Graham Corp (GHM) 2012 Q1 法說會逐字稿

Greetings and welcome to the Graham Corporation's First Quarter 2012 Quarterly Results. 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, Ms. Deborah Pawlowski, Investor Relations for Graham Corporation. Thank you. Ms. Pawlowski, you may begin.

Thank you, [Jackie] and good afternoon, everyone. We appreciate your joining us today on Graham's Fiscal 2012 first quarter conference call. On the call, I have with me today, Jim Lines, President and CEO and Jeff Glajch, Chief Financial Officer.

Jim and Jeff will be reviewing results of the quarter and also provide a review of the Company's strategy and outlook. On our website at graham-mfg. Com, you'll find both the news release as well as supplemental slides that the guys will be talking to here today.

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

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

Thank you, Debbie. Turning to slide four, highlights for the first quarter. I feel we had a very strong first quarter with fiscal 2012. Our traditional sales expanded by 58%. Energy Steel provided $3.9 million in sales. We saw strong sales growth for the Middle East, in particular two projects for Saudi Arabian refineries and for South American refineries.

Our sales mix geographically was 55% international, 45% domestic. From an end-use market perspective, our sales mix was 48% for oil refining markets and 22% to power generating markets, including the nuclear market, 12% for petrochemical markets.

For order intake, we had $5.1 million of orders from Energy Steel for the nuclear market, another 1.8 million within the power market sector for renewable energy and alternative energy markets, $5 million in orders for oil refining markets. Our bidding activity still remains strong and diverse across our market mix. Orders were 37% for power generating markets and 32% for oil refining markets.

We had strong margin in the first quarter with gross margin of 32.8% and EBITDA margins of 20%. This was due to a better leverage and higher sales. We also had strong mix of more profitable orders in the quarter and we've converted much of the low margin backlog that went through our sales in Q2, Q3, and Q4 of last year, pretty much through our backlog now. So that's also helping to lift margins.

Turning to slide five, as you can see our guidance for fiscal 2012 is -- the midpoint is $100 million. We're projecting about 50% international, 50% domestic. Within that projection for fiscal 2012, we are projecting that traditional product growth, including the Navy, will expand by 20% to 25%. And with Energy Steel that yield is about a 35% topline expansion for the business, one-third is traditional products -- sorry two-thirds is from traditional products, and one-third from the acquisition of Energy Steel. We also see a large amount of the Navy order converted during fiscal 2012.

Turning to slide six. In Q1, Energy Steel again provided 5.1 million new orders, 3.9 million of sales. The backlog as of June 30 at Energy Steel is $9.7 million. We're seeing a good amount of bid activity by Energy Steel within the existing US plants and also we have some activity around new construction in the US market that Energy Steel is pursuing as well.

We see a huge addressable opportunity for Energy Steel in new construction with a long-term perspective is not necessarily [meagerly] in front of us, but from a longer-term standpoint to see a lot of opportunity there.

Onto slide seven; our outlook for fiscal 2012 remains unchanged. Revenue between $95 million and $105 million. Energy Steel being 16% to 20% of that total revenue. Again, traditional product growth rate in the 20% to 25% range. Gross margins, we're projecting to be between 29% and 32% with SG&A between $16 million and $17 million.

Our priorities in fiscal 2012 are to advance our market share in our traditional market of oil refining and petrochemicals, primarily in Asia and South America, where there is a good amount of bid activity now, continue to maintain our strong market position in the Middle East, and also to defend and dominate our position in the North American markets for oil refining and petrochemicals.

We also wish to expand the capabilities of Energy Steel to increase their sales and profitability by exploiting the synergies of Graham engineering and fabrication capabilities and by aggressively pursuing sales to US nuclear utilities and also capitalize on new opportunities for new construction.

Moreover, we'll continue to push in the Naval Nuclear Propulsion Program. I'm very pleased with our progress thus far. This is a long-term strategy and I'm very pleased with where we are at this point in time. And we'll also consider and evaluate additional acquisitions as part of our growth strategy.

