Karen Howard - IR, Kei Advisors LLC Jim Lines - President and Chief Executive Officer Jeff Glajch - Chief Financial Officer.

Brian Rafn - Morgan Dempsey Capital Management Paul Dircks - William Blair John Karla - Oppenheimer.

Greetings and welcome to the Graham Corporation First Quarter Fiscal Year 2017 Financial Results Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Ms. Karen Howard, Investor Relations for Graham. Thank you. You may begin..

Thank you, Audrey and good morning everyone. Thank you for joining us to discuss the results for Graham’s fiscal 2017 first quarter. We certainly appreciate your time today. You should have a copy of the news release across the wire this morning detailing Graham’s results.

We also have slides associated with a commentary that we are providing here today. If you don’t have this 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 as well as our outlook. We will then open the line 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. And with that, I am going to turn the call over to Jim to begin.

Jim?.

Thank you, Karen, and thank you everyone for joining our first quarter results conference call. I will begin my prepared remarks starting with Slide three. $22.4 million of revenue in the quarter was down 19% compared to the same quarter last year and comparable on a sequential basis compared to the fourth quarter of fiscal 2016.

Revenue decline is due to weak market conditions for oil refining and petrochemicals, revenue is also negatively impacted by timing of backlog conversion for our improved nuclear utility backlog and long lived large naval orders that don’t meaningfully contribute to revenue until the second half of fiscal 2018.

Short cycle sales in the quarter were up approximately 20% from the same period last year and about 10% down sequentially. Reported net income was $0.01 per share without the impact of non-recurring restructuring expenses, earnings per share was $0.05. The management team implemented restructuring activities at both our Batavia and Lapeer operations.

Both reduced headcount to more appropriately align capacity with demand that is anticipated across the next several quarters. Batavia expenses were restructuring in our first quarter income statement; Lapeer completed their reductions in July resulting in minimal expenses that will impact second quarter results.

In both cases, headcount was reduced by approximately 10%. We did not change commitment to growth over the importance of diversification strategies for the naval and nuclear markets. And therefore we are judicious about reductions that supported those strategies. Approximately 75% of expense reduction is in cost of goods sold and the remainder in SG&A.

On an annualized basis the savings is $2.7 million. There is other belt tightening occurring which is reflected in our guidance that I will note later. Backlog on June 30th was $99.9 million.

We had $18 million of orders in backlog cancelled during the past six quarters and coupled with weak oil refining and petrochemical markets resulted in backlog contraction.

Please now turn to slide four, of the $22.4 million of revenue in our first quarter 32% was for the oil refining market or $7.2 million, 23% to the chemicals markets or $5.2 million, 21% to the power market and the remaining 24% was to defense and other industries.

Power sales in the quarter were up 27% from the same period last year, sales to defense and other industries were up 10% from last year in the first quarter. Jeff, I am passing the call over to you to review detailed financial results.

Jeff?.

Thank you, Jim and good morning everyone. I’m on slide six. As Jim mentioned sales in the first quarter were $22.4 million down from $27.6 million in the first quarter last year reflecting the weakness in the commercial order environment over the past 18 months.

Sales in the first quarter were 73% domestic, 27% international compared with last year with the split of 64% domestic and 36% international. Gross profit was cut nearly in half to $4.1 million due to the lower volume, gross margin was 18.4% in the quarter down from 29.1% in last year’s first quarter.

This year’s margin was unfavourably impacted by the lower short cycle sales as Jim mentioned earlier, lower overall volume and which of course resulted in under absorption of cost. We do expect gross margins to pick up from this suppressed level as the year continues.

EBITDA margin decreased to 5% down 15% in last year’s first quarter driven by the low gross profit margin. SG&A spending however was down by $1 million or 21% primarily due to lower volume, lower compensation cost and the cost savings actions which were taken last year.

As Jim mentioned we did incur a pre tax charge of $555,000 approximately $383,000 after taxes to right size our business based on current market conditions. As Jim also mentioned there will be a small charge in the second quarter, this will be less than $100,000 on a pre tax basis.

Net income excluding the restructuring charge was $483,000 or $0.05 per share compared with $2,361,000 or $0.24 in last year’s first quarter. Also included in this year’s results was $100,000 non-repeatable tax credit.

If we could move to slide seven, we had positive cash flow in the first quarter increasing our net cash position by $2.6 million to $67.7 million or approximately $7 per share. The step up in the quarter was aided by an increase in customer deposits related to our navy jobs offset partly by accounts receivables and unbilled revenue.

