Karen L. Howard - IR, Kei Advisors LLC James R. Lines - President and CEO Jeffrey F. Glajch - VP, Finance & Administration, CFO and Corporate Secretary.

Joe Mondillo - Sidoti & Company Bill Baldwin - Baldwin Anthony Securities.

Greetings and welcome to the Graham Corporation First Quarter Fiscal Year 2018 Financial Results Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation [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 Corporation. Thank you. You may begin..

Thank you, Audrey, and good morning everyone. Thank you for joining us to discuss the results of Graham's fiscal 2018 first quarter results. We certainly appreciate your time today. You should have a copy of the news release that crossed the Wire this morning, detailing Graham's results.

We also have slides associated with the commentary that we're providing here today. If you don't have the release or the slides, you can find them at the Company's Web-site 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 lines for Q&A. As you are aware, we may make some forward-looking statements during this discussion as well as during the Q&A.

These statements apply to future events and are subject to risks and uncertainties as well as other factors which could cause actual results to differ materially from what is stated on the call.

These risks and uncertainties, and other factors, are provided in the earnings release and in the slide deck, as well as with other documents filed by the Company with the Securities and Exchange Commission. These documents can be found on our Web-site or at www.sec.gov.

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

We have provided reconciliations of comparable GAAP to non-GAAP measures in the tables accompanying today's earnings release. And with that, it is my pleasure to turn the call over to Jim to begin. Go ahead, Jim..

Thank you, Karen, and good morning everyone. I am referring to operations on Slide 3. First quarter revenue was $20.9 million. This was above expectation and in line with our stretched goal that management had set for the quarter. We were able to accelerate certain projects from the second quarter into the first quarter.

On a comparison basis, revenue in the quarter was down 7% compared to last year. This was due to the order pattern in the recent past several quarters. I do compliment the management team however for effecting positively what they can control.

First quarter income was $900,000 or $0.10 per share, compared to one year earlier which was $100,000 or $0.01 a share that did include $0.5 million that was due to restructuring charges last year. So, on a comparable basis, you would compare $500,000 to $900,000.

There is uncertainty still in the downstream energy markets, principally in the refining market, that has affected order levels and the backlog trend. First quarter orders were $11.1 million versus $14.6 million a year earlier.

The order environment has indeed been challenging, not necessarily due to competitive pressure, but more due to customers unwilling to make final investment decisions, and that has affected the pace at which orders are released by our customers, and consequently has resulted in our backlog declining to just under $73 million at the quarter end.

And of that, 64% is due to our naval strategy. Moving on to Slide 4, by end-use markets, refining sales were down about 50%. The refining market has been consistently and persistently low or slow. This holds true for new capacity, retrofit, and aftermarket opportunities.

We do however feel that is not enduring, but it is the reality that we are facing currently. We had an increase in chemical/petrochemical industry sales to $7.2 million, up just under 40% compared to last year. This was due to conversion of our U.S.

based ethylene project revamp and also due to an ammonia/urea plant project, new capacity project for Asia. Power industry sales were relatively flat, but down about 15% to $4 million. And our other commercial, which includes naval work, was up 16% to $6.1 million.

Regionally, all regions had a decline compared to last year due to the general health of our end markets, refining, chemicals, and power generation. In the face of this, we are not adjusting our full year revenue guidance and are holding it in the $80 million to $90 million range.

With those introductory remarks, I am going to pass it over to Jeff for a more detailed review.

Jeff?.

Thank you, Jim, and good morning everyone. I'd like to direct your attention to Slide 6. Our first quarter sales were $20.9 million, down from $22.4 million in last year's first quarter. The domestic and international split was 71% domestic this year, 29% international, compared with last year which was 73% domestic and 27% international.

Gross margin increased from 18.4% to 23.3% this year and gross profit increased from $4.1 million to $4.9 million. The adjusted EBITDA for the quarter was 8%, up from of 5% last year. Q1 net income of $935,000 or $0.10 per share compared with the adjusted net income of $468,000 and $0.05 per share last year.

As Jim mentioned, we did have a restructuring, which was $383,000, which impacted last year's Q1. So the reported result last year was net income of $85,000 or $0.01 per share. If I can move on to Slide 7, cash increased up to $75.3 million, up by $1.8 million from the end of the fiscal year, and we now have $7.71 per share of cash on hand.