With that brief overview, I will turn it over to Jeff to give more detail on the financial results for the quarter.

Thank you Jim and good afternoon, everyone. As Jim mentioned, we had a strong start to fiscal 2012. Sales in the first quarter were $25 million, up $11.6 million or 87% compared with the first quarter last year. Organic growth was 58% of this; the remaining $3.9 million was from Energy Steel.

Sales in the first quarter were 45% domestic, 55% international, which is slightly closer to more domestic business [that was last time]. Graham's historical markets continue to be tilted more toward international, however, Energy Steel is almost exclusively domestic.

EBITDA margins in the quarter was 20%, up from 12% last year. Q1 net income was $3 million or $0.30 per share, up from $900,000 or $0.09 per share in Q1 last year. And as expected and as we've communicated in the past, Energy Steel continues to be accretive to earnings in this quarter as it has since we purchased the business.

On the next slide, looking at backlog, orders in the first quarter were $19 million, up from $8.1 million in the first quarter last year. Included in the first quarter orders were $5.2 million from Energy Steel, which continues to add to its backlog. Backlog at the end of June was $85.2 million, down from $91.9 at the end of March. Energy Steel's backlog is up to $9.7 million as its orders continue to be strong.

Finally, as we mentioned on the May call, we have no orders on hold by our customers. The last order, which had been on hold for just over $1 million, was reinitiated by our customer earlier in the first quarter.

On slide 12, gross margin in the first quarter was 32.8%, up from 28.8% in the first quarter last year and up sequentially from 30.5% in the fourth quarter of fiscal 2011. SG&A in Q1 was 14.8% of sales, down from 19.2% in last year's first quarter and at a similar level that we've been at in the last two quarters of fiscal 2011. Operating margin was 18% in the first quarter, up from 9.6% in last year's first quarter and 15.4% sequentially.

On slide 13, our cash position continues to be strong with $41.1 million of cash and no bank debt. In fiscal 2011, we used $18 million of cash to purchase Energy Steel. We believe we are well positioned to utilize this cash for future acquisition activities as well as internal growth opportunities. We are very pleased with the acquisition of Energy Steel, its performance, the strength of its management team, and its nice fit to Graham.

We are continuing to look for newer acquisition opportunities going forward. We intend to use the same discipline and thorough methodology as we did with Energy Steel. We believe it's not whether we make new acquisition that's important, but rather that we make the right acquisition.

Finally, to reiterate Jim's comments on the full fiscal year, we expect revenue growth of 30% to 40% to be between $95 million and $105 million. Of this growth, there's organic growth of 20% to 25% with the rest of the growth coming from Energy Steel. Energy Steel is expected to provide 16% to 20% of Graham's overall revenue in fiscal 2012.

Gross margins are expected to be between 29% and 32%, SG&A between $16 million and $17 million, the tax rate is unchanged, expected to be between 33% and 35%, and as we discussed in May, we expect capital spending to be between $3 million and $3.5 million as we look to upgrade our facility in Batavia.

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

Thank you. We will now be conducting a question-and-answer session. (Operator Instructions) Rick Hoss, ROTH Capital Partners.

Jim, Jeff, Debbie, good afternoon.

Good afternoon.

Good afternoon.

Hi, Rick.

On Energy Steel, the $4 million or so in sales, is there seasonality with the business or it seems to be -- for this particular quarter, it seems to be maybe a little bit lower than the run rate and the growth rate, et cetera.

Rick, this is Jeff. There is a little bit of seasonality really around when facilities are shut down and when they start back up. The $4 million was -- just under $4 million was actually in line with what we expected for this quarter, but there was a little bit of seasonality.

Okay.

Just to add a bit to that as well, with the floods in Nebraska, there were two delayed shipments that were outside of Energy Steel's control due to the inability of the utility to come in for mandatory inspections before progressing with further production on the orders. We didn't have control over that, but it did affect the overall revenue in the quarter for Energy Steel.

