Graham Corp (GHM) 2012 Q3 法說會逐字稿

Greetings and welcome to the Graham Corporation third quarter fiscal year 2012 quarterly 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 Ms. Pawlowski. You may now begin.

Thank you, Shea, and good morning everyone. We appreciate your time here today with the Graham Corporation's third quarter fiscal year 2012 conference call. On the call, I have with me Jim Lines, President and CEO; and Jeff Glajch, Chief Financial Officer. Jim and Jeff will be reviewing the results of the quarter and also providing a review of the Company's strategic -- strategy and outlook.

You should have the website -- on the website, there are slides that accompany the conversation today. If you don't have them, you can find them on the Company's website 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 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. Good morning everyone, and we appreciate your time today. Please turn your attention to slide four.

I feel we had a solid quarter with revenue expanding year on year 27% to $24.3 million. Organic sales are up 13%; Energy Steel represented 14% of total sales. An indicator to the market direction for us, one of them, is our organic short cycle sales, and we've seen that segment of our business improving year on year. It's up 25% in revenue while also providing expanded margin due to price strategies we implemented earlier in the year.

The power market in whole, that expanded about $2 million year on year. Petrochemical market -- we are continuing to see good activity there, primarily on the order intake side. Sales to the refining market were flat in the quarter. Our geographic sales mix was 57% domestic, 43% international.

Please turn to slide five. Margin was in line with expectation for the third quarter. Gross margin came in at 27%, and a 13% EBITDA margin. Organic production volume as measured in total labor hours was up 15%. Here, too, we believe this is an indication that our markets are improving. It's one of our leading indicators to the direction our markets are moving in. We are also nearing the end of producing a couple of large Middle Eastern refining projects, and that did have an effect on sequential gross margin.

Please turn to slide six. Our strategy to diversify has had a positive impact. Our second quarter was a clear indication of what this can mean, as our traditional refining and petrochemical markets gained momentum. Coupled with growth from power generation markets along with our work for the US Navy, we anticipate stronger growth this coming expansion cycle than we enjoyed the last cycle. We also feel going forward our geographic sales mix will be roughly 50-50, domestic and international.

Slide seven -- we do have a solid pipeline of good quality opportunities. Order growth was 23% year on year, driven primarily by our strategy to be in the power market, principally Energy Steel's win for new construction in the US -- nuclear energy facilities. New orders in the quarter were $21.9 million; Energy Steel provided just under $10 million.

For the organic business, order rate was down 28% to $12 million. As I look at that, while that was disappointing, we do believe that partly due to timing. Several orders that we were expecting to close during the quarter for Asian applications moved out of the quarter. To be candid, we actually thought a few of those orders would close in the second quarter, but as we've communicated on several calls, it's been difficult to predict when orders will close. We do expect these orders to finally close in the fourth quarter.

Also in the quarter, we did face stiff competition from South Korean competitors that took a few orders from us. To be direct, they were at price levels that were unsatisfactory for us, and coming out of a downturn into recovery, it's not a time to be anxious and make decisions to take business off the street to load the business with inferior profitable orders. So we were smart in our decisions, I feel. It's tough to lose these orders at this point in time, but I do feel they are the right decisions that we made at this point in the recovery.

Power market -- that continues to be strong. The order level from the power market was just under $11 million. We had a terrific win for AP1000 new nuclear energy facilities being built in the US. Chem and petrochem markets provided just under $5 million in new orders. Oil refining was down year on year. Here, too, I do feel that's timing. Several of the orders have pushed out of this recent quarter into the fourth quarter that we hope to close in the fourth quarter are for the refining sector.

Our outlook is very strong. We see our pipeline continuing to expand with opportunities. It's a fairly diverse pipeline going across refining, petrochem, power gen, -- within power gen, nuclear, renewable energy, such as biomass energy, geothermal, all areas where we have a very strong brand. While near-term order levels may vary, our conviction to the long-term remains very strong.