We expect cash flow to remain positive over the remaining nine months of the year especially in this next quarter or so as the accounts receivables and unbilled revenue increases which occurred in the first quarter will unwind. We continue to look aggressively for acquisition opportunities to utilize a portion of our cash position.

With this Jim will complete our presentation by discussing the market outlook and full year guidance..

Thank you, Jeff. I am now referring to slide nine. Like the sales slide I discussed previously, here too the severity of the energy market downturn is evident in trailing 12-month net order rates. Net orders reflect the $18 million in cancelled orders the past six quarters including $12 million cancelled the past 12 months.

Our bidding pipeline as measured by the aggregate total of trailing 12 month bidding activity has contracted approximately 20% and that is being reflected directly in the order rates. First quarter orders were $14.6 million. This is a particularly difficult downturn in energy related markets.

They always feel harshest in the middle of a downturn; however this current downturn is more severe than last one in the late 2000s with the one prior to that in the late 90s. It may well be worse than the downturn in the early 1980s. We aren’t sitting back waiting for the eventual recovery.

We will fight aggressively for every order and defend vigorously our market share. We also are deploying sales resources into customer plants, customers delayed maintenance and turnaround spending over the past 12 to 18 months. We feel spending at the plant level has to come forward. It cannot risk unscheduled shutdowns or safety issues.

Our early involvement will be important to capitalizing on revamp, turnaround and ordinary maintenance spending. Market diversification actions certainly have helped on a consolidated basis to deal with this energy sector pullback.

We continue to experience improvement in our pipeline of opportunities and orders for the nuclear utility market, also strategies to secure market share within the U.S. naval propulsion program have delivered positive results. We are diversifying what we are bidding to the U.S. navy some of which is expected to close in fiscal 2017.

Our bid pipeline overall has contracted 20%, trailing 12 month quotation activity is about $600 million to $800 million rather than $800 million to $1 billion as it had been in the past. Also, and importantly procurement decisions have slowed.

Our bid pipeline size and quality has remained a strong leading indicator, we will continue to monitor our pipeline closely to be ready for the eventual recovery within energy markets. Please move onto slide 11. The importance of diversification strategies is shown in the top pie chart.

Naval and nuclear market backlog is approximately 60% of total backlog. These are markets or customer we did not serve in a meaningful way prior to fiscal 2011. This has provided backlog stability and will result in reduced financial volatility over time.

Our backlog has a longer conversion duration and prior to five years ago when 80% to 90% would convert over 12 months. We project current backlog will have 45% to 50% convert within 12 months, 10% to 20% between 12 months and 24 months and the remainder converting longer than two years out. I am now on slide 11.

We are operating in a challenging period with a great deal of uncertainties surrounding our energy markets. We are intending to play, we aren’t intending to play defense or simply whether those downturn waiting for the eventual recovery. What we do now and during this cycle bottom, that’s the stage for future growth.

We will and have structured costs with long term growth as our top priority while managing to an acceptable profit level [Indiscernible] the realities of where we are in the cycle. We cannot meaningfully effect demand for our products or control external market forces.

We do have clear focus on those aspects of our business that are within our control, such as managing order opportunities and pricing to secure work that is available to leverage the capacity that we have.

Improving customer value drivers including our selling process, water management processes, process and product quality, and overall service provider to customers, also and importantly developing our workforce and unlocking their capabilities to drive productivity, quality, lead time improvements, improvements in safety and overall customer service improvement and lastly deploying capital as Jeff had mentioned to expand and diversify revenue opportunities.

We are experiencing greater receptiveness of owners to engage in M&A discussions. We are not on solid footing for developing guidance or near term projections to much uncertainty within energy markets. There will be unevenness to quarterly revenue and income.

We have developed a range of potential outcomes bounded by revenue between $80 million t o $95 million, gross margin between 24% to 26%, SG&A between $16 million and $17 million and an effective tax rate that is projected to be between 30% to 31%. Audrey, I ask now that we open the line for questions. Thank you..

[Operator Instructions] Our first question comes from the line of Brian Rafn with Morgan Dempsey Capital Management. Please state your question..

Good morning, guys..

Hi, Brian..

Give me a sense, you talked a little bit about the headcount reductions, what - at 10% how many employees at Batavia and Lapeer is that and what specific areas were they from?.

In total it was about 40 employees, about 10% of the workforce, and it crosses both direct labor, some engineering personnel, some administrative personnel and other functions within the COGS area of our business..

Okay....

It’s roughly 50:50 between direct labor and indirect personnel..