Okay, that makes sense. Thank you for that. And then, [what are you] hearing about the NRC reviews? I think they finished it up and I think that if I read correctly, there's quite a bit of suggestions for facility improvements and additional infrastructure safety, et cetera. What are you hearing from your customers?

Well, the report is relatively new, but what is encouraging to us is the findings that relate to additional safety measures around secondary cooling and extending the ability of the plant to operate in an electrical power outage. We think both of those initiatives should create demand for Energy Steel and Graham products.

Okay. And then, Jim, if you can focus on a bigger picture, more of the cycle, thinking about where the Company traditionally, you have visibility for several years out as you're starting to work on projects. It's a two, three-year type of process where you start the proposals in engineering and go from there. What are your visibility into -- how many years out are you confident in a cyclical recovery and a growth trajectory for demand for your products?

What's really great about our sales model is that you're inferring, we do get involved very early during project conflict and initial front-end engineering design work before a project is funded. There is a great deal of bidding activity that we're involved and that relates to that type of work. I've made comments on prior conference calls that it does feel to us as itself back in 2003 and 2004 with respect to how the processes are beginning to circulate through the pipeline and it's continuing to build on a number of projects and announcements [have] at the inflection point, pretty strongly, primarily in the Asian markets.

These are all encouraging signs. So, as I said in prior conference calls, it feels to me and to our sales management team, that it's like it was back in the 2003, 2004 timeframe and the quality of (inaudible) most importantly is it's just a matter of time before that converts to real bidding activity in orders and then translates into sales. So we feel pretty confident about the longer-term view as we did in 2003 and 2004. It's less clear to us this quarter and next quarter, but our view long-term is very optimistic.

Okay. And if we were to graph out the demand from the last cycle, it would almost look exponential to certain degree. Are you expecting a similar type of pattern where it starts out slowly, and then it builds and accelerates and accelerates and then we hit the peak?

Well, there is always that possibility that the past plays out again. One of the things that we observed in the last cycle is too many projects came too quickly and the supply chain couldn't handle it. And that escalated the overall cost to the owner. And invariably and quite honestly, I'd prefer to see it [pace] a little more slowly, so we can capitalize and take more market share of the available opportunity of this expansion.

How it actually rolls out? We'll actually have to watch and see, but we are encouraged in general by the amount of bidding activity and the type of bidding activity suggesting that there is a multi-year expansion at some point here in the future.

Okay. And then last question, with additional work coming from Asia and China, what does that do to gross margin?

It does have an effect to put pressure on gross margin. Now, in view of that and as we've indicated back in the late 2008, 2009 timeframe, we felt we were going to experience margin pressure due to our sales mix becoming more internationally weighted. The management team is focused on gaining capacity, improving productivity to defend our margin on given sales dollars through cost and productivity improvements, while comparatively, the price pressure is there. So we've done some things to prepare the business for those headwinds, but there is margin pressure internationally, but we have not stood still in response to it.

So it shouldn't be something that would deviate from the historical trend of, within the cycle, you have revenue growth and you have gross margin expansion simultaneously.

That's correct and what we've said is as we go into the hotter periods of the next expansion, we would expect the upper end of our gross margin range to be in the mid to upper 30s, whereas before as you might recall, we did eclipse 40%. We're going to go at it again with the same figure, but we do expect it to be in that mid to upper 30% range at the next peak, but on higher volume.

And with that hotter period, as you term it, then we would also potentially have growth rates above the 20% to 25% organic that you're implying with your fiscal '12 guidance?

(inaudible). We've implied that the traditional product growth rate might be above 25%. Is that what the question was?

Rick, are you there? Jackie? Hello?

Yes, he's no longer in queue.

Okay. As we model the recovery, we tend to think of our traditional product growth rate as it was last time somewhere in the upper teens to the mid-20s, depending up on what year. The overall growth rate through the last cycle was about 25%, 26%. We see a great opportunity here as well in this next expansion where that's possible. To achieve a traditional product growth rate above that, that is possible, but we'll have to see how the project paces as well as our ability to gain capacity within our organization to execute at that higher level.

