Karen Howard – Investor Relations Jeff Glajch – Chief Financial Officer Jim Lines – President and Chief Executive Officer.

John Sturges – Oppenheimer & Company Bill Baldwin – Baldwin Anthony Securities Chris McCampbell – Hilltop Securities.

Greetings, ladies and gentlemen, and welcome to the Graham Corporation Second Quarter 2019 Fiscal Conference call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] And it’s now my pleasure to introduce your host, Ms. Karen Howard from Investor Relations.

Thank you, you may begin..

Thank you, Jane, and good morning everyone. We appreciate you joining us today to discuss Graham’s fiscal 2019 second quarter and first half year results. You should have a copy of the news release that was distributed across the wires this morning. 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 on 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 periods, as well as our outlook.

We will then open the lines for Q&A. As you are aware, we may make some forward-looking statements during this discussion, as well as during the Q&A. These statements apply to future events, and are subject to risks and uncertainties, as well as other factors, which could cause actual results to differ materially from what is stated on the call.

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

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

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

Jeff?.

Thank you, Karen, and good morning everyone. If you could turn to Slide 4 in our deck, Q2 sales were $21.4 million, up 24% from the same period last year. As we discussed in Q1, we believe we are in a recovery in our key markets. Also, please note the Q2 of last year was a very easy comparable as we were in the bottom of the downturn.

Q2 net income showed a strong improvement again versus an easy comparable. Finally and importantly, orders in Q2 were very strong at $34.4 million, with key wins in both the refining and petrochemical markets. Our backlog has improved to a record $127.8 million.

It is important to note, that while our Navy backlog continues to be strong at just above $65 million, our commercial backlog is now $62.5 million or nearly triple the $22.8 million level of the commercial backlog just 12 months ago. On to Slide 5. Q2 sales were $21.4 million compared to $17.2 million in the second quarter last year.

Sales in the second quarter were 70% domestic and 30% international, compared with last year’s second quarter, which were 65% domestic, 35% international. $3.9 million of our $4.2 million increase in sales in the quarter, came from the domestic market with the remaining $300,000 coming from the international markets.

Gross profit increased to $6.2 million from $3.7 million in last year’s second quarter, primarily due to higher volume, improved pricing, as well as a few high margin projects. Gross margin was up to 29% up from 21.7% in last year’s second quarter.

EBITDA margins were 10.3%, up from 4% in last year’s second quarter, driven primarily by the higher gross profit margins. Net income increased to $1.8 million or $0.19 per share, up from a reported level of breakeven or an adjusted level of $200,000 or $0.02 per share last year.

Last year’s net income number was adjusted for a small restructuring charge, which occurred in the quarter – in the second quarter of the previous year. On to Slide 6. Sales in the first half of fiscal 2019 were $51 million compared with $38.1 million in the first half of last year.

Year-to-date sales were 56% domestic and 44% international, compared with 68% and 32% respectively last year. Domestic sales increased 10% to $28.5 million, compared with $25.9 million last year. International sales were $22.5 million, up 86% from $12.2 million last year.

You may recall, as we discussed in the first quarter, we had a very large Canadian project, which recognized most of its revenue in the first quarter, and finished up early in the second quarter and has skewed the split between domestic and international a bit for the first half of this year.

Year-to-date gross profit was $13.4 million, up from $8.5 million last year, and gross margins are up 380 basis points to 26.2%. Year-to-date EBITDA margins were 10.8%, up from an adjusted level of 6.4% in the first half of last year.

Finally, net income was $4.2 million or $0.42 per share, up from a reported level of $900,000, and an adjusted level of $1.2 million or $0.12 per share last year. On to Slide 7. We continue to have positive operating cash flow in the first half of this year of $5.1 million. We paid just over 1/3 of this as dividends or $1.9 million.

You may recall, that we increased our quarterly dividend by 11% this past August. Our cash balance is now at $79 million or just over $8 per share. This is up from $76.5 million at the end of fiscal 2018. We continue to be pleased by our expanding acquisition pipeline, despite the higher prices that we’re seeing in that arena.