Okay, okay. From the standpoint in your two markets Jim, what from the standpoint is skill set recovery when markets turnaround, how tough is it when you are rebuilding that from the standpoint of loss, your discussion with Boeing when they lose their production guys they go to the [indiscernible].

How was it for you guys in your markets?.

Yes, I think back probably five years ago and before that it was very challenging. What I am very impressed by and proud of is –the work that our HR teams have done to create greater interest in Graham as an employer and an ability to acquire the challenge that we need, when we need it.

But we have seen a very nice improvement through HR activities that were implemented a few years ago.

And then secondarily to the credit of our management team we rethought about the on boarding process and the training process and the time to proficiency when we bring someone onto the team both in welding or machining or the production areas and in the office for engineering or other critical functions that has been reduced appreciably, so we have an attraction improvement of being able to acquire the talent, the talent and then also an ability to get them into our workforce and able to add value quickly.

So with those two things I feel much differently today than I felt or the management team also felt four or five years ago. It was going to be a constraint to growth; you feel less about that worry today than we did four or five years ago..

Okay, all right.

From the standpoint of kind of a top down strategic viewpoint the -- certainly the roll off in the energy markets from spot over 150 to into the 30s and gyrating around - taking that versus some of the instability that we see in the world, China in the South China sea, Russia with the saber rattling with NATO, I think there has been 43 ISIS attacks in 29 countries in the last month, how much of that terrorism and political impacts your business versus just something specific to energy?.

It’s hard to discern.

I can’t -- none of us can believe it doesn’t have an impact because of the uncertainty that surrounds that but if we think about our energy markets which is the one that’s most impacted by contraction at this point in time, I believe it’s less sensitive to those issues and then I also think on the defense side or our naval strategy perhaps there is I don’t want this to happen, but perhaps there is an increase in demand that might come from that uncertainty and then risk in the globe, in the global arena about terrorism and the associative concerns around that.

Again....

Yes, okay. Specifically you jumped forward to my naval question. There has been some modest issues with first of class with USS Ford, now I think it’s the advanced arresting gear.

Has that at all delayed CVN 79 or 80, we used to build carriers on a four years and now five, we are talking six, more for budgeting issues, but has the sea trials at all with a Ford done anything that changed the Navy’s procurement of the Kennedy or the Enterprise?.

Certainly as you said the first in class vessel that came out had, because it was first in class, some issues, they weren’t associated with the delivery of our products, we did not have anything on that particular vessel. It has affected the progress on CVN-79 however we have delivered our scope of supply and that’s through our backlog.

We are seeing as you had said Brian the centers are moving from five year centers to perhaps six to seven years. We think CVN-80 is staging now for procurement activity. You may have read about procurement funding release by two Huntington Ingalls about $150 million for the finally procurement activity, so that’s all very encouraging.

We tend to think of carriers now probably between a five and seven year center rather than a five year fixed center..

Right, right, no, I got you there. You talked a little bit about your short cycle work.

Is the composition of that changed? It has just dried up and when you look at some of the work in the energy space specifically maybe your longer duration work, do you get the sense that the backlog cancellations are cancellations or projects that will be just cancelled, terminated or do you think these things are just kind of delayed pent up demand?.

I have to bifurcate that a bit. One of the projects that was cancelled representing roughly 40% of the $80 million that have been cancelled was for the oil sands. I think that’s less predictable in terms of the timing of recovery and more co-related to the price of oil.

If I think about the other backlog that was cancelled it’s more for the classic refining sector and now as we heard from our customers when they made these cancellations very apologetic and message that was just timing and let them get their feet back underneath them.

So they had a different perspective and so do we that we would have in the oil sands area. So roughly 60% I think comes back into the pipeline at some point, the 40% which is the oil sands, less clear, but we are less clear about that..

Okay, I’ll get back in line. Thanks..

Our next question comes from Paul Dircks with William Blair. Please take your question..

Good morning Jim and Jeff..

Hey Paul.

Hi, Paul, good morning..

So first question from me, I guess Jim you mentioned earlier the year-over-year and sequential decrease in the short cycle market, how has your view of that market changed here as we go into the midway point of calendar 2016 and do you have confidence that market bouncing back either over the balance of your fiscal year or is it something where we need to look forward to fiscal 2018 in order for that market to begin to recover?.

Paul, we had mentioned on several prior conference calls about what we had observed as a change in the buying pattern from our energy markets for spares and replacements. They actually slow that down appreciably.