We do have Mr. Rick Hoss back in the queue.

Sorry, Rick, if I didn't actually answer your question. Rick?

Do you guys hear me at all?

Yeah. We can hear you now.

Okay. Great. Yeah, I think you answered that. I got disconnected for some reason. It was basically you're implying with your fiscal '12 guidance here implying a growth rate of 20% to 25% and with your comment, you described the cycle as having a hotter period of it. And so my question was, well, does that hotter period imply a growth rate higher than the 20% to 25% that you're currently putting out there with guidance? And I think you answered as, yes, there is a potential for that to happen

I did, yes.

Okay, thanks, guys.

Thanks, Rick.

Thank you. Joe Mondillo, Sidoti & Company.

Good afternoon, everyone.

Hi, Joe.

My first question was just sort of a follow-up on two questions earlier. One, how much did that order that you sort of lost some of it at Energy Steel due to the flooding in Nebraska? How much did that account for? And the other follow-up was, do you know anything specifically how you're going to benefit from the suggestions of the new regulations that the NRC has put out there, specifically within your business or is it just, sort of, it sounds positive, there's going to be more regulation out there and it sounds potentially that you're [stapling at a] benefit from?

The first question, the push out was between $0.25 million and $0.50 million. That's still out of the first quarter and will be realized in our second quarter due to the flooding of two utilities in Nebraska.

With regard to the NRC regulations and if we refer back to the 9/11 timeframe when new regulations came out, it takes about 12 to 18 months before they get into the supply chain. Qualitatively, what we're reading is, it should create demand for Energy Steel and Graham products. We need to learn more what specifically needs to be done, but the high-level comments are around additional cooling, secondary cooling, and to be able to operate from longer period of time with a loss of power and we can envision that will drive demand for Graham and Energy Steel products. To be specific about it, it's too premature.

Okay. That's fine. My second question has to do with sort of the backlog and what that looks like. What percent of the backlog are you expecting to hit in fiscal '12?

I think we said 85% to 90% of that would go over the next 12 months and typically -- for this year, we're probably thinking about -- roughly 75% of that will go over the next nine months. 75% of the total.

Okay, okay. And then, so looking at the rest of the backlog, what kind of margins are you seeing in your fiscal '13 backlog?

The fiscal '13 backlog primarily is the Navy contracts. I don't really want to disclose that margin.

Okay.

But I would qualify that it's comparable to the average margin of Graham that's not extraordinary on the upside or on the downside.

Okay. And then seeing that you brought up the Navy, my next question, I guess, has to do with that. How much of the $95 million to $105 million of sales guidance is associated with the Navy this year?

Yeah, ballpark around 10%.

Okay. And then how much leftover I guess of that Navy contract, are we going to see following this year?

We have more than half of it left exiting 2012 and of what's left, the majority of it, we'll book in 2013, but that will be a piece of it that goes into 2014 also.

Okay. And can you remind me how much that total contract was?

It was in excess of $25 million.

Okay. And if you could just talk about the relationship with the Navy, I think you said in your prepared remarks that relationship is going well, have you seen any new orders or how do you foresee that relationship going forward?

Sure. We've had the Navy, two of their shipyards, and a couple of their procurement contractors come through and do audits of Graham. And in each case, the comments were very positive around employee engagement, the Company's focus on safety, the professionalism of the management team, and the way in which the Company has executed the Navy order we have now has received very high praise from the buyer.

We have secured engineering-only orders for initial concept engineering on some submarine work. So that suggests to us that we're progressing in the right direction. We're demonstrating to the Navy that we are a credible supplier, highly capable supplier to execute the very complicated orders. And it's all moving very well from my standpoint.

Okay. And that secured engineering work is, sort of, new work that you've received in the first quarter?

We received it in the fourth and the first quarter. We've got [smarter] orders, but they're not -- they don't really move the needle, but they are more foundation orders that lay the stepping stones for the larger orders.