We will continue to be disciplined. However, we do hope to be able to use – utilize some of this – some of our cash to grow inorganically. Capital spending has been very light in the first half of the year at $400,000, the same as the first half of last year.

We still expect to spend between $2 million and $2.5 million in capital for the full fiscal year. We had a similar back-end loaded capital spending plan in fiscal 2018, where we spent approximately 80% of our capital in the second half of the year.

Jim will complete our presentation by providing more depth on Q2, our market outlook, and updating our full year guidance..

Thank you, Jeff. Good morning. We appreciate everyone joining our second quarter earnings conference call today. I will begin my remarks on Slide 9. Overall, as Jeff noted, sales in the quarter were up 24% compared to a year earlier. Definitely, orders improved about 1 year back, and that now was reflected as a recovery in quarterly sales.

We’ve discussed a number of times during previous calls that when refining markets came out of the downturn, spending on existing facilities would occur before new capacity investment. three factors are relevant when considering the importance of that view.

First is that Graham has a rather large installed base throughout North America, and in the Middle East, Asia and in Latin America. Second is that the original equipment supplier often is preferred for retrofit or replacement, as that supplier knows precisely how the existing equipment was designed.

And third is these investments move quickly, and not as slowly as new capacity investment. Replacement equipment, bid opportunities maybe in our bid pipeline for just a few months, whereas new capacity bidding could be in the pipeline for more than a few years.

Approximately 75% of the $9.7 million of sales to the refining industry during the quarter, were derived from the installed base, which highlights the significance of investment in the refining installed base, and how Graham is positioned to benefit from these investments.

Another beneficial consideration is retrofit and replacement work has a higher margin potential than will most new capacity investment. Turning to chemical industry sales. While sales were down $1.9 million compared to last year, we consider that to be timing. The chemical industry is active.

Here too, there can be retrofit or replacement sales along with new capacity sales. We do, however, view the chemical industry as a whole differently and that it is more about new capacity.

However, for North America, with low cost natural gas as a primary feedstock, we are seeing from our installed base retrofit and replacement orders as chemical plants restart, revamp and expand existing facilities, implying sales to this sector will improve in the coming quarters.

Sales into the power industry were flat, while sales to our other markets that include defense were up 18%. There is still a heavier weighting toward domestic sales due to the U.S.

refineries commitment to improve their existing operating assets, low cost natural gas in the U.S., burning capacity expansions in the chemical industry and, of course, our Navy work is domestic. We should expect this trend to continue where greater than 50% of sales are for domestic markets. Please move on to Slide 10.

The trailing 12-month new order trend of $140 million is encouraging, although it is impacted by two back-to-back $40 million bookings quarters. If we were to annualize the last two quarters, that would imply a 12 month bookings level of $112 million. Due to the size of certain orders, it is difficult to model a bookings run rate.

On a qualitative basis, I can state, however, that the bookings environment today is superior to 18 to 24 months back. Again, refining industry new orders were strong with a combination of orders for new capacity and for those derived from the installed base.

Chemical industry orders were up nicely, driven by orders that are for new capacity in the US Gulf Coast. Let’s now discuss backlog and details provided on Page 11. As Jeff said, we have a record backlog at just under $128 million. It sets up nicely fiscal 2020 for year-on-year growth.

Importantly, refining industry backlog is up $20 million from this time last year, and similarly, chemical industry backlog is up approximately $15 million. It is encouraging to have a strong high-quality backlog from our traditional refining and chemical markets that is complemented by our large Navy backlog.

Additionally, backlog conversion spans several years with 55% to 60% of backlog converting to sales within the next 12 months and 25% to 35% converting beyond two years from now. Turning to guidance for the remainder of the year, I ask that you refer to Page 12. Full year revenue guidance has narrowed to $98 million to $105 million.

