Graham Corp (GHM) 2017 Q4 法說會逐字稿

Greetings, and welcome to the Graham Corporation Fourth Quarter and Full Fiscal Year 2017 Financial Results Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Karen Howard of Investor Relations for Graham Corporation. Thank you. You may begin.

Thank you, Christine, and good morning, everyone. Thank you for joining us to discuss the results of Graham's fiscal 2017 fourth quarter and full year. We certainly appreciate your time today. You should have a copy of the news release that crossed the wire this morning detailing Graham's results. We also have slides associated with the commentary that we're providing here today. If you don't have the release or the slides, you can find them at the company's website at www.graham-mfg.com.

On the call with me today are Jim Lines, our President and Chief Executive Officer; and Jeff Glajch, our Chief Financial Officer. Jim and Jeff will review the results for the quarter and full year as well as our outlook. We will then open the lines for Q&A.

As you are 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 is stated on the call. These risks and uncertainties and other factors are provided in the earnings release and in the slide deck as well as with other documents filed by the company with the Securities and Exchange Commission. These documents can be found on our website or at www.sec.gov.

I also want to point out that during today's call, we will discuss some non-GAAP financial measures, which we believe are useful in evaluating our performance. You should not consider the presentation of this additional information in isolation or as a substitute for results prepared in accordance with GAAP. We have provided reconciliations of comparable GAAP to non-GAAP measures in the tables accompanying today's earnings release.

And with that, it is my pleasure to turn the call over to Jim to begin. Go ahead, Jim.

Thank you, Karen. Good morning, and welcome to our fourth quarter and year-end earnings call for fiscal 2017.

Please turn your attention to Slide 3. We had a strong fourth quarter, with revenue at $25.6 million. It was 15% greater than the fourth quarter last year. We completed in the fourth quarter a large nontypical naval order. This nontypical order also impacted positively gross profit and gross margin for the quarter. Net income in the quarter of $0.18 per share or $1.8 million.

Our fourth quarter performance pushed the full year to the upper range of our revenue guidance. Full year revenue was $91.8 million, and it was comparable to fiscal 2016 revenue. Full year income was $0.52 per share or $5 million, down from $6.1 million for fiscal 2016.

Throughout fiscal 2017, we experienced a difficult pricing environment for large orders to our refining and chemical markets. This resulted in stiff margin headwinds that were partially offset by margin for the nontypical naval order that benefited our third and fourth quarters.

Lastly, fiscal 2016 had the benefit of $1.8 million in cancellation charge income that is not routine nor was such a benefit in our 2017 results.

Please move to Slide 4. Refining industry sales continued to be contracted due to the state of the downstream energy markets. In the quarter, refining industry sales were approximately half what they were during the same quarter of fiscal 2016. Chemical industry sales were up 15%. This is due to ongoing investment tied to low-cost natural gas in North America that serves as a feedstock to the petrochemical and chemical plants in North America. Also, we had chemical industry sales for Latin America and Asian markets in the quarter.

Power industry sales were 19% of total sales at $4.8 million. Due to the nontypical naval order sales, other industries' sales were reported at $9.9 million, up $3.3 million from last year and up $2.2 million from the sequential third quarter. We have completed this naval order, therefore, sales to our other industries will be lower as we move across fiscal 2018.

There was a high concentration of domestic sales in the fourth quarter due to nuclear and naval sales being for U.S. customers. Importantly, 30% of full year revenue was from diversification strategies in nuclear power and naval nuclear markets that aren't correlated to our cyclical energy markets.

I am going to pass it over to Jeff to go into greater detail about financial results. Jeff?

Thank you Jim, and good morning, everyone. I'm on Slide 6. Q4 sales were $25.6 million, up from $22.3 million in last year's fourth quarter. The sales split was 78% domestic and 22% international compared with last year's fourth quarter, which were 60% domestic and 40% international. As Jim mentioned, the completion of our nontypical Navy order as well as our nuclear business, which favorably impacted the domestic sales in the quarter.

Gross margins were 26.3%, up from 20.4% last year. Adjusted EBITDA was 12% for Q4, up from 5% last year. Q4 net income and EPS were $1.8 million or $0.18 compared with $500,000 and $0.05 last year. Again, all the profitability measures were favorably impacted by the nontypical Navy order previously mentioned.