Right, understood. I guess one of my last questions has to do with the chemical processing markets. Could you just give a little color on what's going on there and why that's been fairly stable for you guys? Is that just a macro factor or sort of what's going on there?

Largely, the chemical -- petrochemical activity that we have in sales and our bookings has been for the international markets, primarily in Asia, where they have continued to build, not at the same pace as the mid-2000s, but they have continued to build up (inaudible), which to us is a nice indicator of the early stages of the next recovery. And we think that recovery will be led by the Asian and Middle Eastern economies.

But more importantly, another aspect that's occurred relatively recently has been strengthening in the domestic petrochemical market tied to the new gas -- natural gas finds. And as you may know, the primary feedstock to the U.S. petrochemical industry is natural gas. The cost of that feedstock now has come down appreciably. So, we are seeing some early stage bid work on reactivating some petrochemical plants in the U.S. that were shut down due to high cost of natural gas in the early 2000s. So that's a very encouraging sign. We see that longer-term is very beneficial to us and we're seeing some early stages of traction there with some initial bid work.

Okay, so the past three quarters where you've been sort of floating around that $3 million range, international growth is still very strong, but because you haven't seen a rebound because the growth in the U.S. just hasn't been there, but you're sort of expecting that that could rebound in the future. Is that correct?

Yes. And moreover the pace of the expansion in the Asian or international markets is not one that would suggest it's a full petrochemical market recovery, but we'll think that in the future.

Okay, understood. And then real finally, just coming back to sort of my question on margin, just generally speaking on the backlog, is it sort of a progressively improved margin profile as you go out quarter to quarter to quarter in the future?

With our type of sales process, the margins in our backlog or the margins for any given order can vary greatly. On a prior conference call, I think it was two calls ago, the question came up and I indicated that the average margin of our backlog was in excess of the margin for the sales being realized. That suggested that we would see margin lift in coming quarters. You saw that in Q1 when the quality of the backlog was higher, as it was converted into sales. So we are seeing an improvement in Q1 and we expect that improvement to carry into Q2 as we convert more profitable orders from our backlog into sales.

Has pricing changed at all in the orders that you're receiving?

As a general comment, I would say, no. I don't think the market has fully recovered, where the pricing really has had meaningfully improved.

Okay. Great. All right, thanks a lot.

Thanks, Joe.

Thank you.

Thank you. (Operator Instructions) Dick Ryan, Dougherty.

Good afternoon. Jim, moving beyond kind of the engineering work with the Navy on some of the submarine business, is the certification complete or nearing completion to get the necessary clearances?

Yes, I don't think that's a deterrence in winning future work. I think we'll have to point now where we're considered (inaudible) of qualified supplier and we'll be bidding on new construction for sub work.

Okay. So, I was just looking from a timing so that it looks like that's been taken care. You talked about the North American refining market, but I think in your earlier comments, you have something about the new construction, new nuclear construction with Energy. Can you talk a little bit more about what you're seeing now?

What we did see immediately after the Fukushima incident was a couple projects in the US went on hold. What we have seen though is projects that were used in the AP1000 reactor technology are still advancing, but we're bidding a couple of those projects. Our real litmus test will be, will those projects move to procurement? And our sense is, yes. And we'll know a little bit more over the second half of the year.

Yes, Dick, they need -- ultimately those facilities, which are in South Carolina and Georgia, need to get licensing approved before they can move forward in the licensing approval process right now.

Are you agnostic to the nuclear design or are you kind of tied with the AP1000 with Westinghouse or how do you view that opportunity?

We're not aligned with any particular technology. It all provides opportunity for us. We think the passive cooling technology of AP1000 is putting them, at this point, in a position to move forward with new reactor designs for new plant construction. But from a demand -- creating demand for Energy Steel and/or Graham with our traditional products, we are agnostic.

Any international opportunities developing it for Energy Steel?

Nothing meaningful. We've done some machinery work to understand, say, the activity in China. That will be a longer-term process to get ourselves in a position to capitalize on that. While having said that, I do expect this opportunity to win some smaller orders for Chinese reactors, but to meaningfully move the needle, if you will, I think that's a longer-term process for us. So there's a fair amount of machinery work that has to be done to capitalize on that more fully.