On slide eight, just to provide some color on our key markets, for oil refining and petrochemical markets, we believe we are in the early stages of the next wave of investment to expand capacity. I've said on prior calls that it feels to us, it feels to the sales management, that we are at a point where we were in 2003 and 2004 today -- the early stages of the next wave of substantial investment in this particular segment of our business. In Asia, we are seeing a lot of activity for new refining capacity, petrochemical capacity and fertilizer additions throughout the region. In the Middle East, we are wrapping up a few large projects for Saudi Arabia; there are others in the pipeline of similar magnitude, in particular Ras Tanura Jazan refining projects, both 400,000-barrel-per-day projects like the ones we won a few years back. Also, throughout the rest of the Middle East, Kuwait, Qatar, UAE, a lot of activity starting to percolate. We're feeling very good about that.

In North America, we are seeing oil sands activity, new extraction capacity, as well as upgrading capacity. Both aspects of oil sands drives the demand for our products.

In the US refining space, we are seeing investments being made. We've won a few orders this last quarter for smaller refinery revamps to expand capacity and to enable the refiner to diversify its feedstock. Also, with the shale gas activity and the current price of natural gas, we are seeing investments being planned in the US for new petrochem capacity, revamping idle capacity, investment and fertilizer capacity, something we haven't seen in about a decade. And that's very exciting for us, because those are types of projects that we have a high probability of winning, it's right in our wheelhouse, and those projects cover all of our products -- our vacuum systems, our condensers, our heat transfer products. So we're feeling very encouraged about the direction of the US petrochem market.

Also in South America, we are aware of very large multi-year investment plans in Colombia, Brazil, Venezuela -- again, areas where Graham has an extraordinarily strong brand.

In power generation, our strategy to move into the power gen market is on the mark. It's delivering a benefit to us very early. In the nuclear energy area, new builds -- we've won our first order for new build activity in the US. Our team has identified opportunities in the new build area outside of the US. We are also working with our team in Lapeer, Michigan, to expand our addressable opportunities for the existing US facilities. So that's been a terrific acquisition; it's integrated very well, and we are very excited about the top-line growth that we see there over a multiple-year period.

Also, in renewable energy, biomass energy is still active in North America, and geothermal in Latin America, Southeast Asia, and to a smaller extent, in North America, is still active.

The Naval Nuclear Propulsion Program -- that was another one of our diversification strategies during this downturn. The carrier program, the order that we have in-house that we won about two years back, is progressing very well. There's additional work on that carrier that we will be bidding over time and we hope to secure in the coming years. Also, with the submarine program, we are continuing to make progress there to become a consistent supplier to the submarine program. That's a long process, but it's moving along very well. In other markets that we serve, edible oils, general industrial, HVAC, that's very active as well.

Another nice leading indicator that suggests the health of our markets are improving, is improving, is the aftermarket. And the demand we are seeing there has picked up quite a bit when we compare the first three quarters of fiscal 2011 to the current three quarters of fiscal 2012. Orders are up 33% as are margins in that segment. And the aftermarket spans all of our markets -- refining, petrochem, edible oils and general industrial. So we're seeing a nice lift there.

We are narrowing our guidance. And now a look for fiscal 2012 -- full-year expectation for revenue is $105 million to $108 million, Energy Steel providing 16% to 20% of that total revenue. Organic growth rate, 25% to 30%; gross margin gross margin expectation for the full year is 32% to 33%. Full-year SG&A, about 15% of sales; and the effective tax rate remains approximately 34%.

Slide 12. Our priorities and challenges as we go forward -- we view fiscal 2012 and as we move into fiscal 2013 as positioning years for the market recovery. We've taken directed action to prepare our business with a strong wave of work that we are expected to come in the coming quarters and in the coming years. I don't feel our business was fully prepared in our past to take advantage of a strong recovery cycle. We will be better prepared this time. We're making investments in personnel, in process improvement, our capital plan is paying dividends, and we will be ready to capture greater market share and expand more rapidly in this coming cycle. We also plan to advance our market share in oil refining and petrochemical markets in Asia. We have a healthy share there, but I believe there's more that we can do, and there's more that we can capitalize on in that region. We also intend to maintain our strong brand and our strong market share throughout the Middle East, and continue to dominate the North American markets.