We felt that the time and we still feel today that that's a discretionary point in time decision that cannot be enduring, so therefore we are expecting to see that begin to improve. We have not yet begun to see it improve in our bid pipeline and in our order pipeline. However, most of the contraction is in the spares and aftermarket area.

And I don't think that's irreparable, I think that's going to recover as we move forward. I don't think we're seeing the inflection point in our bid pipeline just yet or certainly in corresponding order pipeline. However, we do still feel very strongly that that's a decision that can stand the test of time..

I appreciate that color.

Are you guys allocating any additional internal resources to focus on that part of the market given the fact that some of the large projects in refining and other markets are a little bit beyond the way?.

Actually we've -- sometime ago we focused our next investment of personnel and energy into the plants because it’s there where we think the recovery will occur first. It’s there where we feel the delayed spending for maintenance and normal revamp, replacement of parts, has to usher in first ahead of the overall recovery. So we want to be there first.

We’ve strategies in place and resources deployed to get into the plants to make sure we're ID-ing those opportunities really. We're influencing those outcomes. Again our view here is that will lead the way to an energy sector recovery.

We'll see spending there first because it has more urgent needs and it also has very quick payback versus a long payback period of new capacity if you will..

Right. Okay. Make sense..

We have taken that action to put our resources, our technical resources and our sales resources toward the plant level, toward the installed base..

Okay. Understood. Has that kind of strategy -- is that what you been doing in a sense on the nuclear aftermarket side, you'd said that the bid opportunities there are growing and while the backlog benefit and the earnings benefit may not be for some time, I feel like your tone was pretty positive there.

So, what exactly is going on in the nuclear aftermarket business that's given you some seeds of optimism here?.

We're elevating our presence at the plant level, you said it very appropriately the nuclear strategy is principally an aftermarket strategy supporting the installed utility base.

And its elevating our focus, its diversifying and opening the funnel of global biding and we're pleased by the degree to which we been able to expand our opportunities and diversify our number of opportunities and diversify those opportunities, but that strategy that was implemented about two years ago, maybe 18 months ago.

Actually is bearing fruits in terms of the composition of our bid pipeline and some of it has translated into backlog expansion. So we're generally we're very positive about those lead majors..

That's helpful. I guess maybe more near term, over the rest of the 2017, fiscal 2017, your maintained outlook suggest it's a pretty significant ramp in gross margin, obviously there are number of factors that affected the gross margin performance here in the fiscal first quarter.

So, understanding the restructuring benefit that you guys will be able to enjoy here coming up.

What are the factors are going to contribute to this sequential increase in gross margin over the next few quarters from where we started the fiscal year and what level of confidence do you have and achieving that? I certainly appreciate the difficult energy market conditions and as you said the ground is little unsettled, but what gives you the confidence to be able to achieve the ramp that you guys are continuing to expect in the rest of the fiscal year?.

Well, our confidence comes from a couple of considerations. Let me just chat through those with you. One is we're well point now where we can move to fair amount of our nuclear backlog through the engineering functions and into production.

And that was a drag on gross margin where for the last several quarter where we have the backlog and we're having corresponding revenue. We should begin to see our nuclear strategy revenue improve and therefore our margin lift improve as we're in Q2, Q3 and Q4, and the confidence there Paul is that, its move now into production.

It ought to be engineer area and the central production and there's a good amount of that work that's been released into fabrication.

And that provides a greater level of revenue predictability than when it sits in the office where the nuclear orders flow and the regulated way in which we can actually not begin production until certain milestones are met.

The fact that it's out -- launch into production or being launched into production very shortly gives us that confidence that we're now at a go for revenue generation and profit generation. So that's positive. And then secondarily, we are – and we talked about this on our calls.

And I don't want to say we don't have some work this on our backlog, but we had taken some very aggressive positions on orders to when business that was available to protect market share, to make sure we were giving our team to chance to exercise their capabilities and a chance to enhance margin, but we had some pretty tough orders that were coming through Q1 in terms of margin.

I don't revert those decisions, but we have to deal with those. I think the mix of work we feel the mix of work as we go into Q2, Q3, Q4 while there still are some tougher orders in backlog on average that mix of work should average job margins.

So there is two factors here, the release of the nuclear work and then the mix of the orders that are converting across Q2, Q3, Q4 have the probability of a richer margin..

That's helpful color. One more from me. Over the last three quarters your customer deposits have been a nice driver of your cash flow and Jeff you certainly added some nice color there as well they suggest there'll be further improvement in the next quarter.

