Karen Howard - Investor Relations James Lines - President and Chief Executive Officer Jeffrey Glajch - Vice President, Finance and Administration and Chief Financial Officer.

Jason Ursaner - CJS Securities Paul Dircks - William Blair Joe Mondillo - Sidoti Dick Ryan - Dougherty & Company.

Greetings, and welcome to the Graham Corporation second quarter fiscal year 2014 financial results conference call. (Operator Instructions) It is now my pleasure to introduce your host, Karen Howard, Investor Relations for Graham Corporation. Thank you. You may begin..

Thank you, Christine, and good morning everyone. We appreciate your participation in our second quarter fiscal 2014 financial results conference call. You should have a copy of the news detailing Graham's results that was released earlier this morning. We also have slides associated to the commentary that we're doing here today.

If you do not have the release or the slides you can find them on the company's website at www.graham-mfg.com. On the call with me today, we have James Lines, our President and CEO; and Jeffrey Glajch, our CFO. Jim and Jeff will review the results for the quarter as well as our outlook, and then we will open up 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 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 our website or at www.sec.gov. And with that, I'm going to 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 our second quarter fiscal 2014 results. Please refer to Slide 3. Our strategy across this expansion cycle in our market is to double revenue to exceed $200 million in the next peak.

We believe our focus on the energy markets with engineered-to-order, custom fabricated products and our commitment to the Naval Nuclear Propulsion Program will provide sufficient opportunity to realize this strategy.

Our plans to accomplish this include, leveraging our investment that expands Batavia's execution capacity to take greater market share in global refining and chemical/petrochemical markets; capitalizing on our brand strength; installation record and relationships, and have a leading market share for what is expected to be substantial investment in new chemical and petrochemical capacity in North America driven by low-cost natural gas.

Leveraging our engineering know-how; custom fabrication expertise and complex project management skills to provide equipment to both surfaced ship and submarine programs of the U.S.

Navy; expanding our presence in power generation markets, including nuclear, geothermal, biomass and other renewable energies; and driving both organic growth and acquisition growth by putting our exceptional balance sheet to work. Please move on to Slide 4.

We had solid execution in the second quarter and are positioned well at the midpoint of fiscal 2014. Our talented employees put forth a terrific effort. Second quarter sales were down 5% or $1.4 million compared with last year. This was due to customer schedules and the level bookings during the first three quarters of fiscal 2013.

At midyear, sales were up 9% or $4.3 million when compared with last year at this time. Net income in the quarter was flat at $2.6 million, despite 5% lower sales. Improvement in market fundamentals led to higher level of short cycle sales that were up approximately 20%. Additionally, higher quality backlog converted during this period.

$48 million in new orders in the quarter is tremendous and indicative of improving market fundamentals. There was nice balance of orders across our key end-markets of refining, chemicals and petrochemicals, power and Naval Nuclear Propulsion Program.

The pipeline of bidding activity remains elevated and we believe our global refining and petrochemical markets are in the early stages of recovery. $800 million to $1 billion is the range of trailing 12 month total bidding activity.

We believe this is a positive leading indicator for the direction of future orders, subsequent backlog expansion and ultimately revenue growth. Please refer to Slide 5. Sales for global refining markets were $10.5 million in the quarter, up $4.7 million.

Backlog for Canadian new oil sands upgrader projects began to convert and there were several projects for North and South American refining revamps and replacement equipment that drove refinery sales expansion during the quarter. 58% of sales were domestic and 42% international.

In Middle East, Asia, Canada, South American regions continue to be important international markets for us. It is important to point out that sales by market or geographic location can vary appreciably quarter-to-quarter. Always consider longer time periods when the evaluating changes to sales mix.

I'm going to pass it over to Jeff now for a more detailed review of the financial results.

Jeff?.

Thank you, Jim, and good morning, everyone. As Jim mentioned, we had a good earnings quarter and a very strong order levels within the quarter. And despite slightly lower sales compared with the second quarter last year, the margin improvement kept our earnings flat.

Q2 sales were $24.5 million, down 5% compared with $25.9 million in last year's second quarter. As Jim mention, the sales split of 58% domestic and was 42% international, and this was comparable to last year's second quarter, which was 59% domestic and 41% international.