We'll focus with our team at Energy Steel in Lapeer to explore the synergies of Batavia and Lapeer's capabilities, expand our addressable opportunities within the existing US plants, and also capitalize on new construction in the US and international markets, continue to develop our naval propulsion program sales strategy -- and as I said, that's moving along very well. We are at a point where our balance sheet is in very good shape; we have positive operating cash flow; and we are actively seeking additional acquisitions to diversify and expand our revenue growth and profitability. We expect to be building backlog as we move into subsequent quarters. We do expect order rates to vary somewhat, but we are quite convinced and we have a strong conviction that our very healthy pipeline will convert to orders in the coming quarters.

I'll turn this over to Jeff now for greater detail on Q3. Jeff?

Thank you, Jim, and good morning everyone. As Jim mentioned, we had a good third quarter. Q3 sales were $24.3 million, up 27% from last year. Half of that growth was organic, and half of that growth was Energy Steel. And just to clarify, we purchased Energy Steel late in the quarter, third quarter of last year, so the comparable results for last year have very limited amount of Energy Steel in them in the third quarter.

Sales in the quarter were 57% domestic and 43% international. When you compare that with last year, last year had 36% domestic sales and 64% international. If you look at Graham's historical commercial markets, they do continue to be tilted toward the international arena, whereas Energy Steel is almost exclusively domestic, and the U.S. Navy-related work, of course, is also 100% domestic. Therefore, looking forward, we think a 50-50 mix is probably in the right range.

EBITDA margin was up slightly to 13%, compared with 12% last year. Of that 12% -- and I will speak to this not only on the EBITDA, but on other earnings-related issues -- that 12% backs out the acquisition-related costs that we incurred in the third quarter of last year, so the comparables will be slightly different than what's reported, but we want to -- from an intellectual integrity standpoint, we want to make sure you're looking at apples and apples. So again, 13% versus 12% last year.

Earnings per share were $1.6 million in the third quarter, up from $1.3 million or $0.13 a share last year. For the first nine months of fiscal 2012, sales were $82.9 million, up from $48.3 million last year. Organic growth was 44% or a $20.9 million increase and Energy Steel contributed an increase of $13.8 million. EBITDA in the first nine months of the year was $17 million or an EBITDA margin of 21%, and we do have the EBITDA reconciliation information in the backup slides. This is up from $6.4 million or 13% in the first nine months of last year.

Finally, net income in the first nine months of the fiscal year was $10.1 million, or $1.01 per share, up from $3.7 million or $0.37 a share.

On to the next slide, gross margin in the third quarter was 26.6%, up from 24.7% in the same quarter last year, but as expected, down sequentially from 38.1% last quarter. SG&A in the third quarter was $3.8 million, up from $2.9 million in last year's third quarter. The increase came from both investments in our organic business as well as the addition of Energy Steel.

Operating margin was 10.9% in the third quarter, up from 9.5% in last year's third quarter.

If you move to slide 16, you can see our cash position remained strong at $44.5 million, up slightly from $43.1 million at the end of last fiscal year. But what I think is important is to look at the last quarter. As we talked about on the last call, we had a cash usage in the first half of fiscal 2012, primarily related to timing of some projects as well as, obviously, outgoing spending around capital. We turned that around and then some in this last quarter, and our cash position increased nearly $7 million in the third quarter. We expect going forward to continue to generate cash.

We believe we are well positioned to utilize this cash, and if necessary, our untapped line of credit for future acquisition activities as well as internal growth opportunities. On the acquisition side, we would be quite happy to find another company of the caliber of Energy Steel. As Jim mentioned, we continue to be pleased with Energy Steel, the expansion of their addressable market opportunities, their financial performance, the strength of the management team, and its nice fit within Graham. In addition to the team that's in place, we have been enhancing the management team with new additions to prepare for future growth.

On to slide 17 -- backlog at the end of December was $72.6 million, down from $75.1 million at the end of September, and $91.1 million at the end of March. We haven't quite seen the book-to-bill ratio make it to 1.0%, but we were at 0.9% in the third quarter, so we are getting closer. As Jim mentioned, we do expect to see that moving above 1 sometime in the next few quarters.