On to Slide 7. For the full year, sales were $91.8 million, up slightly or 2% from $90 million last year. Sales mix was 75% domestic, 25% international, a much stronger domestic weighting than the 63% domestic last year. Gross profit at $22.2 million was down from $23.3 million last year due to the unfavorable mix, which drove a lower gross margin at 24.1%, down from 25.8%.

SG&A was $14.9 million, down from $16.6 million last year. The $1.7 million reduction was due primarily to lower commissions, which was related to our sales mix, to cost controls as well as a $759,000 insurance settlement, which was reached earlier this fiscal year. EBITDA margin was 10.5% for fiscal 2017, down from 12.1% last year. Net income, adjusted for a $0.04 restructuring charge which occurred in Q1, was $0.56 compared with $0.61 last year.

On to Slide 8. We continue to have a very strong balance sheet. Our cash position in fiscal 2017 increased by $8.4 million to $73.5 million or $7.54 per share. We had strong cash flow from working capital as well as low capital spending in the year. We paid $3.5 million in dividends in the fiscal year and continue to have a $0.09 per quarter or $0.36 per year dividend rate.

Capital spending for the year was very low at $300,000, down from $1.2 million in fiscal 2016, which is also a low level. You may recall in fiscals 2014 and 2015, we spent over $5 million per year as we pre-invested in capacity and specifically for our Navy business. We expect capital spending to return to a more normalized level of $2.5 million to $3 million in fiscal 2018.

We are and will continue to look to utilize our strong balance sheet to opportunistically identify acquisitions.

With that, Jim will complete our presentation and comment on the market and our outlook for fiscal 2018.

Thank you, Jeff. I will now refer to Slide 10. Refining and chemical markets turned downward in the third quarter of 2015 and have remained contracted. Gross orders in the fourth quarter were $15.5 million, and net orders were $9 million after adjusting for backlog cancellations that related to 2 Latin America refining projects.

I've commented during prior conference calls that this particular down cycle in our energy markets that include refining and chemical industries has been the worst in my 34-year career. Customers have canceled since the start of calendar 2015 $24.5 million of orders that were in backlog, including $6.5 million canceled during the fourth quarter. The order environment and impact of cancellations results in an underwhelming graph shown on Page 10.

There has been a scarcity of opportunities. However, we are aggressive at securing what is available to hold or to gain market share and to load our operations. The bidding pipeline is a healthy $600 million to $800 million. The amount, though, that is at an EPC bid or purchase stage is not hinting toward a recovery as imminent.

Please refer to Slide 11. Approximately 70% of our $82.6 million backlog on March 31 was for nuclear power and naval nuclear markets. This, too, points to the severity of the current energy market downturn and to the importance of our diversification strategies that aren't correlated to energy. 45% to 55% of current backlog is planned to convert across the next 12 months, and 35% to 40% planned to convert in fiscal 2020 or later.

On to Slide 12. Guidance for fiscal 2018 is for revenue to be between $80 million to $90 million, gross margin between 22% and 24%, SG&A to be $16 million to $17 million and a tax rate in the range of 30% to 32%.

2018 is set up to be a challenging year, and our first quarter is in particular. The management team will control all that it can control to affect financial performance throughout the year. My sight remains on how our company is positioned for growth coming out of the down cycle. I will continue to not trade longer-term value creation for near-term earnings. Energy markets will rebound, notwithstanding $40 to $60 per barrel oil.

We cannot concede market share in the down cycle, and we must be ready to capitalize and take share when spending is stronger in the energy markets. We have built an infrastructure to execute our naval backlog. Those costs reside in cost of goods sold. We cannot unwind those investments based on current backlog and expected naval backlog growth across fiscal 2018.

Our nuclear power strategy is about share growth and having capacity and capabilities to execute on that growth. The management team has built up the execution bench, and the learning curve is long in the nuclear market. Therefore, it's difficult to unwind those investments.

Lastly, Jeff and his team have built and continued to expand our M&A prospect pipeline. Areas of concentration are in the aftermarket space, naval nuclear, energy, nuclear power and markets that will continue to diversify revenue. We aren't simply attempting to ride out this downturn. We intend to be offensive, so that growth is strong when energy rebounds or, if the energy recovery is tepid, we still grow.

Christine, please open the call for questions.

(Operator Instructions) Our first question comes from the line of Joe Mondillo with Sidoti.