Okay. And can you comment, Jim, on oil sands projects that you're seeing there from a bidding perspective?

Sure. Actually, when we went into the downturn, you might recall that we indicated that the upgraders, which is where Graham traditionally have provided its products, we wouldn't expect to see activity in the upgrading side of the oil sands until around 2012. We've begun to see and we are involved in a couple projects that are kicking off -- will be kicking off that were idled at the start of the downturn.

So those are very encouraging signs. These are pretty large projects for us and we are seeing the initial engineering work get restarted. We don't feel procurement is in the next one or two quarters, but what's really good is the moving ahead and everyone's more optimistic.

And secondarily, as you might recall that we've moved into the extraction side, which we had not done in before, which has had more consistent levels of investment throughout the downturn, whereas upgrading has actually put on a pause for a couple years. So, in general, we are seeing new vitality and we're also hearing from our US refiner customers that they are again considering revamp projects to configure their refineries to be able to process the crude oil that's being produced from the oil sands.

Right. Thanks, guys.

Welcome, Dick.

Welcome.

Thank you. George Walsh, Gilford Securities.

Jim, could you discuss the psychology a bit of your customers going forward? It looks like they are all moving forward with projects and there's no real skittishness out there in the markets you're seeing. I mean there's one that was [an order] on hold, you don't have that situation any more. I guess that was related to the, as you mentioned just before the Energy Steel business. So it seems that they all feel that the economy is helping us, but they want to just keep moving forward with their projects.

We are gaining a sense from the contractors and from the end users that we've turned the corner. There are still some skittishness as to how positive the outlook is more near-term, next one or two quarters, three or four quarters, but longer-term without question, the view of our customer base is that it's getting much better.

Okay. That's good. Thank you.

You're welcome.

Joe Mondillo, Sidoti & Company.

Hey Jim, yeah, I just wanted to address the gross margins again. So you held your guidance at 29% to 32% and you are at 33% this quarter and almost 31% the fourth quarter. So I'm just wondering are you expecting those margins to fall again later in the year or what (inaudible) sort of keeping that guidance or maintaining that guidance?

Following the guidance that we've given, that would imply that the second half of the year will have margin pressure versus Q4, Q1, and possibly Q2.

Okay. Is that just a -- is that a product mix issue or just -- you're still working off low backlog or what's --?

It's, I would call, more of the just the environment in which we are selling into still is not as healthy as we would like it to be and is still a very aggressive marketplace with not enough projects moving ahead at the same time, giving the supply chains -- giving us some pricing power. We need to see that to actually begin to have improved margins. So it's still early in the recovery.

Okay. All right. Thanks.

You're welcome.

(Operator Instructions) John Sturges, Oppenheimer & Company.

Nice quarter, gentlemen. I was just curious about the $41 million, is that unencumbered, the $41 million from -- prefunding from customers?

Yes, John. While we still have a significant customer deposit balance, we also have a significant unbilled revenue, which are projects that are in process that haven't been fully built yet. If you move back a few quarters, you would have seen that [the two of those out of since] the customer deposit number was significantly higher than the unbilled revenue. If you look at it now, you'll see that pretty much the same number. So the answer is, yes, it's unencumbered.

So, if an opportunity comes by, you're free to go with that capital?

Correct. And, of course, we do have -- for flexibility, we do have a pretty significant line of credit available with Bank of America if we ever needed that flexibility.

Terrific. That's it. Thank you very much. Nice quarter. Thank you.

You're welcome, John. Thank you.

Thank you.

Thank you. There are no further questions at this time. I'd like to hand the floor back over to management for any closing comments.

Thank you. We appreciate your time this afternoon. We feel we had a very strong first quarter. We're optimistic about the full-year and the long-term recovery in our markets and we look forward to updating you on our -- during our next call in October. Thanks.

This concludes today's teleconference. You may disconnect your lines at this time. Thank you all for your participation.