Graham Corp (GHM) 2013 Q4 法說會逐字稿

Greetings and welcome to the Graham Corporation fourth-quarter fiscal year 2013 financial results conference call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation.

(Operator Instructions)

As a reminder, this call is being recorded. It is now my pleasure to introduce your host, Karen Howard. Please begin.

Thank you, Brenda, and good morning, everyone. We certainly appreciate your joining us here today for the Graham Corporation fourth-quarter fiscal year 2013 conference call. On the call we have James R. Lines, President and CEO, and Jeffrey F. Glajch, Chief Financial Officer. Jim and Jeff will be reviewing the results of the quarter, and then we'll handle the Q&A session afterwards. They will be talking to the slides that you should have. But if you don't, you can get them on the Company's website at www.Graham-mfg.com.

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

And with that, let me turn the call over to Jim to begin the discussion. Jim?

Thank you, Karen. And thank you to everyone that joined our Webcast to review fourth-quarter results. Please refer to slide 3. Our strategy across this next expansion cycle in our markets is to double revenue and exceed $200 million at the next peak. We believe our focus in the energy markets with engineered-to-order, custom-fabricated products, and our commitment to the naval nuclear propulsion program, will provide sufficient demand to realize this strategy. Our plans to accomplish this include taking greater market share in refining and chemical petrochemical markets; extending our supply to the naval nuclear propulsion program to include equipment for submarine programs; capitalizing on what is expected to be substantial investment in new chemical and petrochemical capacity in North America, driven by low-cost natural gas; expanding our presence in power generation markets including nuclear geothermal, biomass, and other renewable energies; and putting our balance sheet to work to drive both organic growth and growth from acquisitions.

Please move on to slide 4. We had a solid fourth quarter. Our team, management, and employees together executed exceptionally well. Actions taken in the second and third quarters to drive revenue and profits in the fourth quarter came to fruition as planned. It was a terrific effort by the whole team. Fourth-quarter sales were just shy of $31 million, up $10.7 million from a year earlier. When compared to the second and third quarters, fourth-quarter sales are up approximately 20%.

Full-year sales were $105 million, mid point of our guidance and at the lower end of the guidance provided at the start of the fiscal year. Operating margin in the fourth quarter was 18.4%, generating $5.7 million of operating profit. When compared to the second and third quarters, operating profit is up more than 45%. Improvement in profitability was driven by greater throughput and thus improved leverage, quality of backlog converted in the fourth quarter, and timing of refining industry backlog conversion. Full-year operating margin was 14.5%, generating $15.3 million in operating profit. Net income in the fourth quarter was $4.1 million. And for the full year it was $11.1 million. Our bidding activity remains elevated. I continue to believe this is a positive leading indicator for the direction of future orders and subsequent backlog expansion.

Please refer to slide 5. Let me offer a little more detail into the quarter sales. There's been a surge of refining markets' spare or replacement parts orders that we began to identify about one year back. Certain of those orders contributed to the fourth-quarter sales and profitability. A level of spare parts sales in the quarter was roughly 2 times what is ordinarily expected. Sales to the refining market were $13.7 million, driven in part by the step up in spare parts, but more importantly by orders for new capacity in China. Power industry sales were $7.3 million. And sales for nuclear power generation market were roughly 75% of those sales.

Chemical and petrochemical market sales were just under $5 million. 53% of sales were domestic and 47% international. Sales to Asian end users were 20% of quarter sales, and to the Middle East was 11% of sales. Full-year sales were $105 million. Again, 53% domestic and 47% international. Asia and the Middle East markets were 16% and 14% of sales, respectively.

I am going to pass it over to Jeff for a more detailed review of financial results. Jeff?

Thank you, Jim, and good morning, everyone. If you could turn to slide number 7. As Jim mentioned, sales were up in the fourth quarter by $10.5 million, just over $10.5 million, primarily driven by increased refining sales. We also saw increases in the power markets and in our other commercial and industrial markets, with a slight decline in the petrochemical market. We saw growth across all major geographic regions. Our gross profit increased from $5.2 million to $10.5 million, doubling year over year. The growth in gross profit was really driven by two things.

Obviously the sales growth increase of over 50%. And then on top of that our gross profit margins increased from 25.6% up to 34.1%. The increase in gross profit margin was driven by the capacity utilization, the additional volume, as well as a very favorable mix with higher after-market sales in the fourth quarter of fiscal 2013. The improvement in gross profit dropped down dramatically to operating profit and our operating profit margins, as well as obviously our EBITDA margins. As you can see, our EBITDA margins were at 20.1% or $6.2 million in the fourth quarter, up from $2.1 million and 10.5% last year.