First question related to your final remarks there, Jim, in terms of being aggressive to the point where you're positioned the best for if and when the upturn finally does come. What can you do at this point internally? Without doing acquisitions, setting those aside, what can you do internally to position the company better? I know you had -- you expanded capacity right before this downturn, an unfortunate timing there, but capacity-wise, I think you're pretty well positioned. So what more can we do to be better positioned for any upturn in terms of what you're doing internally?

Sure. There are a number of actions that are being taken by the management team. And our Batavia operation, which is principally our energy space as well as our naval nuclear, we're looking at and have implemented process improvement. So more simply, it's about being able to execute more efficiently and have greater capability with our fixed cost. So we're focused on implementing through our [QROS] strategy, quick response office sales strategies, to collocate key departments in one area to process the orders more quickly and more seamlessly and without the iterative cycle of how our sequential flow of orders happened in the past. Secondly, we're using the FranklinCovey 4 Ds of execution to drive our execution implementation across the workforce, so they're aligned with our corporate strategies for process improvement, for error reduction, for lead time improvement. And ultimately, that all leads into better service to our customer. In the operations area, there's a degree of cross-training so our workforce is flexible. We do have surges in demand across our different products, so we want to be able to have a workforce that can align with the changes in demand, whether it's naval, whether it's surface condensers, whether it's ejector systems, whether it's machining operations or assembly and welding. We want to make sure that our workforce is cross-trained and able to adjust to surges or changes in demand. So Alan and his team, Alan oversees our Batavia operation, they've been focused on -- under our roofline, now that we've made the significant capital investments that we have, how do we take the team we have and improve the efficiency with which they execute the orders? So that's been our focus there, to ready the team, to have the right cost structure and the right productivity for stronger growth not if it recovers, when it does recover because there will be a recovery. In our nuclear operation, led by Frank Helin, he and his team have deployed similar strategies around quick response office sells and project management initiatives to, again, flow and order more quickly and more productively through the business. So -- and our business, as an ETO business, what throttles our growth to an extent is our capacity through the office. So we've been focused on how do we unlock capacity in our office to execute more and to execute it more efficiently and with less errors? So that's what we've been focused on in our -- in this downturn.

Okay. And so I guess, the other side of the equation is external growth. Could you update us on the M&A? I think it's pretty fair to say that the progress or steps that we've made with M&A have been a little disappointing over the years, just given that we haven't been able to make anything. But is that a case in point and just nature of your business? And maybe we're not -- should expect something? Or could you update us on sort of what you're thinking with M&A and the balance sheet?

To a degree, we won't go into too many details, part of our -- or an important element of our process is financial discipline on evaluating the acquisition target. And when the outlook in the near term is on unsteady footing, it's challenging to work through the valuation through the first, second or third year of post-acquisition. So we have had some deals that we've gotten pretty close to concluding. However, in the end, there was a separation in our evaluation of the value of the business. And we didn't break our judicious process for how we look at value creation and a return on our investment, so we separated from those opportunities. And we will continue to do that. While we're eager to deploy our capital, we're not interested to do so in a way that elevates the risk profile of our business or, in hindsight, creates buyer's remorse. So therefore, we've been quite disciplined, notwithstanding where the organic segments of our business are and recognizing that in our external growth, provide growth during this down cycle, we won't break our discipline. So we've been very active, but we've been disciplined, Joe.

Okay. And then, can you -- taking Navy out of the equation, could you go down through your 3 major sort of segments of the business, in terms of oil and gas, chemical processing and nuclear power, and sort of rank which ones you feel best about? And sort of maybe give us a little color regarding the $600 million to $800 million of quoting or order activity related to each of those sort of segments.