Gross margins were up 330 basis points to 33.8%, as improvements in product mix and short cycle sales occurred. EBITDA margin was 18% for the quarter, up from 15% last year. Q2 net income and EPS were flat at $2.6 million and $0.26 respectively.

Looking at the business on a year-to-date basis, the sales were $52.7 million, up 9% from $48.4 million in the first half of last year. Gross profit increased to 29% to $18.3 million. This gain was driven by a 550 basis point gain in gross margin, which was favorably impacted by the higher sales level as well as the improved product mix.

SG&A in the first half of the year was $8.8 million, up 4% compared with the first half of last year. EBITDA margin increased 620 basis points to 20% in the first half of fiscal '14, driven by both the increase in gross profit margin as well as leveraging the SG&A cost.

Net income in the first half of the year increased 60% to $6.4 million, up from $4.0 million in the first half of last year. EPS was up to $0.63, up from $0.40. Our cash position has increased $3.2 million in the first half of the year to $54.9 million. This is also an increase of $8 million, when compared with September of calendar year 2012.

We continue to have a clean balance sheet with no bank debt. This allows us to focus on utilizing our cash, and if necessary untap lines of credit and internal growth opportunities as well as future acquisition opportunities.

Finally, on Slide 10, as we initially discussed in our July call and we finalized in a press release on September 24, we are expanding our capacity at our Batavia, New York facility. This will increase the expected fiscal 2014 capital expenditures to $6 million to $7 million.

In the first half of the year, our capital expenditures have only been $900,000. So clearly we will be spending a lot more cash in the second half of the year. We expect to fund this increased capital, the funding of this is to come primarily from operating cash earned in the second half of the year.

So we do not expect a significant change in our cash balance position positive or negative over the next few quarters. The majority of the cost of this expansion project will be incurred in the second half of fiscal 2014. However, there will be some cost incurred at the start of fiscal 2015.

As with the spending in the second half of this year, we expect operating cash flow to cover the costs, which occur in early 2015. When the expansion is completed in the first half of fiscal 2015, we expect the capacity of Batavia to increase by $15 million to $20 million.

This will increase the capacity at full staffing of the Batavia site, including outsourcing to $150 million to $170 million, up from our previous estimates of $135 million to $150 million. In addition, we believe our Lapeer, Michigan facility has an added capacity of $40 million to $50 million.

The combined capacity will support our $200 million organic growth target, which Jim mentioned earlier. Jim will complete our presentation and comment on our view for the rest of fiscal '14 as well as an early topline view of fiscal '15.

Jim?.

Thank you, Jeff. I am now on Slide 12. Second quarter new orders were $48 million, an 89% increase from the same period in fiscal 2013, and new orders expanded 48% sequentially. Trailing 12 month orders were $131 million compared with $109 million at the end of last quarter.

It is important to note that while total orders in the quarter were within our expected range, there was considerable variation looking at monthly order levels. The pace at which orders have been released is encouraging and supports our belief that market fundamentals continue to improve.

Projecting the timing of order placement is becoming better, but still remains challenging. We're pleased to see good balance of orders across our key markets of refining, chemical and petrochemicals, navy and power. U.S. markets continue to remain strong and represented 61% of total orders.

It was encouraging to have this level of bids in our $800 million to $1 billion trailing 12 month pipeline convert to orders. Bidding activity is holding, enthusiasm for North American chemical/petrochemical markets hasn't changed and the inventory and quality of bids for international markets continuous to improve.

However, we don't expect order levels in the first six months at $81 million to hold during the second half. This is a timing issue for the staging of the next large projects rather than a change in market fundamentals. On to Slide 13. Backlog expanded approximately 26% sequentially to $114 million as of September 30.

Backlog is distributed well across our key markets. It was 29% for refining markets, 27% for chemical and petrochemical markets, 14% for power generation and the remainder 30% for naval work and other markets.

Revenue to 75% of backlog is projected to convert over the next 12 months, 15% to 28% between 12 and 24 months and approximately 10% after 24 months. We expect our markets will continue to improve, although quarterly order levels will likely fluctuate. Slide 14.

We have refined fiscal 2014 guidance, now that there is clear understanding of conversion cycle for recently secured orders. Revenue range is tightened to $100 million to $110 million. Gross margin has increased to 31% to 33%. SG&A increased to 16% to 17% of sales.

