Graham Corporation
Q4 2013 Earnings Call Transcript

Published: 31 May 2013

[Operator:]

Greetings and welcome to the Graham Corporation F4Q 2013 Financial Results Conference Call. (Operator instructions.) As a reminder, this call is being recorded. It is now my pleasure to introduce your host Karen Howard. Please begin.

[Karen Howard:]

Thank you, Brenda, and good morning everyone. We certainly appreciate you joining us here today for the Graham Corporation F4Q 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 financial 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 on 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?

[Jim Lines:]

Thank you, Karen, and thank you to everyone that joined our webcast to review F4Q 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 fabrication products and our commitment to the Naval and nuclear propulsion program will provide sufficient demand to realize this strategy. Our plans to accomplish this include taking greater market share in refining, chemical, and 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 F4Q. Our team, management and employees together executed exceptionally well. Actions taken in F3Q and F4Q to drive revenue and profits in F4Q came to fruition as planned. It was a terrific effort by the whole team. F4Q sales were just shy of $31.0 million, up $10.7 million from a year earlier. When compared to F2Q and F3Q, F4Q sales are up approximately 20%. Full-year sales were $105 million, the midpoint of our guidance and at the lower end of the guidance provided at the start of the fiscal year. Operating margin in F4Q was 18.4%, generating $5.7 million of operating profit. When compared to F2Q and F3Q, operating profit is up more than 45%. Improvement in profitability was driven by greater throughput and thus improved leverage, quality of backlog converted in F4Q, and timing of refining industry backlog conversion. Full year operating margin was 14.5% generating $15.3 million in operating profit. Net income in F4Q 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’s sales. There’s been a surge of refining market spare or replacement parts orders that we began to identify about one year back. Certain of those orders contributed to the F4Q sales and profitability. The level of spare parts sales in the quarter was roughly 2x 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 the 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?

[Jeff Glajch:]

Thank you, Jim, and good morning everyone. If you can turn to Slide #7, as Jim mentioned sales were up in F4Q 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

[Jim Lines:]

Thank you, Jeff. Please move on to Slide 12. F4Q new orders were $25.9 million, a 39% decrease from an unusually strong F4Q one year ago that included a large order for US-based new nuclear power plants. F4Q bookings were in line with F2Q and F3Q 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 twelve months of quotation activity is between $750 million and $1 billion. This is more than twice the level prior to the start of the 2005-2009 expansion cycle. I view this as 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 twelve 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 twelve months. Backlog breakdown 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. Side 14. F2014 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 F1Q and F2Q 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 a keen focus on error elimination, process improvement and aligning processes to reduce lead time, leveraging existing physical plan assets and investing to improve productivity. Strong cash flow from operations will be realized by the work on the entire team focusing from the start of the quoting process where cash flow terms are negotiated to operations, reducing lead time and working capital, through to collections. A 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:]

Thank you. We will now be conducting a question-and-answer session. (Operator instructions.) Our first question comes from the line of Chase Jacobson with William Blair. Please proceed with your question.

[Chase Jacobson:]

Hi, good morning. Jeff, I think this first one’s for you – just on the aftermarket in the quarter can you give us any color as to how much the aftermarket sales actually were and maybe just some general comments on how the margin profile compares to the OE business? And then was it something specific on specific projects that drove those better sales or any color on that?

[Jeff Glajch:]

Sure, Chase. If you think about our aftermarket business, normally it is about 30% of our overall business. It was up pretty significantly from that. The margin on our aftermarket is also significantly greater, so really the mix of the two – without giving too much on specific numbers, the mix of the two was a 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.

[Chase Jacobson:]

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

[Jeff Glajch:]

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

[Chase Jacobson:]

Okay, that’s helpful. And Jim, on the bid pipeline obviously it’s still strong - $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 I’m just trying to get a sense of what’s different compared to last quarter.

[Jim Lines:]

That’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 and old Graham prior to the acquisition of Energy Steel. The rough numbers, Chase, is Energy Steel adds about $100 million of trailing twelve month bid activity.

[Chase Jacobson:]

Okay. So but on the lower end does that have to do with material pricing or is it just… I’m just trying to understand why it’s lower.

[Jim Lines:]

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

[Chase Jacobson:]

Okay. And then one more and I’ll get back in queue, but 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 midpoint of the guidance is kind of like flat revenue so I mean is there conservatism there or 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, how that relates to your current backlog.

[Jim Lines:]

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. And what we’ll have, if we have for the sake of three months soft bookings in F1Q that could drive us to the lower end of the range. It’s a timing issue and we have to come out with the guidance for the full year next year and we try to 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. With one more quarter behind us I’ll be more definitive and perhaps give more clarity on where that guidance should be.

[Chase Jacobson:]

Okay, that was kind of what I was expecting. I appreciate it, I’ll get back in queue. Thanks.

[Jim Lines:]

You’re welcome.