In -- so I'll step through it. We're talking about refining, chemicals and nuclear, and I'll add to that, say, the aftermarket segment. So a fourth element. In our energy space, our team, our company still is long-term bullish on refining, notwithstanding where it is at this point in time. Energy demand will grow. Absent of strong growth, there will be a clear focus, in our view and from what we're observing from a capital spending by our customers, in leveraging what they currently have, getting more out of their existing facilities, meeting demands for more efficient or less environmentally unfriendly fuels. Therefore, we're focused on the installed base, if you will, the existing operating refineries. There will be new capacity, but over the next few years, we see the central focus for CapEx around sustaining capital as opposed to growth capital. And our sales force has been focused on this now for about 2 years. We got out in front of it to get closer to the plant level, which is where the demand will be. So long term, I've liked refining and I still like refining, and I think it's a very important market segment for us, notwithstanding its cyclical nature and notwithstanding where it is today. That's where our differentiation is the strongest. That's where our margin profile is the best, and that's where our capture ratio has always been the strongest globally. And there will be a recovery. Although we're not waiting for that recovery, sitting on our laurels, we are taking action. So refining, long term, I still plan to focus our assets toward the refining sector and be a dominant, relevant force in the refining space for what we do. Secondarily and likewise, in the petrochemical and chemical space, I echo the same sentiments there that I had for refining. North America is going through its investment in new -- I'm sorry, petrochemical capacity. We've benefited from that. We're now seeing the downstream investments behind the big ethylene plants or the methanol plants. So we have some of that going through backlog. And now we're seeing a building pipeline of the next wave of new ethylene capacity in North America. Will it be as strong as the first wave? I don't think so, but it's starting to stage up, and we've had a strong capture rate and a nice margin profile there as well. Globally, refining and petrochemicals, we'll invest in new capacity because energy demand aligns with global GDP growth, and there will be global GDP growth. So therefore, there will be demand for new capacity, new plants, and we will win in those opportunities, just as we have in the past. In the nuclear space, that market's going through an adjustment tied to low-cost natural gas, actually. That's probably the root cause. Yes, there was a Fukushima event that slowed investment. But primarily, it's now around getting the economics right for the operating plants that are in place to be competitive with low-cost natural gas and the forcing into the supply chain, cost improvement, productivity gains. And I think there will be a shake-up in the nuclear supply chain. We plan to be a strong player, a relevant player in the nuclear market. We have a small share. So therefore, we're a small fish in a very, very large pond. And we believe we know how to grow our share in the nuclear space, notwithstanding the supply chain pressures that are being put on as a result of the nuclear promise that's been implemented in the nuclear market. In aftermarket, that's always been a very stable area for us. It does have some cyclical nature to it, but it doesn't have the gross variation that we see in our large-capital projects. We're bouncing off of a low period in the aftermarket. We've talked about that over the last few conference calls -- several conference calls, actually. We are anticipating and we are reading reports that CapEx or spending, MRO spending, will increase in the aftermarket space as they work through calendar '17 and into '18. Here, too, our focus on the -- concentrating our sales efforts at the plant level will pay dividends. So I'm very encouraged across those 4 segments that are not naval nuclear. And in terms of our bid pipeline, we're seeing petrochem be stronger right now relative to refining. We think that's a point-in-time type of phenomena. They do tend to jostle and switch importance over a cycle, start of the cycle, end of a cycle, peak of a cycle; one can be stronger than the other. Long term, though, we see refining being very important, having about 30% or 40% of our sales mix; chemicals, 20% to 30% of our sales mix. We don't see that changing, and our bid pipeline suggests there's no change there long term. I think I've answered the questions.

Okay, yes. No, that was really good. I appreciate that. Just one last follow-up, and I'll jump back in queue here. Regarding the aftermarket MRO spending and maintenance piece, especially on the refining part of the business, I'm hearing that there's maybe more turnarounds currently, even as we speak right now, plants coming down to provide some maintenance. And just wondering more specifically regarding that topic, are you able to still, given the model of the overall industry, capture fully what you've captured in the past, and it's just a case in point of demand coming back? Or are refineries doing more in-house maintenance that's maybe adding to the risk of the aftermarket part of your business? And then just to add to that, could you specifically provide a little more color on your commentary that you've said, at the end of 2017, 2018, you're hearing about MRO spending coming back?

Sure. The turnarounds, our team, our sales team, our customer-facing team, they've been focused [and] spending more time at the plant level as opposed to the EPC or major OEMs. We are having conversations about '18 turnaround activity, '19 turnaround activity. '17 turnaround activity, we would have either won that or lost that. But we're now talking about the '18 or '19 turnarounds. The refiners still are focused on yield improvement, which means getting more out of a barrel of oil, converting a barrel of oil into more transportation fuels. They're also investing on processing efficiently the different types of feedstocks, whether it's a heavy feedstock or a light shale-based feedstock, there'll be investments to be able to operate their process units efficiently there. We don't see a change -- a structural change in our ability to participate in that or how that work will flow through the supply chain from a process licensor to an EPC to a supplier like Graham. We don't see that work coming in-house. We still see the same participants along that value chain, and we haven't seen an alteration in our ability to be successful there. And more importantly, with the investments that we're making of getting closer to the end user, spending more time with the end user as they develop these turnaround concepts, we do feel that will support margin and also support strong capture rate when money is spent. On the MRO side, the more routine spares, last year, was down about 15% compared to the level of routine spare parts activity the last 4 years. Margin has held up, but the volume was down about 15%. This cannot persist. An unplanned shutdown, the safety risk, the environmental risks are all very high. We felt that these are point-in-time delay decisions. They are not structurally changing the way in which they will procure spare parts. And the reports that we've seen, there aren't many, but we've seen a few that are suggesting a step-up in MRO spending in the refining space across calendar '17 and '18.