This change, which is an upward change isn't due to an increase in SG&A expense in absolute terms, but it is a result of a lower revenue level, and the tax rate of 30% to 34%. It is early to frame fiscal 2015.

However, we do expect next year's revenue to fall between $115 million and $135 million, and the management team is developing plans and strategies to execute at that level. Christine, please open the line for Q&A..

(Operator Instructions) Our first question comes from the line of Jason Ursaner with CJS Securities..

You mentioned you have more clarity on the conversion cycle.

Can you just talk a little bit about timing of deliveries and what you expect for the second half versus the orders you're receiving and the reduction in the high-end of revenue guidance?.

If we look at our current guidance and take the midpoint of that, which will be a $105 million, it basically suggests that the second half revenue level is comparable to the first half.

And that's not necessarily due to our execution capacity, but more due to our ability to get projects released into the plan, tied to customer timing and finalizing engineering design between us and our customer. That gives a more realistic view, one quarter later for when we talked about this last call.

We now have a better understanding of how these orders will flow through engineering, and ultimately when our customers will release us to begin fabrication. And again that reflects a fairly similar, straight to mid-point of the guidance, revenue level in the second half as we experienced in the first half..

And you can just maybe provide an update on the outsourcing that you plan to do with the orders bunched up and what type of margin impact that might have?.

Again, working within our guidance, I think it gives an ability to frame what the second half gross margin would look like on that similar revenue level to the first half.

We are doing more outsourcing in the second half than we did in the fist half, tied to the where the orders came in and how delivery schedules were bunching up, it does have a margin compression impact on it. However, within our guidance that we've given, you can see we've upped our overall gross margin guidance from where it was at the last call.

It went up from 29% to 31%, to 31% to 33%..

Is that more due to internal efficiency there or that you're getting better returns on the outsourcing?.

I think it's a reflection of a couple of things. One is the market fundamentals continuing to improve pointing to perhaps improvement in pricing. And also I believe our operations every quarter continue to improve..

Our next question comes from the line of Paul Dircks with William Blair..

So couple of questions if I may, first kind of attacking on to that last question, with regards to your gross margin outlook for rest of fiscal '14, I guess how should we think about your expectations for short-cycle orders over the balance of this fiscal year and into next year.

Is there an expectation that they'll continue to be robust? And if they could help offset any of these dilutive impacts from outsourcing and timing of backlog execution..

There is a counterbalancing of that, as we go into the remainder of this year. If I were to characterize where we view our short cycle sales, comparatively to a year ago, first quarter and second quarter were roughly 200% up in terms of the revenue level.

We are expecting that to hold, as we work through the rest of this year for the short cycle sales. And that does counterbalance to an extent some of the margin compression we realized through outsourcing.

But we are advancing a materially different outlook on our short cycle work, as we've been able to experience this first half of the year, which is up about 20% year-on-year..

Now, regarding the recent announcement, I guess confirmation for the increase in your capital investment in Batavia.

How confident are you at this point in this cycle that you'll be able fill the new capacity with that kind of high quality, high margin work that could be out there, if coming from North America especially? And are you taking new orders for the additional capacity now?.

Two questions there. We had a decision to make. We were going to become potentially capacity limited, because our lead time reduction strategies could not release capacity in alignment with how order rates were coming in.

We had a decision to make at this juncture which was, do we manage this cycle as we did the last cycle, which was simply take the best of the orders and underserve the market, underserve our customers.

Or, because of our perspective on the outlook, the clarity that we had into our bidding pipeline, make this investment to take greater share, to be the supplier our customers are expecting us to be and because of our conviction over the next several years of how we see market fundamentals playing out, we choose to make this investment and we are selling into that expanded capacity right now..

I guess one more question related to that expansion.

Do this have in any way any sort of impact or perhaps push up the timing of some of your evaluation as far as making an additional acquisition? Should we think at all about the Batavia expansion, perhaps putting some of those plants off to the sight for a little while?.

I would characterize it this way and then I might turn it over to Jeff for a more full response. If we look at the aspects of our acquisition program that would have related to addressing our core markets, I would say the CapEx that we're putting into Batavia addresses that aspect of it, which wasn't necessarily a diversification investment.