Slide 18. Orders in the second quarter were $21.9 million, up from $17.8 million in the third quarter last year. In the first nine months of fiscal 2012, orders were $64.4 million, up from $38.4 million in the first three quarters last year, and actually slightly above the total for the full 12 months of fiscal 2011, which was $63.2 million. In the quarter, strong order levels from Energy Steel of $9.7 million offset slightly lower -- offset lower order levels from our traditional business -- traditional markets.

Finally, on slide 19, just to reiterate Jim's comments for the full fiscal year, we expect revenue to be between $105 million and $108 million, a growth rate of over 40%. Of this increase organic growth is expected to be 25% to 30%, with the full-year impact of Energy Steel adding the rest. Gross margins for the full year are expected between 32% and 33%; SG&A expected to be approximately 15% of sales and the tax rate at approximately 34%. We also expect for the full year to spend between $3 million and $3.5 million in capital, and we've spent a large portion of that in the first three quarters.

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

(Operator Instructions) Tien San Lucas, Brasada Capital Management.

Hi. It's actually Gabe for Ken; how are you? Just a few questions. Can you help us understand the size of the orders that were pushed out this quarter?

Sure. That was between $5 million and $10 million, and that was across three or four projects.

Excellent, thank you. Another question I had is regarding the cash -- is 100% of that available, or does any of that include advanced payments from customers?

No, 100% of that is available. The advanced payments which had spiked about two years ago have been consistently coming down and are now at a more normalized level.

Excellent. And is there anything that's particular in the third quarter that is seasonal from a cost standpoint? Can you remind us there?

No, nothing in particular. No.

And then last question, on the backlog, can you just remind us on, slide 17 you had the Navy project that was booked in 2009. Do you expect 50% of that to be remaining -- is that right -- at the end of fiscal 2012 -- the size of the original Navy contract?

No, at the end of fiscal 2012, there will be nominally two thirds of that project left.

And the original size was greater than $25 million.

Excellent. Any comments as we look out to fiscal 2013?

I think the important take-away that I would like to share, as I said in the earlier remarks, is the early stages of a recovery -- it's difficult to predict the timing of orders, but what we can state with strong conviction is our pipeline is extraordinarily strong, and it's more diverse than it was the last cycle. So we're very encouraged by that, and as we also look at some fundamental leading indicators of what actually has transpired over the last 12 months, we are seeing order development improve for our larger orders. It's up about 18% trailing 12 months versus the prior trailing 12 months. But equally importantly and indicative of the environment is the gross margin is superior in the trailing 12 months to the prior trailing 12 months.

So we're seeing order development improve as is margins. So that's a sign that things are getting better. Also, on the short cycle order side, trailing 12 months, we are seeing that up about 13% to 15% and, as well, having margin expansion.

So those are clear signs that we think the worst is behind us, and the markets are just slow in their recovery, but our bidding activity is not slow. Those are bidding activity slow in 2003 and 2004 when we saw the wave of work coming. So we're really excited, and if I were to pass on a comment from our sales management side, it's get ready.

We appreciate that color. One more question, if I could just throw it in there please. Your comments on the petrochemical cycle -- you said you haven't seen any projects like this in over a decade. So it's safe to assume this would be new this cycle relative to your last one.

The context of that comment related to the USA. Globally, the market is in the early stages of recovery similar to the last recovery. What's different this time and beneficial to us is we're expecting to see a stronger investment in the US this coming cycle than we saw the last cycle because of the price of natural gas. And just anecdotally, we have secured a couple of orders now for investing in additional ethylene capacity for US petrochem plants, and there's a number of those that are under consideration.

So that's very encouraging to us, because the ethylene plant to us is the surrogate for the overall health of the petrochemical market, and as we see investments being made there to primarily drive our surface condenser product line. But downstream at the ethylene plant with ethylene as a feedstock to the rest of the petrochemical industry, that drives demand for all of our products, all of our traditional products -- condensers, ejectors, vacuum systems, heat transfer products. So we are very excited about what we're seeing there, and we just need to allow some time for that to play out. But we have secured a few orders already.

Thank you very much for the color. Great job, guys. Thank you.

Mark Tobin, ROTH Capital Partners.