Capital spending was light in the first quarter at $117,000, but we still expect to spend $2.5 million to $3 million across the entire fiscal year, with the vast majority of that occurring in the second half of the year.

With our cash balance of $75 million, we continue to be very active in expanding our M&A pipeline as we look to use some of that capital to grow our business inorganically. Jim will complete the rest of our presentation and comment on our outlook for the rest of fiscal 2018..

Thank you, Jeff. I am on Slide 9. During last quarter's conference call, we spoke a little bit about this slide and the trend of our trailing 12-month order pattern and the volatility of our quarterly order pattern. We indeed are in a tough order environment.

On the positive side, our level of orders – I'm sorry, our level of proposals and bids has remained fairly constant at an aggregate value of between $600 million to $800 million. We are seeing conversion of the bids to orders at an uncharacteristically low level. We have seen this before in other steep downturns that have been protracted.

So that does give us a sign of positivity that the bid pipeline is rich and ample and our customers are holding onto their decisions to release orders, but eventually that does open up. So I'm very pleased that we are active. We have high participation in the opportunities that will materialize in the coming months or quarters.

I can't define when the trend will shift to upward. However, the pipeline suggests that there is a point in time in our future when that will materialize. As a result of the order pattern and the decline in backlog and our projection for revenue, management does continue to review carefully its costs in relation to future revenues.

We are committed to a long-term strategy and long-term value creation, focused on our naval participation, our strategies around the installed base in the energy sector, the nuclear market, and having capacity and capability for the eventual energy sector recovery. We'll move on to Slide 10 please.

Our backlog segmentation is largely to the naval market at roughly two-thirds of our backlog being with the naval market, two-thirds of the $72.9 million.

We aren't really seeing a significant shift in the conversion trend; about 35% to 40% converts beyond 24 months; about half of the backlog converts in the next 12 months; and 5% to 10% converts in year two.

Importantly, our diversification strategies have been very beneficial during this downturn and we were very fortunate about the actions that were taken by management five to seven years ago, they also have been very helpful as we deal with this harsh downturn currently. Moving on to Slide 11, our guidance is unchanged, as I said a moment ago.

Revenue guidance is held at $80 million to $90 million. Gross margin guidance is between 22% and 24%. SG&A is expected to be between $16 million and $17 million. And the effective tax rate for the year between 30% and 32%. Audrey, I would ask you to open the line now for Q&A. Thank you..

[Operator Instructions] Our first question comes from the line of Joe Mondillo with Sidoti & Company. Please state your question..

I wanted to ask you about the short cycle business of your Company.

Just wondering if there is any part of the short cycle businesses amongst any of the end markets, the geographic markets, that are showing signs of improvement yet?.

We haven't seen a trend for improvement there. It has trended down in the range of about 20% from peak of a couple of years ago. It's now flattening. But we have not yet seen it trend up. But fortunately, we haven't seen it trend down from a sequential quarter basis. So it does seem to be stabilizing.

Our contacts with the customer, our bid work is still strong. So therefore that suggests that the buying pattern should change in the near future. But at this point, we haven't seen that catalyst for change in terms of the order pattern in the short cycle work..

Okay.

And in regard to your oil refining business, do you have any sense of how much longer your customers can sort of push out the work that you do? It's been a few years now, and I think from what I've read, the crack spreads are really good, so they are continuing to run these facilities at high capacity rates, just try to squeeze out every dollar at these crack spreads, but do you have any sense of are we close to a period where no matter where the crack spreads are, these facilities have to do some work and take some work from you?.

To be candid, we are surprised it hasn't happened yet, and I don't think we are the only ones that are saying that. Many of the suppliers to this industry had expected the MRO type work to have moved forward by now, but it just hasn't. Again, we don't believe this is something that can be enduring or a structural change afoot.

The capital spending to keep these plants up and running, just basic spending to keep the lights on and the doors open, those can be delayed for quarters but not for long periods of time. And that typically is half to two-thirds of annual CapEx, is I would say ordinary CapEx, just keeping the house in order and in good shape.

And then the other one-third to half is around growth or strategic investment. That can be more discretionary. So we are seeing that being pushed to the right and deliberate conversations about that or Boards unwilling to make a higher financial commitment.

But the budgets that are allocated to classic MRO, we have to see that start to pick up and we would expect that to pick up and we are ready for it. It's just a surprise it hasn't happened yet..