It was to capitalize through an acquisition on the strong fundamentals we were pursuing in our marketplace. So I think we've addressed that with the CapEx that we're putting into the Batavia operations to drive our core business expansion.

Around diversification and the strategic objectives there, I'll turn it over to Jeff, to maybe offer a response on the acquisition program..

Paul, if you think about our acquisition process, one of the things that we have done is cast a fairly wide net around the areas that we're looking at. So we put the product diversification over to market diversification, part of certainly one of those areas can also be looking at the incremental capacity or serving our existing customer base.

So as Jim mentioned, we think we've hit that by investing internally, but there are many other avenues for our acquisition program to go down. And this we believe was the most efficient and least risk avenue to take advantage of within our existing markets and the strength of the North American business today.

But we clearly have many other avenues to look at in acquisition. So I think the summary answer to your initial question is, no, it really does not effect our acquisition program, other than in that one avenue..

Our next question comes from the line of Joe Mondillo with Sidoti..

I was wondering, in terms of gross margin, is there any difference amongst different geographies or different end-markets in terms of gross margin, generally?.

That's a very insightful question. If we look at what's driven our bookings growth, it's one of our core product lines, which is surface condensers. And if we think about margin profile across our different products, we have spoken in the past about the ejector product line, in general, has a higher margin potential than does surface condensers.

And vacuum pump packages has a lower margin potential than either of those two. So from a product point of view, the margin potential of our surface condenser order is a little different from ejectors, primarily because it has a higher labor content than ejector systems do.

So therefore the impact on cogs changes a little bit differently with that particular product. So from a product point of view that gives an idea of margin potential, with what's been driving the bookings pattern. On the geographic perspective, North America, and I would argue that Middle-East are fairly comparable in terms of margin potential.

When we move into the other international markets of Asia, China or South America, the margin potential can be less than the Middle-East or North America..

So having said that, does that have anything to do with sort of the product mix that you're getting in the back half of the year? Just trying to understand a little bit more on the product mix shift from the first half of the year to the second half?.

The product mix in the second half of this year relates to orders that were secured in 2013, to a large degree, except for the short-cycle work.

I'm going to answer it this way, the margin that's being relieved through backlog and reflective in sales, if we think about the surface condenser product line, we're replenishing that backlog with higher margin work.

However, the second half versus the first half relates to orders that were secured in 2013, which was a different market environment and a different pace for order is being released, and therefore pricing was different..

So it's a higher mix of condensers versus maybe ejectors in the back half of the year?.

Yes..

And then in terms of the backlog, the backlog beyond 12 months in the last two quarters has started to jump up quite a bit.

Our customers are starting to make order much sooner in advance and as a result are you seeing any upside in pricing because of that?.

The elongation of our backlogs has two aspects to it, identified one, Joe, which was in some cases, we had received orders in the June timeframe and in our second quarter that were ahead of when we ordinarily would have gotten those orders, because our customers are recognizing the supply chain, it's starting to tighten up, the clinical equipment suppliers, and we are one of them, are beginning to have their backlogs expand, so they wanted to lock down those critical suppliers such as Graham earlier.

And the deliver dates therefore are extended for when they actually need the equipment, but they want to get the engineering and secure the supplier they want, so that has an aspect of taking what had been a normal cycle of 12-ish months from order to shipment for these large orders, to maybe it's 15 to 18 months depending upon the particular project.

And then secondarily, we have had secured some additional navy work and that tends to have a longer cycle..

So in terms of your first comment regarding, maybe capacity tightening up around the industry, is it fair to say that the work that you're receiving today and the work that you received in the second quarter is much better margin than you've seen in the past?.

As a high-level remark, if I look at a year-on-year comparison or just reflecting on what was relieved from our backlog reflected in our sales gross margin versus what went into backlog with new orders, the margins in general are better..

And then the backlog in the other commercial and industrial, that jumped up quite a bit. I was just wondering what's the driver there over end-market..

But what goes into that category is our other markets, which include edible oils, pharmaceutical, industrial HVAC and navy work..

So is it just a combination?.

As I mentioned, we did secure some additional work last quarter and the quarter before that for some U.S. Navy vessels..