On the next slide, if you look at the full-year results, you'll see that our sales increased from $103.2 million up to $105 million, up approximately 2%. As we've discussed on previous calls, we saw a significant shift year over year where in fiscal '12 the first half of the year was stronger and the second half of the year weaker. And then in fiscal '13, the first half of the year was slower, and it picked up dramatically in the second half of the year. This affected our gross profit margins, which were down slightly fiscal '12 to fiscal '13. And that drop was really driven by the first half of fiscal '12 when we had extraordinary margins related to some refining projects in the Middle East that had been won with pricing at the top of the last cycle.

Gross profit in fiscal 2013 was $31.8 million and a gross profit margin of 30.3%. Our EBITDA margin in fiscal '13 was $17.3 million and 16.5%. Again, down slightly from last year, driven partly by the slight decline in gross profit, as well as the additional investments that we've put forward in our business as we anticipate future market growth. Cash flow in fiscal '13 was very strong. Cash flow from operations was $12.4 million in fiscal '13 compared with $2.6 million in fiscal '12.

Turning to the next slide, you can see our earnings per share were $0.41 in the fourth quarter of fiscal '13, up from $0.04 in the fourth quarter last year. Fourth quarter last year did have an R&D-related tax settlement charge of $0.04. So, on an operating basis, we're really comparing $0.41 to $0.08. Full-year EPS was $1.11 versus $1.06 last year, up $0.05. And while the increase was driven by the slight improvement in revenue, we also, as I mentioned earlier, are pre-investing, or have pre-invested, in fiscal '13, which adversely impacted fiscal '13 earnings. And we're pre-investing for growth that we see going forward.

Finally, on slide 10, you can see our cash position continues to be very strong. We continue to have no bank debt. We have $51.7 million in cash, up $10 million from last year, driven primarily by our cash flow from operations, offset slightly by capital spending and in dividend payments But our cash position is very strong. We also have a $25 million line of credit, which is expandable to $50 million, with Bank of America. So clearly, we have a significant amount of dry powder to utilize for organic investments, as well as the financial flexibility to support our ongoing acquisition strategy.

With that I'd like to pass it back to Jim.

Thank you, Jeff. Please move on to slide 12. Fourth-quarter new orders were $25.9 million, a 39% decrease from an unusually strong fourth quarter one year ago. That included a large order for US-based new nuclear power plants. Fourth-quarter bookings were in line with the second- and third-quarter order levels. Domestic orders represented 58% of total orders in the quarter. Recovery in our markets has been moderate thus far. And quarterly bookings levels have been in the $25 million range the past three quarters. That is below where we thought they would be by now. However, if we consider the level of bidding that has been done, it is substantial. The value of our trailing 12 months of quotation activity is between $750 million and $1 billion. This is more than twice the level prior to the start of the 2005 through 2009 expansion cycle. I view this a leading indicator that is quite positive.

On to slide 13. Backlog is $85.8 million as of March 31. We expect 75% to 80% of it to convert within the next 12 months. There are long-lived orders in backlog, specifically the order for the naval nuclear propulsion program and those that are for US-based new nuclear power plants. This is why we project 75% to 80% backlog conversion during the next 12 months. Backlog break down is 40% for refining markets, 25% for power generation industries, 8% for chemical petrochemical markets, and 27% for naval work and other markets. We do expect order rates to begin to pick up. However, they will likely remain choppy.

Slide 14. Fiscal 2014 guidance is for revenue to be between $100 million and $115 million, gross margin between 29% and 31%, SG&A at 15% to 16% of sales, and a tax rate of 33% to 34%. Orders in the first and second quarters of this fiscal year will define if we move to the upper end of the range or perhaps higher. I will update you on this in July.

Slide 15, please. Our strategic focus is on sustainable earnings growth. We plan to do this by taking greater market share, expanding into submarine programs, and leveraging our balance sheet to drive growth. We're also focused on reducing earnings volatility. We will do this through elevating the level of less cyclical orders and diversifying our customer base. Improving operating performance is a key strategy for us. We have keen focus on error elimination, process improvement, and aligning processes to reduce lead time, leveraging existing physical plant assets, and investing to improve productivity.