Our next question comes from the line of Brian Rafn with Morgan Dempsey.

Jim, Jeff, let me ask you, the Trump administration on the Navy side jumped out with a lot of discussion about a 300-ship -- 350-ship surface Navy. But in the budget, General Mabius (sic) [Mattis] has just kind of put a focus on parts and readiness for the first year. We're seeing a lot of cannibalization of Marine and naval air wings and fighters that aren't ready. I'm just wondering, as you guys have been involved with the Navy, if you dial back any of your expectations on shipbuilding in either the Virginia or the fleet strike carrier or the new Columbia boomer, from what you've had, say, maybe preelection to maybe now, it looks like we're getting a little bit of an extension on some of those delivery schedules.

In a broad sense, no, we haven't altered our view of the build schedule. The one that's been difficult to nail down is the next carrier. You've heard us talk about that as the CVN 80 project. They were tending to build carriers on 5-year centers. We're now looking at that span between 79 and 80 to be more like 7 years. However, the new administration is suggesting they want to move to a 11- or 12-carrier fleet, which should shorten the intervals. This is not in the next couple of years that would manifest itself, more on a decadal basis as opposed to a couple-of-year basis. However, we view that very positively because of our position in the carrier and the size of those carrier orders for us. But as an umbrella comment, Brian, we haven't seen a need to change the cadence at which we see our naval revenue flowing.

Okay. No, I appreciate that. With the new class of Ford fleet strike carriers, is your content -- has it changed at all? I believe you guys weren't on the Ford. You are on the Kennedy and with CVN 80, the Enterprise, as there's a learning curve to how they build these new Ford-class carriers. Are you seeing any greater content expected if you were to be in the bidding process for CVN Enterprise from what you've got from Kennedy?

Our scope between 79 and 80 is anticipated to be comparable in terms of the type of product.

Okay, right. You talked -- certainly, I think you guys are very wise. You've certainly built capacity in roofline, you talked about CapEx. You don't take the knee jerk in putting a lot of talent out on the street and cutting headcount. Are there any things that you guys can do, maybe short week cycles, 30 hours, 25 hours, furlongs, extended vacations, to kind of buttress this period of slowness and retain the real content of your labor without sending your labor to the four winds?

Certainly, retaining our talented workforce is paramount. And the options available for us to try to manage through this difficult downturn are all -- are available to us. So nothing's off the table. And so we will consider any avenue that allows us to preserve the long-term capabilities and the long-term value creation of the team that we've built. So everything's on -- it's a bit of a la carte. Nothing's off the list.

Okay. All right. Anything -- as you guys kind of look to fill a little bit, any maybe statement bid quota activity, what maybe you're looking at from a project versus some of the -- maybe the short-cycle work that you might fill in? Or is that somewhat as depressed as what you're seeing in the big project?

The -- here can be a deceiving element of our business if you're not into the weeds like we are. Our quote count, which is an indication of how active we are, is fairly stable. It hasn't really gone up or gone down to any measurable degree. The aggregate value of our number of opportunities we're bidding monthly or on a trailing 12-month or 6-month total basis. What is different is the aggregate value. And whether we're bidding something, just for an example, that's $2 million or we're bidding something that's $500,000, the resources required to put that bid together and, comparably, the resources required to execute that order through the office, are really no different. So therefore, the opportunity set in terms of number of opportunities is the same. The aggregate value of the opportunities is down about 20% or so. But we're just as busy as we generally have always been with the number of opportunities. That's a unique aspect of our business. But when the value declines and if our capture [ratio] is the same, that math suggests revenue is going to decline.

Yes. No, I think it's a fair comment, Jim. With the Trump administration, the passage of the pipeline construction, some talk about opening drilling on public lands, certainly, going after and shrinking the EPA, does that give you or foster a better outlook for kind of domestic oil and gas refinery with maybe a little more friendly fossil fuel strategy coming from the current administration versus Obama's administration?