[Operator:]

Our next question comes from the line of Dick Ryan with Dougherty. Please proceed with your question.

[Dick Ryan:]

Thank you. Hey Jeff, with F2014 how should we look at kind of first half/second half? You’ve given us kind of a feel in the past; how do you think those roll out?

[Jeff Glajch:]

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 one way to think about it as Jim mentioned, the orders over the last three quarters have been relatively consistent at around mid-$20 million or so, so if 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.

[Dick Ryan:]

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

[Jim Lines:]

This is a look back comment

[Dick Ryan:]

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?

[Jim Lines:]

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 sizable. Those orders are fairly sizable 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 twelve-month bid activity of about $100 million for Energy Steel-type products, the nuclear products.

[Dick Ryan:]

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

[Jim Lines:]

Some of it is international but to be candid, your second comment is probably more accurate – it’s largely domestic.

[Dick Ryan:]

Great. Great, thank yo.

[Jim Lines:]

You’re welcome.

[Operator:]

Our next question comes from the line of Jason Ursaner with CJS Securities. Please proceed with your question.

[Jason Ursaner:]

Good morning, congrats on a strong quarter. I have a couple of follow-up questions about orders and the guidance. Other than F4Q last year orders haven’t topped the $30 million level since the last cycle really, and that level’s 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 timeline do you expect you’ll need to achieve a more sustainable $30 million per quarter level order rate?

[Jim Lines:]

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 F4Q. 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.

[Jason Ursaner:]

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

[Jim Lines:]

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 timespan. 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’re 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.

[Jason Ursaner:]

And so you mentioned this 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 F2015 for you guys would you expect something close to that $30 million a quarter to be sort of the lower bound on revenue at that point? Or could it still take longer than that?

[Jim Lines:]

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

[Jason Ursaner:]

Okay, that’s it for me. I appreciate the detail.

[Jim Lines:]

You’re welcome.

[Operator:]

Our next question comes from the line of Joe Mondillo with Sidoti & Company. Please proceed with your question.

[Joe Mondillo:]

Good morning guys. Just to jump on that last question, you pointed to several different types of projects that are pretty much related to I guess your petrochemical business. And I understand that you are anticipating this coming but we have seen backlog down I guess 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 F4Q, maybe here in F1Q and that maybe we should expect that backlog within the petrochem to begin to tick up.

[Jim Lines:]

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 dialog 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.

[Joe Mondillo:]

Okay. And in terms of the gross margin and sort of the dynamic between the aftermarket and OEM, I understand F4Q was largely driven by that weighting of aftermarket. How have sort of orders been trending or what is the mix like between the aftermarket and OEM?

[Jim Lines:]

We’ve had a nice uptick in aftermarket 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 aftermarket work. At that point in time in 2007-2008 it was so important for the refiner to be on stream producing gasoline they couldn’t afford to have an unscheduled shutdown. 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 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, aftermarket 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 F2013 to what went into backlog across F2013 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 and 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’d 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.

[Joe Mondillo:]

So 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 sort of put out a year ago. And considering sort of the improvement in equipment margins, improvement margin in the total backlog that you mentioned, is that just a case in point of sort of conservatism or equipment, the total sales transitioning more towards equipment as the cycle proceeds? So how can we sort of look at that? I’m just trying to figure out sort of the upside I guess.

[Jim Lines:]

I think the way to think about that is there is upside. How we’ve come out with our guidance is to… It’s really not a pricing issue; it’s more of a utilization or leverage issue. So if we have strong order rates leading to strong revenue for the full year, moving toward the upper end of the guidance we would expect that gross margin to move above what we’ve guided to. If we have softer F1Q and F2Q orders and 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 F1Q our visibility will be far more definitive and we hope to be adjusting guidance as we move forward. But this is how we see it today as potential outcomes on both ends of the spectrum.

[Joe Mondillo:]

Okay great, thanks. And then the last question regarding your sort of 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 I’m just wondering sort of your, I mean obviously there’s a lot of positive indications in the US markets and everything so if you could maybe just comment on why you think some of those orders have been a little light internationally and sort of what your outlook there is?

[Jim Lines:]

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. I think that’s been the biggest issue for the 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 for some Middle Eastern work just wasn’t staged yet to be secured.

[Joe Mondillo:]

Okay, thank you.

[Jim Lines:]

You’re welcome.

[Operator:]

Our next question comes from the line of Tom Lewis with High Road Value Research. Please proceed with your question.

[Tom Lewis:]

Yeah, hey Jim, I was wondering the aftermarket 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?

[Jim Lines:]

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 shutdowns and then their desire to extend the run rates from four years to a longer interval and making investments now to ensure that when they’re up and running they will do their best not to have an unscheduled shutdown, 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 a fantastic work for us. And I don’t want to diminish it – 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 with “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.”

[Tom Lewis:]

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 downtime.

[Jim Lines:]

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 that they thought about 18 months ago and has already been bought.