Strong cash flow from operations will be realized by the work of the entire team focused on, from the start of the quoting process where cash flow terms are negotiated, to operations, reducing lead time and working capital, through to collections. Strong commitment to our customers and in developing our workforce is a key strategic focus. Our customer is first in everything that we do. We go to extraordinary lengths to be the supplier of choice by serving customers better than any competitor. Our employees make that happen. Our management process to engage them in creating our success, and by having our Company be where employees want to build careers, has magnified our success and will drive it going forward.

Brenda, please open the line for Q&A at this time. Thank you.

(Operator Instructions)

Chase Jacobson with William Blair.

Hi good morning. Jeff, I think this first one is for you. Just on the after-market in the quarter, can you give us any color as to how much the after-market sales actually were? And maybe just some general comments on how the margin profile compares to the OE business. And then was there something specific on specific projects that drove those better sales? Or any color around that.

Sure, Chase. If you think about our after-market business normally it is about 30% of our overall business. It was up pretty significantly from that. The margin on our after-market is also significantly greater. So, really, the mix of the two, without giving too much on specific numbers, the mix of the two, the higher percentage of it and the fact that it is always our highest-margin business, really gave us a nice bump up in gross profit margin in the quarter.

Okay. There's some equipment companies that say their after-market is double the gross margin of their OE business. Is that a fair assumption to make?

No, it's not that high. It's certainly quite a bit higher. But, no, double would be way out of line.

Okay that's helpful. And, Jim, on the bid pipeline, obviously it's still strong at $750 million to $1 billion. What's different than before that caused you to widen the range of that? Because I think previously you said $800 million to $900 million. So just trying to get a sense of what's different compared to last quarter.

It's a good question, very perceptive. What we did this time is we've laid in Energy Steel. The prior remark related to traditional Graham, the old Graham, prior to the acquisition of Energy Steel. In rough numbers, Chase, Energy Steel adds about $100 million of trailing 12-month bid activity.

Okay. But on the lower end does that have to do with material pricing, or is it just --? I'm just trying to get why it's lower.

Actually, to be honest with you, no particular reason to have broadened that range. It's just that's probably a little safer than it really is.

Okay. And then one more and I'll get back in queue. Looking at your guidance range for revenue, and your expectation of what's going to come out of backlog, it looks like you have about roughly 60% of the guidance range in your backlog now. The mid point of the guidance is flat revenue. So is the conservatism there, basically does it have to do with the timing of the new orders that you're expecting? Or does it have to do with the timing of what's coming out of backlog? Just trying to get maybe some color on how we should expect the revenue and earnings trajectory to play out throughout the year, and how that relates to your current backlog.

Sure. It's an anticipated question. It's an awkward point in time for us when you look at the juxtaposition of the quotation activity and the timing for which we need the orders to be secured and into backlog for conversion across this coming fiscal year. If we look at the last four quarters, our order levels were $96 million. If we look at the last three quarters, the order rate had been $25 million, plus or minus a little bit each quarter. We're expecting that to expand quite well as we move forward. However, the critical time for us, Chase, is this quarter and next quarter, to position the year to drive to the upper end of the range, or perhaps even farther. However, if we have, for the sake of three months, soft bookings in the first quarter, that could drive us to the lower end of the range. It's a timing issue.

We have to come out with guidance for the full year right now and be realistic relative to what we look backward at versus what we see in our pipeline. And that's a matter of timing, Chase. So we're at a tough point. And we will update more definitively on the July call when we see how this quarter plays out for new orders. It's beginning to get more frothy, a lot more excitement from our customers and from our sales guys. However, until we book it, we see it in backlog and we understand the conversion schedule, we're just at a tough point going out with a more aggressive set of guidance. One more quarter behind us I'll be more definitive and perhaps give more clarity on where that guidance should be.

Okay, that's what I was expecting. I appreciate it. I'll get back in queue. Thanks.

Dick Ryan with Dougherty.

Thank you. Jeff, with fiscal '14, how should we look at first half, second half? You've given us a feel in the past. How do you think those roll out?

Sure. Dick, I think if you -- to Jim's comments answering some of Chase's questions, we gave a pretty broad range. And, as Jim mentioned, the upper end of the range is achievable if orders in the first half of the year are strong. And if orders aren't as strong, then we're more likely in the lower end of the range. And so I think the one way to think about it, as Jim mentioned, the orders over the last three quarters have been relatively consistent, at around mid 20s or so. So, as you look at that, you could consider the first half of the year to be fairly in line with that. And if the orders pick up, you should see a stronger second half. If the orders don't pick up, then the second half is likely to be in line with the first half.