Certainly, Brian, as you hinted, the sentiment is more favorable for fossil-based energies. The administration has that attitude. How that actually flows through to our customer and then through the bid pipeline and to orders, someone smarter than me probably can answer that question. And then when there's a new administration 4 years or 8 years later, their view could be different as well. The comments that we hear are more long term in nature and directional as opposed to the immediacy of how they affect our business. I like the positivity of fossil-based focus as it would relate to our business. How enduring the desires of the current administration are is hard to say. I can't say.

Okay. No, I certainly appreciate that. You said, I think, that in your 34-year career of the -- that turndown cancellations in the oil and gas refinery side are as difficult as you've ever seen. On the backside, inevitably, population grows, economies get better, GDP global growth will recover. How explosive and how much pent-up demand might you guys see? And historically, if you could put a little bit of color or visibility, what -- do you think that the ramp-up might be slow and tepid? Or might there be some real pent-up demand that you want to be in a position to capture once this moderation passes?

The view that we have is, the longer the contraction, the stronger the wave of new investment becomes. When we think about the downturn before the last downturn, the 1998 downturn, that happened to span 5 years. That wave of energy-based investments was incredible. And we saw it building about 2 years before it manifested itself in terms of new orders and sales. I'm not suggesting it plays out again, but the thesis would be as underlying demand continues to grow and investment is not tracking that, that pent-up investment need will be met. And that's our long-term thesis as it relates to energy. I don't like a long downturn because it's tough to manage that long downturn and hold on to your competencies with the realities of what that downturn means. But as -- in my position, I have to look through the downturn, make sure we do the right things in the downturn but be ready for that eventual recovery and capitalize on it. So a long downturn, in my estimation, results in a stronger wave of new capacity investment when it does occur.

Our next question comes from the line of John Koller with Oppenheimer.

Quick question on the SG&A expense. It looks like it's up a little bit year-over-year. And maybe I missed it in the commentary, but I'm just wondering if you can -- what are your expectation for '18 over '17, if you can explain.

John, yes, John, this is Jeff. If you think about our SG&A for last year, which was $14.9 million, we have the insurance settlement in there, which was almost $800,000. So if you back that out, our run rate was around at $15.7 million, and this year's guidance is $16 million to $17 million. We had a low commission level last year just due to our mix of sales. So our range is really based on a little bit -- obviously, adjusting out the insurance settlement and then getting back to a more normal mix on the commission side.

Our next question comes from the line of John Bair with Ascend Wealth Advisors.

I've got 2 questions, the first one going back to the nuclear power business. In the last, say, 6 months, 12 months, there's been a considerable number of announcements of closures or projected closures of nuclear power plants. And I realize that the projected time frame, of course, is 4, 5, 6 years. And of course, there's a lot of discussion about issuing or creating 0-emission credits at the state levels to try to -- for these -- the power companies to try to figure out a way how they can keep these things running. And so I guess, the question is if you have any sense what you feel the likelihood of those ZECs being created and issued and how that might affect, ultimately, your nuclear power business if, in fact, a lot of these plants are being shut down. I think I can think of about 6, perhaps 8, offhand that have been announced.

Sure. The U.S.-based nuclear fleet, one could bifurcate it to those that operate in regulated markets and those that operated -- operate in deregulated markets. Where you've been advised mostly of the shutdowns, it's been in deregulated markets. And will those come to fruition or not? That will depend on how the state responds. You might recall that New York State, with the announcements of potential 1 or 2 closed nuclear plants, they stepped forward, leaned forward and put in tax -- or rebates that protected the profitability of the utility relative to the alternative electrical-producing facilities. So there was another state that also responded in a similar manner. It will come down to, will the states lean forward in these deregulated markets to protect that fixed load -- baseload utilities that are environmentally friendly that are up and running and the rate payers, it can be dealt within the rates that are being charged to the consumer and how the state leans forward and supports that. So it's hard to fully understand the direction of this because there's a lot of dynamics at play. We've seen, as I said, some states lean forward. And other states, whether they do or don't, I'm uncertain. So that is a risk. And longer term -- so let's play that out. Let's say, 8 do eventually wind down, 8 out of 100. There still is a pretty large installed base of 90-ish-or-so operating plants. We have a relatively small share of their spend. Our strategy is about getting more of their spend. And then secondarily, there will be a market created around decommissioning and handling the spent fuel from these shutdown utilities. And is there an opportunity for us to play in that space that is becoming available should shutdown of these power plants actually materialize? And our team is spending time understanding the decommissioning segment and the waste fuel segment of the nuclear value chain. So we aren't really altering, long term, our view of where the strategy can go, John.