[Tom Lewis:]

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?

[Jim Lines:]

I think the Naval work or our Naval strategy as a whole, we’re extremely pleased with our progress. We’re doing a very 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 several things. One is our ability to manage these complex projects, to identify design or schedule risks, implement countermeasures; 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’re 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 2013 we’ll be able to define are we in the sub program or not? The 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 2014 if we are a supplier to the Ohio-class program. But the Virginia-class window I think is calendar 2013.

[Tom Lewis:]

Okay. Alright, 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?

[Jim Lines:]

Not yet, and that’s encouraging too because I think we’re at a low ebb on dollars quoted to dollars converted so it should only go up from here. If we look at our historical patterns we’re at a low conversion level of that trailing twelve 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 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 [rest] releases. It’s 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 in 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.

[Tom Lewis:]

Well hopefully that’s something we’ll be talking about in the first half. Keep up the good work.

[Jim Lines:]

Thanks, Tom.

[Operator:]

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

[Brian Rafn:]

Good morning, Jim and Jeff. Question for you, Jim

[Jim Lines:]

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 at the last peak. We’ve gotten that set the last three years. Our Engineering Team, our Operations Team is more equipped today for a 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.

[Brian Rafn:]

Okay. You kind of answered my next question

[Jim Lines:]

Just to give it a frame, we invested in personnel calendars 2010, 2011, and 2012 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 this 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’ll be some incremental adds but the big adds, I think we’ve already taken care of that with the exception of our direct label which will probably slide a little bit as volume goes up. But from the infrastructure, the in-directs, we got at that in 2010, 2011, and 2012. There’ll 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’ll well along on the development and training programs; and they’re very valuable toward the output that they’re 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 in 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.

[Brian Rafn:]

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 the specific channels in your 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?

[Jim Lines:]

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 on several conference calls now, so a lot of that upfront 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.

[Brian Rafn:]

Okay. Let me ask you on the Navy side, when you made a comment about Ohio-class you’re talking about the next generation boomers, right? You’re not talking about the 13 Ohio-class that we currently have, correct?

[Jim Lines:]

I apologize – it’s the Ohio-class replacement program.

[Brian Rafn:]

The replacement program, okay. And then on the fast attack subs, if you were to get some business – and as you go through, maybe a better question is as you become in the process, you’re an approved supplier, you’ve been providing I’m assuming [cadensis injectors] for the carriers and the next-gen SLBM 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 kind of get into the design?

[Jim Lines:]

Well, the design is already done so it’s entering into the Virginia-class program as a supplier for what we would call build-to-print work – the design’s 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. First we won the carrier orders so it’s been two or three years or longer and those discussions have been very, 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 2013; and for the Ohio-class replacement program that’s calendar 2014. And we’re working very hard, our team is working extremely hard to break into the Virginia-class program.

[Operator:]

Okay, thank you. Our next question comes from the line of George Walsh with Gilford Securities. Please proceed with your question.

[George Walsh:]

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 is where you get to about $200 million – do you see your SG&A margins staying flat to possibly going down?

[Jim Lines:]

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.

[George Walsh:]

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 that – 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?

[Jim Lines:]

That’s correct. There is a caveat to that and something that we’re watching as we think about the North American chem/petrochem expansion. We’re trying to understand the decision making of the end user with regards to what contractor EPC they’re 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. The 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 is going to be fantastic for us. We’re focused on winning more than our fair share of that. The caveat I made was around margins and that reflected who was our customer.

[George Walsh:]

Okay, alright. Thanks a lot.

[Jim Lines:]

You’re welcome.

[Operator:]

(Operator instructions.) Our next question comes from the line of Chris McCampbell with Southwest Securities. Please proceed with your question.

[Chris McCampbell:]

Well, I’ve 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.

[Jeff Glajch:]

Chris, yeah. Well as you know, we did bump up our dividend by 50% back in 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’d rather keep that cash available and that debt capacity available to take advantage of acquisition type opportunities. Specifically to the acquisition pipeline, we’ve wrapped 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 the 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’d like to keep our cash available and our debt capacity available to hopefully take advantage of that. And Jim’s talked a lot about the $200 million target that we’ve put out there. We believe that we can do that organically so with the acquisition opportunities we have it’s two things – one is it’ll allow us to get to $200 million faster and also it’ll give us the opportunity to get well past $200 million if we found the right acquisition opportunity.

[Chris McCampbell:]

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?

[Jeff Glajch:]

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 thirty 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 a $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 willing to look a little higher than we did the last time.

[Chris McCampbell:]

Well congrats, guys.

[Jeff Glajch:]

Thanks.

[Jim Lines:]

Thank you.

[Operator:]

There are no further questions at this time. I’d like to turn the floor back over for closing comments.

[Jim Lines:]

Thank you, Brenda, and thank you everyone for listening in on our webcast today for our F4Q 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.

[Operator:]

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