Okay. Jim, you mentioned one of the goals, obviously taking share in refining and petrochemical. Have you seen evidence of yet, evidence so far of you taking share? Or what's your general thoughts on the competition?

This is a look-back comment. My answer to that would be, yes. Through the down cycle my perspective on it is we took share. We not only defended our market share but I think we advanced our market share as we capitalized on what work was available. As we go into this expansion cycle and the type of projects that we see, the relationships that we've built through the bidding process, the end user decision criteria for who they select, I firmly believe going forward we'll continue to take more market share. It's easy to look backward and say we did.

But there wasn't much activity in the marketplace, so we were very aggressive to win that work. What really will be important, Dick, is, as we go forward and we win this chemical, petrochemical work in North America, and some of the global refining work that we're seeing, that will be the evidence going forward. And in an expansion cycle, we are taking market share. And that's where it's going to be more meaningful than doing so in the downturn. But I would commit that we did take market share in the downturn, both in petrochem, chem and refining markets.

Okay, thanks. On the Energy Steel side, you included that in the bid pipeline this time around. What are you seeing there? And maybe in particular from safety programs with the aftermath of Fukushima, are we seeing any funding coming through for such programs?

Finally, yes. We thought we would have seen it by now. However, the assessment of the NRC regulations as it relates to Fukushima, that's starting to materialize in customer RFPs. So we are beginning to see that now. We are also involved in some activity, some bid work, Dick, for additional equipment for the US-based new nuclear power plants. That's fairly sizeable. Those orders are fairly sizeable.

And we think those will close over the next - the vendors will be selected over the next three to six months for that work. So we're seeing activity pick up. We're seeing Fukushima bleed through into the bidding activity finally. And in general we're seeing, as I commented under Chase's question, a trailing 12-month bid activity of about $100 million for Energy Steel type products, the nuclear products.

Is any of that being generated internationally or is it pretty much all domestic?

Some of it is international. But, to be candid, your second comment is probably more accurate. It's largely domestic.

Okay, great. Thank you.

Jason Ursaner with CJS Securities.

Good morning. Congrats on a strong quarter. I have a couple of follow-up questions about orders and the guidance. Other than Q4 last year, orders haven't topped the $30 million level since the last cycle, really. And that level always seemed like a pretty key threshold for operating leverage. And you've talked a lot in the past about getting to it. You mentioned the second half didn't come in quite where you thought it would be at this point. So just looking at the bid activity, what type of time line would you expect you'll need, to achieve more of a sustainable $30 million per quarter level?

My sense -- and you probably have picked this up over the last several quarters, that this has been my sense each time we've had this question -- is it's right in front of us. It could materialize this current quarter. Or I wouldn't expect it to not have materialized by the fourth quarter. So, it seems to be getting pretty frothy. Our operations team and our sales team are pretty frenzied trying to understand the order timing, the execution strategies for the work that seems to be coming pretty shortly. Now, we still have to win it, we still have to get it into backlog. But I'll use the adjective -- it's getting a little frothy out there for us and it's pretty exciting.

And what do you think is pushing it out or getting the bid to not translate into firm orders?

I think it's the ordinary flow of these very large, massive projects. Just to put it in context, these ethylene plants, propane dehydrogenation plants, fertilizer plants in North America really just came into vision about a year ago. And from concept to feed to EPC bid, that has a normal time span. We're seeing those now in EPC bid, or the EPC has won it and now we should begin to, we believe, see it accelerate to orders being placed. And what's exciting to us is our customers are, the end users, are trying to be the first to market, in some cases. So they are starting to move more quickly because they want to get their plants up and running before the competition. And that's reminiscent of 2007 and 2008.

Okay. You mentioned the juxtaposition between bid activity and this frothiness and excitement in the market with what you actually have in backlog. So, just looking at the lead times on your equipment, and with that visibility, when you look out to fiscal year '15 for you guys, would you expect something closer to that $30 million a quarter to be the lower bound on revenue at that point? Or could it still take longer than that?

From our planning premise, that's a fair way to characterize it. Again, I hate to use the timing of orders as the lynch pin there, but it is. However, our planning premise is in alignment with what you've just said, or greater.

Okay, that's it for me. Appreciate the details.

