase as well announced. So we are certainly mindful of our shareholders. Additionally, while we're on this subject let me just say that we did have additional shares authorized at the last annual meeting and we do not believe -- really our only plans for those shares at this time was the stock split that is now announced. We have no additional plans at this time for those shares.

We wanted those shares approved so that we could get and the need for authorized shares or the potential need for authorized shares announced at one time and not have to continue to go on. But we really have no specific plans for a share offering or anything that would dilute earnings for our shareholders. We're very sensitive to our shareholders and dilution. So I think that's kind of a long-winded answer, but in case I'm reading more into your question and the cash per se (multiple speakers) acquisitions through cash.

That's good to hear because you're in a great cash generating mode right now and always -- it's a nice problem to have, but it's something that needs to be addressed.

Absolutely. We're absolutely 100% in line with what you're saying. And to get to where we want to go organically as well as other growth plans it will require utilizing that cash, it's not just going to sit there.

And just a quick follow-up on the previous question where your answer about the margin improvement, the gross margin improvement, only about halfway there to -- you've identified other improvements that you feel you're only halfway to the total end game there. Would that correlate on a gross margin basis of a few percentage points in the coming years given the same kind of mix in the sales if that were the case?

What we're looking at, Greg, to expand our capacity and improve our productivity are a number of strategies that are taking place in our operations, in the plant as well as in the engineering and in the office, to make better use of our infrastructure. There's greater demand than we have capacity across the business. We can't fulfill all the demand.

Our strategy is to continue to grow the business and, 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 right now.

The gross margin, it really will come down to the sales mix and how quickly we can improve the leverage across the infrastructure. We do expect, and we said this on the last call, to have very good quarters going forward and there may be quarters that are below the 44% or below the 42% gross margin that we spoke about earlier. Our objective is to drive the business but not make decisions solely that center around optimizing gross margin. They will center around expanding our earnings and building sustainability into the business.

Okay. Again, I appreciate that color and congratulations again on a great quarter. And Ron, I wish you the best in your retirement (multiple speakers).

Thank you very much, Greg.

(multiple speakers) good shape.

Brandon Austin, Venator.

One quick follow-up. I mean, I know you guys have your total growth target on the basis of organic and acquisitions and you guys foresee 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 -- when you say that the cycle is going to remain strong for three years what kind of growth do you foresee over those three years from just an organic standpoint? Is it sort of a continuation of 20%, is it more sort of midteens? I'm just trying to get a sense of what you guys characterize as strong organic growth.

We expect a target rich environment across our markets as well as other markets where we're looking to penetrate. The compound annual growth rate, as you noted, has been above 20% for the last four years, it's around 23%. I would expect going forward, aside from the 2009 guidance which is 15% to 20% topline growth that's nearer to the midteens.

Great. that's awesome. Thanks a lot, guys.

(OPERATOR INSTRUCTIONS). Seeing as there are no further questions, I'd like to turn the call back to management for closing remarks.

Thank you. Thank you for your questions 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 is from 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 while staying focused on building towards a better future for the Company.

Ron, I thank you for your years as a senior executive at Graham. Our company, and I personally was fortunate to have a financial executive of your caliber on the team. You've prepared the Company well for your retirement. I wish you well for a long and healthy requirement.

Thank you very much, Jim.

In closing I continue to be optimistic about our future. We're executing well on our improvement and capacity expansion strategies. Our brand continues to become stronger and we are using our engineering and manufacturing know-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 teleconference. Thank you for your participation.