And then lastly, the capacity expansion, I think you said in the past that that you had capacity at Batavia, I think somewhere around $125 million around there.

So I was just wondering, sort of where this expansion would bring the upside of your capacity following the expansion?.

We have historically said that it is about a $135 million to $150 million here in Batavia and that will include a kind of a normal level of outsourcing, so that the engineering capacity as well this fabrication capacity. We believe with this expansion we've taken that $135 million to $150 million up to $150 million to $170 million.

So it's that I think is just million of capacity..

So in terms of your sort of decision making in terms of this project, essentially you've seen where the market has progressing, the increased demand, and you guys obviously have an idea or a feeling that you're going to have to get to this.

You're going to see $150 million to $170 million at some point in the near future, in the next couple of years, is that fair to say?.

Joe, I think that's fair and I think as you think about it from an economic analysis standpoint, the way we look at this was the funding of this capital needed obviously to be justified economically, and so to get to that additional volume was something we certainly couldn't invest today and expect that it's going to take a long time to get there, otherwise the map doesn't work.

So yes we do believe that that is in our future..

And just lastly, does this at all takeaway from any of your outsourcing that you'll have to do, and if so will that increase your profitability in some projects?.

Ideally, exactly correct. We plan to continue to have an outsourcing strategy. However, not have it be to the degree that we had to outsource because of the burst of business we saw June through this last quarter.

So we plan over time to continue to have that relief valve of outsourcing, but due lesser bit than we have to because of how orders came in, in the second quarter and end of the first quarter..

So you've always talked about how sort of this cycle, you think gross margins could be in the high-30's.

Could that maybe put a little upside to that?.

I believe it still reflects that general view of mid-to-upper 30s for gross margin as we move to the peak of the cycle..

Our next question comes from line of Dick Ryan with Dougherty & Company..

And so again, moving off to core business, can you talk a little bit about what's going on at Energy Steel, and the nuclear side, the power side as well overall?.

Sure.

If we do a look back over the last 12 to15 months, we did experienced a subdued order environment that had two catalyst, one was Fukushima; secondarily, it was the potential change, which seems to be a real in the energy mix of low cost natural gas, and therefore driving towards more combined cycle power plants for incremental capacity versus what have been thought to have been fulfilled by new nuclear.

So we have seen our customers pull back and evaluate which direction the markets are going. And that was what we were seeing in the last 12 to 15 months.

If I look going forward, I'm far more encouraged by what we're seeing in our big pipeline, the opportunities and the changes that were implemented by the management of Energy Steel, expand the addressable opportunities set and go after it more aggressively, so as we go forward, I'm more encouraged then if I think about the last 12 to 15 months with Energy Steel, in particular.

And as we look at the power market as a whole, moving beyond nuclear to the renewable side, I think here too, low cost natural gas has changed the fundamentals of tax credits that were around biomass to energy.

We feel there still will be some of that work in North America, but the tax incentives are changing and the investment pace has changed somewhat. Moving beyond that to geothermal. We see a lot of geothermal power bidding activity, both in North America, Central America and Southeast Asia, that's in our pipeline.

Those have a pace that can be unpredictable, the nice projects when they do materialize, but what's good is we have a pretty large array of opportunities that we have in our bid pipeline.

So in general, we see our power segment, I would say, picking up from where it had been in the last 12 to 15 months and lifting off of what I would characterizes as what had been a bookings bottom..

With the expansion of the opportunity set you talked about, has that taken the Energy Steel capabilities internationally or is it more having to do with seeing some of the increasing safety issues as a result of Fukushima coming through?.

I think it's the latter, and its principally centered around North America, now that we've lost sight of international work, but my commentary really reflected a more positive outlook that we have today in our North American nuclear markets than we had 12-ish months ago..

Thank you. 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 Mr. Lines for closing comments..

Thank you, Christine. We appreciate your time this morning and your interest in the direction of Graham.

As you can see we're very enthused about the level of order activity, recognized the second half of fiscal 2014, reflex the order patterns in 2013, but the real story here is beyond 2014 and as we grow into '15 and '16, and we're very encouraged by the degree of bidding opportunities that we see throughout our pipeline across all of our markets and we'll update you on our progress on the January call.

Thank you, again, for your time..

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..