Joe Mondillo with Sidoti & Company.

Hi good morning guys. Just to jump on that last question, you pointed to several different type projects that are pretty much related to your petrochemical business. And I understand that you are anticipating this coming. But we have seen backlog down four or five straight quarters. But, just so I'm clear, it sounds like you're anticipating that maybe the bottom in the backlog was in the fourth quarter, maybe here in the first quarter, and that we should expect that backlog within that petrochem to begin to tick up.

That's our expectation. That's our read on the market dynamics. And that's our assessment of how our customers will act as this moves forward. This seems very real to us. The dialogue with the customers is very candid, very direct. And it feels like hurry up, get ready. However, until it's booked and in backlog, all I can offer you are these comments.

Okay. And in terms of the gross margin and the dynamic between the after-market and OEM, I understand the fourth quarter was largely driven by the weighting of after-market. How has orders been trending? Or what is the mix like between the after-market and OEM?

We've had a nice uptick in after-market beginning about one year ago. And it's been principally in the refining market. Let me just give a perspective on that from my point of view. We saw this also in 2007 and 2008 where we had an uptick in refining and after-market work. At that point in time in 2007 and 2008, it was so important for the refiner to be on stream producing gasoline, they couldn't afford to have an unscheduled shut down. So we saw them making investments in spare parts and upgrading their equipment to stay on stream for longer periods of time.

As we look at it today we're seeing metallurgical upgrades, replacing of equipment, with a genuine desire of the refiner to have, instead of four-year run rates between scheduled turnarounds, six- to eight-year run rates between scheduled turnarounds. So we've seen a very nice uptick in orders as a result of that. I think there's a potential that sustains at a nice level. However, we still need to see some of that get into our backlog. But it does feel very good from that point of view. And, as Jeff had mentioned, after-market in general has a somewhat higher margin than the new equipment orders.

Moving to the new equipment orders, if I contrast last year to this year, the margins of what we've been winning is superior to what went into the backlog a year ago. And comparing what left backlog in fiscal '13 to what went into backlog across fiscal '13, the margins are up a good amount. Again, that's a leading indicator to us that the markets are getting healthier. The pricing is getting more favorable. All good signs.

So we're expecting this expansion cycle to play out as we've communicated and as we've planned. And as our long term guidance has suggested, margins should begin to expand. We're not saying they're going to hit the 40% gross margin that we had last cycle. We're modeling mid to upper 30%s this cycle as we move toward and into the peak of the expansion cycle. So nothing is playing out, out of the ordinary for us, or different than how we had planned it. The only thing that's been stressful for you and stressful for us has been the timing of converting the backlog to orders.

Just to follow-up with that, in terms of the gross margin guidance that you're putting out there, it's pretty much almost exactly what you put out a year ago. And considering the improvement in equipment margins, improvement margin in the total backlog that you mentioned, is that just a case in point of conservativism? Or equipment -- the total sales transitioning more towards equipment, as the cycle proceeds? How can we look at that? I'm just trying to figure out the upside.

I think the way to think about that is there is upside. How we've come out with our guidance was to -- it's really not a pricing issue. It's more of a utilization and leverage issue. So if we have strong order rates leading to strong revenue for the full year, moving to the upper end of the guidance, we would expect that gross margin to move above what we've guided to. If we have softer first-quarter and second-quarter orders, take that worst case scenario, then we would guide down to that guidance we've given. So we've had to strike -- again, the juxtaposition of where we are today versus how this pipeline looks, we've had to come out with guidance that was sensible. And all I can suggest is, as we get through this first quarter, our visibility will be far more definitive. And we hope to be adjusting guidance as we go forward. But this is how we see it today as potential outcomes on both ends of the spectrum.

Okay, great, thanks. And then just last question, regarding just your international versus domestic business. The orders over the last three quarters have increased domestically. But internationally have actually decreased over the last three quarters. So just wondering -- obviously, there's a lot of positive indications in the US markets, and everything. So if you could just maybe comment on why you think some of those orders have been a little light internationally, and what your outlook there is.

In certain international markets, and I'll speak to China, specifically, we've seen a more measured pace in China for moving forward on order decisions. The projects remain viable, they just keep sliding quarter to quarter. And I think that's been the biggest issue for a decline in international sales. And the timing of some larger Middle East work that we have in our pipeline. That could right itself in one or two quarters, based on what we see in our pipeline. But I would say right now China has, looking backward, China has been more slow and measured in releasing orders for new capacity. And the timing of some Middle Eastern work just wasn't staged yet to be secured.