Hi Jim, Jeff. First on SG&A, I assume the $500,000 in transaction costs was included in that. And backing that out, it ticked down quite a bit sequentially. And then your guidance assumes that it does, I guess, climb back up in Q4. Can you give us a feel for what the dynamics on that line?

Sure, Mark, this is Jeff. First off, the backing out of the $500,000 was in the third quarter of last year. So that's (multiple speakers) when we were giving -- yes, for fiscal 2011. So if you look at the second quarter and the third quarter this year, we did actually see the SG&A drop a little bit in the third quarter. And that's really just some timing -- nothing out of the ordinary. And in the fourth quarter, it does -- if you look at our guidance, it would go up a little bit. And part of that is, as we are looking to add resources to prepare for it the market expansion, that's where we are seeing some of those costs come in in the fourth quarter.

Okay, understood, my mistake on that. And you talked about the pipeline looking rosy. Can you give us some insight on the productive side as far as the things you're doing from a production capacity standpoint to prepare yourselves for this rebound?

Sure, that's a great question. We took advantage of this downturn to continue to invest in our business. Our capital plan still is targeted on capacity and throughput improvement, focusing on productivity. Ideally, our strategies remain to get more out of our roofline -- not having to expand our roofline to fulfill our growth objectives. So we've been having a targeted investment in welding equipment, machining equipment to reduce lead time and improve throughput, and that's been paying off. And that's been an ongoing program for the last four or five years. With respect to our contract execution, we've been focusing on process improvement, again, to get that lead time reduction, and also to drive areas out of the process. That's an ongoing activity, but that's paying off as well. And IT solutions to create scale and create capacity have provided some benefit as well. So we've been focusing on a number of fronts to help our employees be more successful and more productive in the work that they're doing. And that's had a big impact on our business.

And if we think about our Company, just to give a comparison, in 2004 and 2005 we were about a $40 million company. The organic piece in 2009, organically, we were a $100 million company with the same roofline. And if I think of where we are today and our production capacity, I would state that that's more like $135 million to $150 million as we go into the next cycle. So I think we've done a lot to address productivity and capacity here at Graham. And then in addition to that, we've added diversity through focusing on the Navy and our attention in the power sector with the addition of our team in Lapeer. But it's a great story.

That's helpful. Thank you very much, I appreciate it.

(Operator Instructions.) Joe Mondillo, Sidoti & Company.

My first question -- I'm just sort of trying to get a better feel of what's going on. So the last four quarters have been sort of flattish on a sales and orders basis, but it seems like compared to three months ago, that you guys are feeling a little more positive on the cycle on the business. So with orders and sales sort of flattish still, what are you seeing differently that makes you a little bit more optimistic? And I know you've said that the timing is tough, but when does this come into play in terms of hitting the P&, or hitting your business?

Well, the leading indicator there, Joe, is going to be bookings and quarterly order rates and backlog expansion. What we can only remark to is qualitatively and quantitatively the size and diversity of our potential bookings pipeline, it continues to look very good to us. We feel this is simply a matter of timing. What's really important is the discipline that we have to exercise in order selection. What would be wrong is to become too anxious and too nervous to move too quickly to fill backlog when we could fill it with backlogs that would undervalue our productive capacity. So we are making, I believe, the right decisions on order selection, and our margin appetite while we give the bookings pipeline a chance to move forward to procurement. We think it's the next couple of quarters, I'm not calling it Q4, but it's going to happen. We saw it happen in 2004, 2005. The longer the downturn is, with underlying demand still expanding, which is happening, the wave of work will be that much higher. So we're really excited and we're making investments today before demand comes to be ready.

In terms of the actual projects around the world that you guys track and eventually hope to bid on, or are bidding on right now, how is that trending when you look at all these projects around the world over the last couple of quarters? Are you seeing any significant increase in projects?

To a degree, certainly. And we're also seeing -- which is more important, we are seeing the projects move through their ordinary sales stage, from concept to feed, which is a more detailed engineering analysis, from FEED to EPC bid, and then from EPC bid to contractor award and formal requisitions for purchase. So we are seeing things move directionally to the right toward procurement. That's what we want to see, and that's what we're seeing happening. So while -- we are seeing movement along the sales cycle, which is great, and we are also seeing additional projects come into the pipeline, which is also very important.