Are there any other I should say, at this level of customer deposits, can we expect more over the next several quarters as Navy work begins to come in and perhaps if you're successful on achieving some of the Navy or what opportunities over the next few quarters or should we expect that inflow to wan over the course of fiscal 2017?.

This is Jeff. With regard to the customer deposits that have step-up over the last couple of quarters, particular this last quarter. We actually expect that over the rest of the year they're more likely to go down than go up at this point in time. But the cash flow for the year we still think will be positive for the remaining three quarters.

The reason for that is while the customer deposits will come down some as we start procuring some long lead time materials through some of the navy production that will be in place in fiscal 2018. We believe that the step-up in the quarter receivables and unbilled revenues will revert itself.

So all in cash flow will be positive, but the deposits actually we expect will go the other direction based on what we know today..

Appreciate the time. Thanks guys..

Thanks Paul..

Thank you, Paul..

[Operator Instructions] Our next question comes from the line of Brian Rafn with Morgan Dempsey Capital Management. Please take your question..

Yes.

Jim, from a strategic standpoint have you at all altered obviously the duration of the cycles elongated but you're kind of peak cycle $200 million in sales, does that strategically as this we've seen this impairment in the energy market, is that at all change any of the dynamics of your strategic plan?.

No, it really has not when we think about in the longer term context. It certainly is pretty greater emphasis on deploying capital in the M&A segment of our strategic plan. We felt when we set that Milepost Market of 200 million a couple of years ago. We were standing in front of a very strong wave of Petrochemical Refining.

Bid opportunities, clearly is altered over the last 12 months to 18 months. So while we had put that Milepost Marker out felt that was largely organic, we now think it must come from both organic and the external growth initiatives..

How much did that anticipated bid pipeline in the petrochemical area.

Was new capacity versus just like you spares in that and replacements, general maintenance?.

When we think about the bid pipeline in the context of chemical sector, while there is some investment in revamp and debottlenecking existing facilities, much of the bid pipeline from the chemical sector going back one, two three years ago was what we classify to be new capacity, incremental capacity or brand new plants, a little bit different from the refining mix which can have a greater percentage of investment in existing facilities versus new capacity, chemicals largely new capacity..

Okay.

On the navy side any updates, I didn't ask on the Virginia advancement [ph] tax or the follow-up to the Ohio Boomer Class, anything specific to you guys in the submarine development?.

Really nothing that we can comment and tell about other than from a qualitative point of view and I did mentioned it in the prepared remarks.

We have been able to successfully diversify what we're seeing and what we're bidding which I view as a positive lead measure to hopefully being able to secure more diverse types of component for the submarine programs and the carrier program. That was great to see their receptiveness to considering Graham for more scope..

Yes. Okay. Awesome. From the standpoint you guys certainly have done a lot with your rough line up, up certainly Batavia and that.

As you see a weakness in markets how much you draw in your capital expenditure budgets and is there any with perhaps a softness in business are there any internal property plant, equipment things that projects that you might undertake while business is a bit tepid?.

We've certainly – well, it's not even with the downturn, but the roof line expansion that we had our focus then turns to leveraging what we have.

How do we gain productivity? How do we reduce lead time? How do we have better control over the execution? That's where the CapEx and the focus would be rather than classic capacity expansion to be a roof line expansion. I don't envision we'll expand our roof line for sometime. Teams got to figure out out how to grow..

Thank you much guys..

Our next question comes from the line of John Karla with Oppenheimer. Please state your questions..

Good morning, gentlemen.

How are you?.

Good morning, John..

Hi, John, good morning..

Quick question I guess this hasn't been touched on fiscal around this quarter so I'll bring it up.

On the M&A front are you seeing a flutter of opportunities or rather it’s a limited opportunities and then whether or not you're seeing realistic bid-ask spreads?.

John, I think it's probably somewhere in the middle, but maybe little more towards to the decent quantity of opportunities. We've notice over the past couple of quarters that there are opportunities out there that perhaps more out there a year or two ago at more reasonable prices. So, there are good amount of opportunities out there.

And maybe part of it is that we have been more aggressive in looking to do so, but pricing seems to be a little bit better. In every way buyer really wants it, but it’s better than was a year or two ago..

Okay.

And is this mostly in adjacent areas as we are still servicing the same industries so that their potential targets just feeling the same pressure or these different markets all together?.

Both..

Okay, great. Thanks so much..

Thanks John..

I am showing no further questions at this time. So, I will turn it back to management for closing remarks..

Thank you, Audrey and thank you everyone for listening in on our first quarter conference call. We will look forward to updating you on our second quarter results in about three months. Have a good day. Bye..

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