Okay, thank you.

Tom Lewis with High Road Value Research.

Jim, I was wondering, the after-market business that you were just describing, is that something that you have to go out and sell? Or is it more like something that the customers already understand, it's just a matter of getting to capacity points or capacity utilizations and budgets and all that, and then they call you up and want to do it?

It's a combination of both. We have a service team that does go into the field, and will do performance assessments of our equipment, identify where we would recommend replacement parts be purchased, or modifications to the equipment be done to improve performance. But I think predominantly it's the refiners going into their scheduled shut downs, and then their desire to extend the run rates from four years to a longer interval. And making investments now to insure that when they're up and running they will do their best not to have an unscheduled shut down, which is extremely costly and undesirable for them.

And for us it's been very advantageous because we have such a rich installed base of equipment in the refining space, particularly in North America, going back to the '80s, '70s and '60s, that this is just fantastic work for us. I don't want to diminish. We have to go out and sell it, we have to do a lot of hard work. It doesn't just fall in our lap. But it is a bit of a customer coming to us, in some cases, of -- we're coming down in nine months, we need replacement parts, can you get it to us in nine months. And here's the reason why we need those parts.

Okay. So it's something that's not such a quick fix, but it's going to be done within the customer's larger scheduled down time.

Right, correct. These are normally planned about 18 months in advance. So if they're looking at a scheduled turnaround next month, it was something they thought about 18 months ago and has already been bought.

Okay. And can you give us a little color on what you expect from the naval business? And, in particular, is there a window of time that we might reasonably look to hear about a submarine decision?

I think the naval work, or our naval strategy as a whole, we're extremely pleased with our progress. We're doing a very good job on the carrier order we have. I can share with you, the interaction we have with the Navy or their shipyards has been very positive on both the carrier work and potential submarine work. What they like about Graham is -- there are several things.

One is our ability to manage these complex projects, to identify, design, or schedule risk, implement counter measures. If issues arise, get back on track. Open candid conversations about the realities of these types of projects. So they like our contract management process. They also have identified that the quality of the workmanship that we do, the control over the manufacturing process, the quality of the product that we will deliver is extraordinary and precisely what they are looking for. So those are all very positive signs.

As I think about the submarine program and our strategy there, I would suspect over calendar '13 we'll be able to define are we in the sub program or not. Virginia class sub program. I think the Ohio class sub program we have orders in our backlog for engineering only. That would be defined in calendar '14 if we broke into, or if we are a supplier to the Ohio class program. But for the Virginia class window I think is calendar '13.

Okay. And then, finally, as the market has progressed from depressed to what sounds like moderate, but about to be not so moderate recovery, have you seen any change at all in your rate of winning the bids?

Not yet. And that's encouraging, too, because I think we're at a low ebb on dollars quoted to dollars converted. It should only go up from here. If we look at our historical patterns, we're at a low conversion level of that trailing 12-month bid rate to orders. We haven't seen it fall consistently below where it's at today. So, again, our modeling is such that that conversion of pipeline dollars quoted to orders should begin to step up.

And what's also very favorable -- and this is important -- if you think about the constraints that we've talked about in our business around engineering capacity, is the order sizes should begin to become larger. And if you thought about our average order the last two or three years -- this is average -- on the large projects, those that have press releases, its been $600,000 to $800,000 on average. Some big ones, some smaller ones, but the average was $600,000 to $800,000. We're on the hunt for several, many, $1 million, $2 million, $3 million, $4 million, $5 million projects that will average that up. And, again, I don't like to keep striking a contrast to 2007 and 2008 but that really lifts the business to a much higher margin potential as that order size gets larger. And for us as management it's a pretty exciting time to see that start to move through the pipeline.

Hopefully that's something we'll be talking about in the first half. Keep up the good work.

Brian Rafn with Morgan Dempsey.

Good morning, Jim and Jeff. A question for you. Jim, you talked about the universe of bidding business, $750 million to $1 billion, roughly. As you ramp up, as you build up the next cycle, the $200 million in sales, is there an expectation when you capture market share that you also have some internal bogey, that you're going to raise the level of sales conversion from your bid quote activity? Or are is that sales conversion rate a normal ebb and flow? And is there any instinct? And I don't know what your internal numbers are but is there any issue to maybe raising the sales conversion rate over the next few years?