More in particular, in terms of your oil refining business, it's actually down year-over-year, which was a little odd to me, I guess, if you could talk about that. And then also, oil drilling in the US is as strong as it's been in 20 years in terms of drilling. Do you foresee any opportunities there within the US refining business, or is it just -- there was -- oil reserves within the US are just such a small percentage of overall US demand that you're not going to see a huge significant upturn there?

We are anticipating to see a very nice upturn there. We are not expecting it necessarily to be as strong as it was the last cycle. We have to bear in mind, there was a huge investment in North American refining capacity the last cycle, which is coming on stream now. So the market is absorbing that. There is a little bit of excess capacity, but bearing in mind that new refining capacity, whether it be a retrofit or a revamp or an expansion at an existing site, those construction cycles are two or three years. So what they would start up today -- start working on today comes on stream in calendar 2015. So we're seeing that activity now with some of the independent refiners in the US. Some of the large integrated refiners are looking at expansion projects, and equally importantly, we are seeing, again, work up in the oil sands that we hadn't seen in three years.

Okay. And then last question -- in terms of pricing, what is your backlog -- in terms of the orders that you're receiving today, what does that margin look like compared to the margin that you're realizing on the P&L right now?

Consistent with the last call that we had in October, if we reflected on Q1 and Q2 sales, sales converted -- backlog converted to sales in those two quarters had superior margin to the average of the backlog. But we were winning new work that was also above the average margin of the backlog. So we have Q3 and Q4 to contend with, but we are adding to our backlog business that is at a superior margin to the average of the backlog.

So we have to get through the trough; we have to deal with the backlog that was one, 12, eight, 15 months ago. But what we're doing to address that margin headwind, again, we are focused on productivity, we are focused on error reduction. We have very aggressive strategies to control our costs and actually improve margin after the order. And we've been realizing that margin improvement after the order through the steps that we've been taking. So I didn't want to sound as though we are held hostage to the margin that we booked. We are actually taking action to improve that, and we've been realizing the benefit there.

But to answer your question, what we're winning new business on average is at a higher margin than the average of the backlog.

Okay. So in terms of the backlog compared to -- right now, you realized 27% gross margin in this past quarter. I imagine that's from bookings from a year ago. Is your backlog and the orders that you're winning today much -- considerably higher than that; you know, 300 basis points or more higher than that?

I am not going to comment quantitatively. I could say directionally, it's better.

Okay, all right, thank you.

George Walsh, Gilford Securities.

Jim, is there any comment on or any issues with the integration of Energy Steel, or is that pretty much done? How are those margins out of that division comparing to your overall margins?

Well, there are two questions there. The assimilation of Energy Steel, the team in Lapeer into our team, has gone extraordinarily well. Part of our due diligence was to assess the culture, assess the management team, assess the operating practices to feel confident that it could assimilate into our business well. And there has not been any appreciable surprises, or nothing that we didn't anticipate. So from that standpoint, it's gone extraordinarily well. I'm extremely pleased with that, and the credit goes to the Lapeer team and to our managers that have overseen the assimilation of Energy Steel into our team. Great job.

With respect to the margin, their business, quite honestly, while gross margin and SG&A can be a little different, the operating margin is fairly similar to our overall business. It blends in quite well, and it's not appreciably different.

Okay. Is the SG&A -- are there things that you are still integrating in some of that overhead with SG&A or anything else?

With respect to our strategies to capitalize more fully on the power market, we will be making investments that will both hit cogs and SG&A to capitalize on what we see as a strong growth opportunity at that company -- in that market. Nothing dramatically different, but there will be some investments that hit COGS and hit SG&A.

Okay. And as you go forward, and you talked about -- which is a great story -- the increase to the capacity there. You mentioned that $135 million. With this cycle, could you just review again -- I think you've done it before, but your perception of how margins would change as you come to the better parts in this cycle?