Great.

And in regard to the gross margins that you saw in the quarter, certainly better than I was looking for, and with revenue down, and even more so the refining part of your business as a percent of sales, it was pretty much cut in half from a year ago and pretty much at the lowest percentage in many years, just wondering did you do anything differently throughout the quarter to drive that profitability, even with your high-margin refining business so low as a percent of the total?.

Joe, this is Jeff. We had a little bit of favorability in project mix, but the bigger thing was we had some what would normally be period cost and timing of period cost that were favorable to us within the quarter, and that really nudged our margins up a good amount, above I think probably what you had expected.

As you saw from our guidance, Joe, I'm sorry to interrupt, saw from our guidance, the guidance is unchanged, and despite what was a slightly higher margin than perhaps you might have expected that we had planned for, the reality is the rest of the year is not favorably impacted by this..

Okay. And in regard to your guidance, specifically the SG&A part of the guidance, if you annualize what you did in the first quarter, you come in below that guidance.

And I suspect, given what you sort of pointed to for the second quarter, given the light revenue that you are anticipating and the backlog that you can see there, that estimate potentially could be even lower than where we saw in the first quarter.

So, by mid-year, we are going to be running well below that $16 million to $17 million run rate that you have out there in terms of the guidance.

So is there some downside or could the SG&A come in lower than what you are sort of guiding to, possibly?.

Joe, good question. Given that our SG&A, you're right, in the first quarter was about $3.7 million, generally we see our SG&A in the first quarter of many years being at a kind of a lower end, and it's really a function of some of the activities that we start out beginning of the year tend not to be as heavy on an SG&A standpoint.

So, I'm not sure I would correlate the challenges that we have in the second quarter from a top line standpoint and a margin standpoint to necessarily see our SG&A down. But as we look at our SG&A guidance, certainly if you annualize our sales in the first quarter, you get below the midpoint of our guidance. SG&A will probably be in line.

We still expect it to be within this $16 million to $17 million range, but it will be a little bit variable relative to where we end up from a revenue standpoint. So, for the lower end of our guidance in revenue, probably going to be at lower end in SG&A, and same thing for the higher end of guidance and revenue.

But I wouldn't read too much into the first quarter SG&A and multiplying it out by four. I think if you went back and looked at last year, you were seeing a very similar pattern.

If you adjust out the one big item that we had in the second quarter last year around the insurance settlement, you would have seen the first quarter actually pretty low and then the later part of the year was a little bit higher..

Okay.

But looking at the second quarter, would you suggest SG&A would be lower than the first quarter, just given the revenue that you're expecting, the lower revenue that you're expecting?.

Not necessarily..

Okay.

And I just had one last question, just regarding the carrier program, just wondering if you could update us on what you are hearing with that, are you anticipating – I'm guessing you are still waiting on that bid, but any update on that, that would be great?.

On a positive note, we hear that our customer has received their order from the government, and that was a key pivot point for them to be able to be in a position to move to award some orders for CVN-80.

We expect – we are having conversations, we are expecting that negotiation to begin in this quarter, and tender selection in this or the following quarter, and we hope to be successful..

Okay, great. Thanks a lot. Appreciate it..

Our next question comes from the line of Bill Baldwin with Baldwin Anthony Securities. Please state your question..

I had a couple of issues here I'd like to talk about. Some of the geographical areas where you're down quite a bit in business in the last few years has been the Canadian area, Asia and the Middle East.

Is the nature of your business in those markets such that there could be any dynamics that would be a catalyst for improvement in those areas in the coming 12 to 24 months, based on the type of business that you normally do there?.

I'll cycle through these three that you have mentioned. In Asia, we are seeing a stronger opportunity set start to materialize in terms of bids that we have made and our ability to predict when those orders will be placed.

So therefore, we are expecting to see an increase in order activity, therefore several quarters out sales activity, in the Asian market. So that's just the nature of their procurement pattern and bidding at a point where they are prepared to expand capacity in their energy sector.

Canada, we think that's going to be a repair/replacement opportunity for us. We don't expect to see new capacity up in the oil sands for some period of time at the current price level of oil. They would need to see a higher level of oil.

However, once they have their facilities up and running and operating, we will stay focused on asset integrity and reliability, which has always created opportunity for us for some sales.