We're focused on that. There's a natural improvement in conversion rate the way we measure it based on orders actually moving to being placed. However, we have spent the last three years focused on developing internal capacity. We have been an execution-limited business. We've had to turn work away in our past in the last peak. We've gotten at that the last three years. Our engineering team, our operations team, is more equipped today for strong expansion cycle. So I think that, coupled with the natural improvement that comes when customers are letting purchase orders, we should have a compounding effect. That should be very positive. So my summary comment here is, we will take more share, and we will expand our conversion of bid dollars to sales or bookings, because we're a better company today than we were last cycle.

Yes, okay. You answered my next question. Everyone in cyclical business worries about rationalizing on a down slide. But you also have the capacity, if you have, as you just called it, frothy bid-quote activity, a capacity shock to the upside. Do you have in your plans for property, plant, equipment, and hiring and engineering staff, like you just talked about, if you were to see a dramatic increase above the $30 million run rate in bookings, could you sustain that? Or would you then have to add maybe more manufacturing or more CapEx or more headcount if you really got an upside shock?

Just to give it a frame, we invested in personnel, calendars '10, '11 and '12, for this potential surge of business that we see coming. Not here yet, that we see coming. We took the profit hit in those operating years to prepare for the strong wave of business that we see. I think we've done well to right size our business. I'm picking a number here but let's say it's for $110 million to $130 million. There will be some incremental adds, but the big adds, I think we've already taken care of that. With the exception of our direct labor, we'll probably slide a little bit as volume goes up. But from the infrastructure, the indirects, we got at that in '10, '11 and '12.

There will be some incremental adds but we got at a lot of that the last three years while we had the profitability to do that during the downturn. And what's ideal is these employees have now been with us one year, two years, three years, and they're well along on the development and training programs. And they are very valuable toward the output that they are able to generate. In our past, we were into an expansion cycle 12, 18 months before we began to hire. This time, we had the luxury of doing this during the downturn. So we're more ready today than in our past. So, for us as management, for me and my role, it's extremely exciting. And I'm very eager to watch all this unfold and to see how our strategies fall out and get realized.

Okay. When you look at, and you talked, Jim I think the word you used was choppy relative to the order flow, are there any endemic differences between specific channels or business, say, power versus refinery versus petrochemical versus naval, where some channels tend to have very fluid, very expedited orders, and other channels, just by definition, tend to be very sluggish?

If you think about where we play, where our brand fits, where we focus, it's where that sales cycle is long, where there's a great deal of engineering interaction between us and the customer before an order is placed. That has the tendency of a measured pace for how that work flows. So our refining work, our petrochemical work, certainly our Navy work, and the nuclear power market, that's not urgent order placing. That's very measured, very controlled, and it doesn't move too briskly. What's nice, though, is we've been working on these projects for a long time, and you've heard us comment about the enormity of our bid pipeline for several conference calls now. So, a lot of that up-front time-based work we think is underway or perhaps behind us. Which leads us to believe that it's going to get active very quickly.

Okay. Let me ask you on the Navy side. One, you made a comment on the Ohio class. You're talking about the next generation boomers, right? You're not talking about the '14 Ohio class that we currently have, correct?

I apologize. It's the Ohio class replacement program.

Okay. And then on the fast-attack subs, if you were to get some business -- and as you go through -- and maybe a better question is, as you become in the process, you're an approved supplier, you've been providing I'm assuming, condensors, injectors for the carriers and the next-gen SLB and ballistic fleet missile boat, is there a process where you then have to apply for the fast-attack submarine Virginia class? Or is that something that you've already won? Or is there some issue with that as far as being approved before you actually get into the design?

The design is already done. So it's entering into the Virginia class program as a supplier, or what we would call build-to-print work. The design is already done. And displacing the incumbent through either our quality or our ability to manage these contracts more effectively, or from a cost advantage to the shipyard. We've been having discussions with the shipyards and the Navy regarding the two different sub programs since we won the carrier order. So it's been two or three years or longer. And those discussions have been very fruitful. Our intent is clear to the shipyard and the Navy that we wish to participate in the sub programs. And, as I said on an earlier question, I think the window for entering the Virginia class program should manifest itself over calendar '13. And for the Ohio class replacement program, it's calendar '14. And we're working very hard. Our team is working extremely hard to break into the Virginia class program.

George Walsh with Gilford Securities.