Yes, and that sounds actually more encouraging than I would've thought. So I guess, to your point of trying to expand your market share even in a somewhat of a shrinking market could actually be a benefit to you, then. Is that a fair statement?

Thank you.

Our next question is a follow-up question from Joe Mondillo with Sidoti.

Not sure if that last question was answered or -- hello?

Yes, I'm here.

Oh, sorry. So I just had a couple of follow-up questions. I just wanted to ask about the gross margin that you saw in the quarter that you just reported. The percentage of oil and gas revenue that you saw in the quarter was, I think, the lowest in over 10 years that you've seen in the company. And oil and gas usually carries the higher margin, so seeing such a small percentage of the revenue being driven by oil and gas, I was surprised to see such strong gross margin. I know the quarter benefited from some Navy work, so I'm wondering if you could comment on that. And is there any change of expectations on the gross margin of your Navy work going forward? Because I know you said in the past that you expect that Navy work to be a little under company average in terms of gross margins.

Joe, on the gross margin for the quarter, you are correct on your -- how you -- what you noticed with regard to the refining market. And you are also correct that, normally, our naval business is at a lower gross margin. But the atypical order, the nontypical order that we had that affected us in both the third and fourth quarter, the naval order was at a higher gross margin than a normal Navy work. And that's what helped us in the quarter. We -- I think we mentioned also, it helped us last quarter, but that does not change our expectation going forward of the naval -- the normal naval gross margin.

Okay. And in terms of your outlook for the Navy business itself, you mentioned in your press release that you anticipate $9 million to $12 million of revenue to be converted in fiscal '18. What was the Navy revenue in 2017? And can you give us sort of ballpark expectations on what you're looking at relative to what you have in backlog for fiscal '19?

The '17 naval revenue was about 15% of sales. And our backlog conversion is, as you noted from our press release, estimated to be between $9 million and $12 million. And in addition to that, we are expecting to win orders in fiscal '18 that contribute to the revenue in fiscal '18. So from a modeling point of view, we would expect year-over-year to be between 85% to 100% on a comparable basis. However, we don't have that work in our backlog yet, the additional work.

So you would expect -- do you expect Navy to be down in fiscal '18 relative to '17?

We expect it to be between 85% to 100% of '17.

Okay. And then '19?

And then, as we think about '19 and '20, compare it to '17, we expect growth relative to '17's number.

Okay. And we've talked in the past, I think, about that you could maybe achieve 20 to 25. Is that 20 to 25 on top of the 14 or 20 to 25 total in terms of what the Navy is...

That was the -- sorry, Joe. That number that we've cited in our conference calls or in our investor information, that would relate to total naval sales in a given year.

Okay. And just lastly on that topic. Why -- I'm surprised because I was anticipating going for Navy to be a ramp-up going forward. Why is '18 down from '17?

We've -- well, we've not been able to secure -- we haven't lost it. We've not been able to secure the next large carrier order. And when that does come -- you might recall in 2009, when we secured a carrier order, it was in the order of $25 million, and we've spent a good part of '16 and '17 being ready. So when that does come, we're able to put it quickly into operations.

Joe, I think there's one additional point here, too, that we had expected -- if we went back 12 months from now, we had expected fiscal '17 to have less Navy revenue than fiscal '16. But because of the nontypical order that we've discussed last quarter and this quarter, that actually led to significant year-over-year growth from '16 to '17 that was not anticipated at the beginning of '17. And so that step-up that we were expecting from '17 to '18, it actually occurred from '16 to '17.

Okay. Makes sense. And just lastly, do you see any risk of not winning the carrier?

Well, until it's won, there's always a risk. We are very confident in the dialogue that we've had. But with complete candor, until the order's in the -- in our backlog, there's always a risk of losing it, although we have (inaudible) positive, and we feel very confident.

Our next question is from John Bair with Ascend Wealth Advisors.

Don't know what happened there. Can you hear me okay this time?

Yes.

Yes, we hear you fine.

Good, good. And so what I was saying, I guess, when I cut off, that it actually sounds a little more encouraging than I would have anticipated with regards to the nuclear plant and what's going on there. The other question I had was you've -- I was rather impressed at a visit up there in Batavia about your list of -- your plaque of long-time 20-year-plus employees. So I'm just wondering, given this long drag-out and the operating overhead pressures and so forth, are you finding it difficult to replace those that perhaps are retiring? Or could -- can you address the manpower aspect of keeping everybody cross-trained and that kind of thing?