We do have a number of bids or a few bids that we have made to the Canadian oil sands, what we would call retrofit work, which is notwithstanding where the price of oil is, it tends to go ahead. So we are very excited about that. And then in the Middle East, they just came off of a very large capital plan.

They added 300,000 to 400,000 barrel per day refineries. They are on the back-end of a large petrochemical plant expansion over the last about decade. So they are digesting a fair amount of that. We are reading that the next wave of investment and diversification by Saudi Arabia out of oil into value-add petrochem is starting to stage.

We don't see that in the next 12 to 24 months, but we see that further on the horizon. So we think that just is taking its normal ebb and flow of how they do capital projects in the Middle East and expansion projects. So it's a bit of a timing thing.

If we look at the markets more on a long period of time, longer period of time, we feel they are taking their ordinary supply and demand based pause, with new capacity investments coming out on the horizon..

Very good, Jim, thank you. And on the positive side, I've seen your bid has picked up in the last few years in South America and Mexico.

Are those trends likely to continue or stabilize or how do you see those markets over the next one to two years?.

That was a very positive result of action that management had taken. We've put a territory manager over the South American market, and he and others have spent a lot of time in that territory, getting very close to the nationalized oil companies. And we derived a great deal of benefit from that.

We had a massive amount of opportunity on the table prior to this downturn. We are still staying close to those companies. We don't expect anything of material importance over the next 12 to 24 months, just by the virtue of where those companies are or where those nations are relative to be able to invest in new capacity.

But we have spent a lot of time to increase our participation and increase our success capability in the South American or Latin American market, and that was driven by putting a territory manager over that. We saw some very strong benefit from that..

And when you mention South America, does that also include Mexico?.

Yes. I said South America, and then I rephrased it to Latin America, which would include Mexico..

Okay, okay. And then on another front, it looks like that, pretty likely that the sulfur content on bunker fuel is going to be coming down quite a bit here in January 1, 2020, I think 3.5% to 0.5%. Different ways of getting there but I guess one way is refineries get new cokers, or upgrade what they got if they are not working right, or whatever.

Do you see any potential opportunity for your Company in that as a result of those rigs, assuming they go into effect, which I think most people think they will?.

We have been watching that. We have been watching the MARPOL regulations over the last five years. It's taking a long time, but now they have finally settled on sulfur reduction from X to Y.

In line with what you had identified, when we think about the ultra-low sulfur investment wave that was in the mid-2000s that happened around gasoline and diesel, that drove demand for our products, that drove capital investment to be able to drive down sulfur content.

Those processes required Graham equipment, hydrocracker, hydrotreater, coker, hydrodesulfurization. They don't require our ejector systems but they require our other equipment. So we are keeping an eye on that. We have been watching the MARPOL regulations for a number of years.

And you are right, 2020 appears to be the year that it is mandated and that should create demand for us. We don't yet know how refiners are going to get in front of that investment, but that should be starting relatively quickly because they are not at that standard level now.

A counter to that is, the marine vessels can move to gas-based propulsion rather than bunker fuel. So we need to understand the direction of maritime vessels as well. However, as it pertains to sulfur content, it does drive demand for Graham's products..

Generally speaking, Jim, what kind of lead time would these refiners have if they've got a January 1, 2020, when would they need to begin start making some [FIDs on that] [ph]?.

2018 and 2019..

2018 and 2019, okay. Thank you very much and keep up the good work..

Our next question is a follow-up from Joe Mondillo with Sidoti & Company. Please state your question..

Thanks for taking my follow-up.

I just wanted to get an update on your acquisition strategy and if your confidence of getting anything done in the near-term has improved or changed at all?.

I believe we've shared on previous conference calls that we brought in a business development manager to work very closely with Jeff to open up the pipeline and drive the number of deals that we're beginning to look at. That has matured very well. I have a stronger level of positivity around the direction of our M&A.

That is a focal point for long-term growth for us. I cannot speak to when and something might be concluded because we will maintain our disciplined approach around valuation and strategic fit. What I can say is it's consuming much more of our time..

Okay, great. Thanks a lot..

Thank you. There are no further questions. That does conclude our question-and-answer session. At this time, I'll turn it back to management for closing comments..

Thank you, Audrey, and thank you everyone for your time today and your questions. We'll be very pleased to update you on our progress in the next conference call. Thank you..

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