Jim, if I'm hearing you right, relative to the way you've positioned yourself for the cycle, it seems like with this expansion the idea of where you get to about $200 million, do you see your SG&A more or less -- margins, the SG&A margins -- staying flat to possibly going down relative to your --?

Right. If we look at them where they are today, 15% to 16% of sales, we would expect to get leverage as we get larger and have that slide lower as a percent of sales. I don't see that area being proportionate as we grow, as a percent of sales.

Okay, that's good. And you seem to feel good about the gross margins as you go into this cycle, that there's higher-margin work out there to expand it. It's not a matter of being more competitive as the cycle goes on, and maybe having to get some tighter gross margins in there?

That's correct. There is a caveat to that. It's something that we're watching. As we think about the North American petrochem expansion, we're trying to understand the decision-making of the end user with regard to what contractor EPC they are going to select. Or what turbo machinery OEMs they might select. If the EPC is international versus North American, there is a different margin potential for us based on their supply chain that they would be looking at, our competition.

Same holds true for an international turbo machinery OEM. So we're trying to understand more clearly how the end user is sourcing critical equipment. Are they focused on North American suppliers or are they globally sourcing. And that applies to the EPC involved, or the OEMs that are involved. And we just don't have complete visibility to that just yet because these orders are just now being placed. But that's something that we're watching. All-in-all, with that caveat, we think the expansion of the North American petrochem, chemical market's going to be fantastic for us. We're focused on winning more than a fair share of that. The caveat I made was around margins and that reflected who was our customer.

Okay, thanks a lot.

Chris McCampbell with Southwest Securities.

Wow, I just barely got it in. Congrats, Jim and Jeff, on the quarter. With such strong cash generation at this point in the cycle, and interest rates as low as they are, especially with your line of credit that you have outstanding, can you give maybe a little color on why it doesn't make sense to return more cash to the shareholders at this point? And also just some color on the acquisition environment out there. Thanks.

Chris, yes. As you know, we did bump up our dividend by 50% back at the end of January, early February. But we continue to want to utilize our cash position to allow us to go after acquisition opportunities. And while I certainly understand the low interest rate environment, we're also pretty conservative from a balance sheet management standpoint. And don't want to put ourselves in a position, from a leverage standpoint, that in a future down cycle we would put ourselves in any type of precarious position. But we do, obviously, between the cash we have and the availability of debt, whether it's through our bank line or through any other methodology that we would go forward with, have the ability to make not only significant acquisitions but also to, if the right opportunity were to come along, to do something pretty significant.

So that's all in consideration. And we believe that the acquisition pipeline that we're seeing is pretty significant. And that we would rather keep that cash available, and that debt capacity available, to take advantage of acquisition types opportunities. Specifically to the acquisition pipeline, we've ramped up our acquisition process again. And as you probably recall from the last time we went through this process, it's a lengthy process because our methodology is a lot different than a lot of companies, from the standpoint that we typically reach out to companies that are not for sale. Often private companies, but not exclusively.

And a lot of that process is a courting process and getting the potential seller, who, again, is not for sale when we first introduce ourselves, to convince them that it is a right opportunity for them and us to find a way to work together. So, it's a long process but what we're seeing in the market today are some good opportunities. Pricing is not out of line, in general. And, as I said, we would like to keep our cash available, and our debt capacity available, to hopefully take advantage of that. Jim's talked a lot about the $200 million target that we've put out there. We believe we can do that organically. So, with the acquisition opportunities we have, it's two things. One, it will allow us to get to $200 million faster. And also it would give us the opportunity to get well past $200 million if we found the right acquisition opportunity.

Would you say the size of the candidates you're looking at has changed over the last couple years, to the point where you're looking at larger companies to acquire?

The only change is really that we have one acquisition under our belt. And so we've gone from a company that had not done an acquisition in about 30 years to one that has done one. At the lower end of our range, but we're willing to look beyond the lower end of that range. If the right acquisition next time is $20 million type company, great. If it's a $30 million or $40 million company, that's fine, too. If it's bigger than that, that's fine also. We're not overly focused on size. We're focused on the right fit. But I would say, in general, we're probably looking a little -- we're willing to look a little higher than we did the last time.

Congrats, guys.

Since there are no further questions at this time, I'd like to turn the floor back over for closing comments.

Thank you, Brenda. And thank you, everyone, for listening in on our Webcast today for our fourth quarter conference call. We appreciated your questions and your interest in Graham. And we look forward to updating you on our progress in July. Thank you.

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