Sure. I'm going to address it from the perspective of where we saw a risk in what we've done. There had been a long indoctrination and training cycle to bring new employees into production roles or office roles, engineering, design drafting. 3 or 4 years ago but note, 5 or 6 years ago, we identified that as a strategic risk that would impede our growth. The human resources department and the management team put together an onboarding and training program to bring new employees into our company and develop them to be proficient more quickly. When I joined the company 34 years ago, your freshman year was 3 to 5 years long. Now, through the steps that we've taken, that freshman year is somewhere between 12 to 18 months. So we've gotten that, putting our know-how into our processes and providing training tools that allow an employee to join our complicated company and become proficient more quickly. Secondly, employees are the backbone, of course, of every company and they're the backbone of our company, and we needed to recast Graham as an employer of choice in our community so we could attract the talent, whether it be the welding personnel, the machining personnel, production labor or engineering, accounting, sales. Our HR folks did a great job of recasting the Graham brand as a strong employer, a company that challenges its workforce, engages its workforce, holds them accountable for driving the strategies and making them part of the strategic growth. So we've repositioned our company in terms of how we attract and retain talent. So I think, in response to the question that you've asked, we've done a good job to prepare for the consequence of that plaque that you saw, which lists the 25-year employees and the loss of know-how. We got at that somewhere about a decade or half of a decade ago and have done a good job to mitigate that risk around retention and a seamlessness with which we would move forward as we lost long-tenured employees. I'm not going to say it doesn't hurt when you lose a veteran of 30 or 40 years and their know-how and they've been there and done that and seen those situational circumstances and know how to navigate them, but we've done a great job in transferring the know-how more quickly into the worker.

That's good. That's encouraging. When the upswing eventually comes, you don't want to be caught short there. So that's very good. So appreciate that. Good luck going forward.

(inaudible)

Thank you, John.

Our next question comes from the line of Brian Rafn with Morgan Dempsey.

Yes, I'll maybe just ask, I think you guys talked about CapEx for the next fiscal year being $2.5 million to $3 million. Just wondering kind of where that is, maintenance-wise, capacity-wise, where -- what kind of target are you looking at spending on?

A large chunk of that relates to our naval growth strategy and some new machine tools that allow us to do certain parts more proficiently. And we made an investment with the CVN 79 order, and we're making a comparable investment around, hopefully, in support of the CVN 80 order that provides our workforce with the right tools to deliver the appropriate quality that the Navy mandates. So about 2/3 of that CapEx is around our naval strategy.

Okay. Let me ask, you said that you thought your content would be similar between CVN 79, the Kennedy, versus the Enterprise. Is there any cost savings or time savings that you guys have on preliminary bids with the Navy between carriers that if the programs don't change engineering-, specification-wise, that there's not a ton of wasted time and effort in the uniqueness between one carrier to the next? I'm just wondering how much, if you were to lose that, how much is kind of wasted time and effort, other than just discussions.

Once a design is set for the vessels -- so 78 was the first vessel of that class and then 79 was awarded while that first generation was being built, so there still was some engineering churn. As you get into the third, fourth and fifth, they're build-to-print, and the engineering -- the innovative engineering is pretty much behind. Now for the Columbia that you had mentioned as an example, that's all next-generation design, so there's an immense engineering effort there that will go across the first sub and probably into the second sub. And then, of course, the Navy is always looking for where can there be productivity, where can there be cost improvement, and that's a value they see with Graham as we bring our commercial sensibilities into the naval market, and we're constantly thinking of and challenging why is it this way? Why can't it be that way? We can do it more efficiently this way with less cost. So we bring a perspective of design for quality and design for manufacturability and cost reduction that the Navy does value. So it's important that we share with everyone that we bring a new perspective to the naval supply chain that they see a great deal of value in, which is being competitive in driving cost down without compromising quality.

Ladies and gentlemen, due to time constraints, we have reached the end of the question-and-answer session. I would now like to turn the floor back over to management for closing comments.

Thank you, Christine, and thank you, everyone, for your questions and time on the call today. We appreciated updating you on our fourth quarter results and full year results for fiscal 2017, and we look forward to catching up with you on the next conference call. Thank you.

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.