Sure. I think a real great quarter to look at was Q2. Q2 was about $33 million of revenue, 38% gross margin. It had -- the diversity we were looking for. Power was a very good percentage of our overall sales that quarter, and a good component from Navy. Nice revenue from refining, also reflective of -- because it was a delayed conversion of backlog to revenue, pricing that was similar to the last peak. So that was indicative of where we thought margins will get to. We've indicated many times that while we eclipsed 40% gross margin last cycle, we are going to work real hard to do that again. We feel upper 30s, similar to Q2, is an expectation for the next peak. We're not dismissing that; we won't go above 40%. We know how to do that. But we think realistically and sustainably into the next growth cycle as we hit full stride in the recovery, that's what we are expecting and that's what you should expect.

And obviously, you're including the Energy Steel in this full integration, etc.?

George, this is Jeff. Just a quick follow on to what Jim said -- if you look at the second quarter, and I certainly don't want to extrapolate anything, but I think if you just looked at it on the surface instead of -- if you took that quarter and made a full year out of it during a full recovery, what did that quarter look like? It had revenue for the historic ground business annualized of about $105 million, revenue for Energy Steel annualized at just about $30 million, so you're kind of in the mid-$130 million from a revenue standpoint. Again, gross margin at 30%, EBITDA margins in the mid-20%; that's what -- as Jim said, that's what we believe in the middle of a full recovery we can look like at that size.

And also as Jim said, we have capacity of $135 million to $150 million. That's in the base business; that does not include Energy Steel. On top of that, we believe we have a great deal of available capacity in Energy Steel. So that $135 million level is certainly a nice target, but it's certainly not the peak we are looking for.

What is your capacity at Energy Steel? Is there a general number you have with that?

We believe it's more than double -- and if you look at where we're at right now, we are running at an annualized rate in the high teens. We believe it's more than double what it's at right now. So we think about $40 million plus is certainly not out of the question. And will we need to add some resources people-wise to get there? Absolutely. But, do we -- and it's really just giving us more capabilities in both the front office as well as in the manufacturing facility, but the facility itself has a lot of runway.

Okay, that's great. Well, that's a great picture, thank you very much.

(Operator Instructions.) Joe Mondillo.

I just have one quick follow-up question. I was just wondering -- I don't have the numbers in front of me, but if you could comment how the Energy Steel sales have been trending over the last couple of quarters, and if you could give your updated outlook on the nuclear market overall in the US.

Sure, Joe. If you look at Energy Steel, they are, as we are, a bit lumpy. They had quarters -- if you were to look at the calendar year, so the fourth quarter of last fiscal year was around $5 million. The first quarter of this fiscal year or the second -- you know, the quarter that ended in June, was around $4 million. The next quarter, the quarter that ended in September, was a little north of $7 million, and this quarter was around $3.5 million. So there's some lumpiness in there, really due to timing of projects and how things flow through the facility (technical difficulty) through the business. But we don't tend to look at that business and, again, on an annualized basis we've been running up in the upper teens.

With regard to the nuclear market itself, obviously the win in Westinghouse, we were very pleased about the facilities down in Georgia and South Carolina. That was a big project for them, a big win for them. And there's some more opportunities, we believe, to support those new facilities. So on the new facilities side, or the new reactor side, there's definitely opportunities.

And then in their historic business, which has been supporting the existing plants, we continue to see very good opportunities there. We think we've enhanced their capabilities to go after some opportunities that might have been more challenging for them in the past. And so we think that the addressable market at their historic business, which is the existing plants, has improved. And then on top of that, there are some new build opportunities. So we are very encouraged about what we see at Energy Steel, both currently as well as the opportunities going forward.

Following the Japanese crisis, there was talks at the NRC that increased safety regulation was going to occur, and they came out with a bunch of stuff that they were talking about. And that could benefit -- have you guys heard anything further from that? Has anything come about from that?

Nothing that we could point to directly. And if we reflect back to 9/11, we thought it would take 12 to 18 months like it did last time before it got into the supply chain. So the NRC has drafted certain regulations or recommendations for what the utilities should be looking at. Some of it involves the heat transfer, which is what we are involved in, and other controls. So we're expecting to see that some of that flow into the supply chain in the coming quarters, but I can't point to anything specifically.

Okay, all right, thank you.

At this time, we have no further questions. I would like to turn the call back over to our speakers for any closing comments.

We appreciate your time this morning, and we look forward to updating you during the June conference call -- end of the year conference call. Thank you.

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