Gross margin is expected to range between 25% and 27%. Our SG&A spend will fall between $18.5 million and $18.75 million and our effective tax rate for the year is projected to be approximately 20%.

The focus our team has had during the downturn on improving execution capability, along with effectively managing our bid pipeline enabled us to deliver 25% to 35% top line growth in 2019 compared to 2018, and also to have a strong backlog setting up 2020 as another growth year. I commend the Graham team for their impact on improving the company.

Activity on the M&A front is providing a number of high-quality strategic fit targets that would expand our addressable market, leverage Graham sales channels or diversify revenue opportunities into less cyclical end markets. We are, however, finding these targets to be expensive and to have challenging risk-adjusted returns.

Management and its Board of Directors are committed to putting our balance sheet to work to expand and diversify the company and we will stay disciplined about valuing deploying capital for growth. Jen, I would ask you to please open the line for questions. Thank you..

Thank you. Ladies and gentlemen we will now be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of John Sturges with Oppenheimer & Company. Please proceed with your question..

Thank you. Very nice improvement in gross margins. So a great execution. I’m just curious about the revenue recognition change in the quarter.

The new accounting rule, I thought you might have recognized a work in progress is being higher than the work and completion, which is what you’re – historically you’ve done?.

John, thank you. This is Jeff. The revenue recognition in the quarter being a negative number is simply due to a – one specific project which is in process right now, which under the old rules, would have been a percent complete project. It was started this year, and it will finish up in the next quarter.

So, under the old rules, it would have been percent completion. Under the new rules, this particular project because of the specifics of the project, will actually be a completed contract. So the old way, we would have had revenue in this quarter and then some revenue next quarter.

In the new way, we had no revenue this quarter and we’ll have a larger revenue next quarter for that project. It’s a in-year project. No transition from – anything from fiscal 2018. So it’s really the uniqueness of this particular project.

For the full year, we expect the impact of the revenue recognition standard to increase this year’s revenue by a little over $4 million. First quarter, we had a positive of a little over $3 million, this quarter we had negative, next quarter we will have positive, probably by the end of the third quarter, we should be pretty well through all this.

So it’s a confusing issue because you’ve got last year things going on and in this particular case, you have a in-year thing, in-year adjustment going on, but – hopefully by the end of third quarter, we should be pretty well done with the – any of the impacts of the revenue recognition change.

So I apologize for the confusion but unfortunately didn’t write the rule..

It is what is a transition effect. Thank you..

Exactly..

Thank you. Our next question comes from the line of Bill Baldwin with Baldwin Anthony Securities..

Good morning.

Can you offer any color, Jim, on your visibility as far as the outlook for refinery – new refinery business, looking out the – over the next 12 to 24 months? At least directionally, do you believe that it will be stable or hold its own, how do you see that in relation to what you’ve seen over the last 12 months?.

In comparison to the last 12 months, from what we have identified in our bidding activity, we are seeing a pickup in EPC work or feed work that would pertain to new capacity.

We did win in our last quarter, the quarter that recently closed some new capacity or expansion work, but we are seeing more of that type of work come into our bid pipeline, predominantly in Asia, in China, and in India, but elsewhere, outside of those two countries, we are also seeing some new capacity work come into the bid pipeline..

Is generally new capacity work, Jim, is it, in terms, of project sizes equal to or larger than replacement type orders?.

Surprisingly, as this has evolved over time, we’ve seen the revamp retrofit upgrade work closely approximate the opportunities that we see from new capacity, which is also very encouraging.

I would say though it does depend on the size of refinery being built and some cases, there are some 300,000 barrel per day and 400,000 barrel per day refineries that are being evaluated. Those would be much larger than a retrofit or a replacement opportunity..

And kind of in relation to this replacement market, can you talk a little bit about the additions you’ve made to your sales organization to go out and focus on that retrofit and replacement market? At least, that’s the way I interpret your initiative in terms of the sales effort is to get more focused on the end customer, which I assume is basically on the installed base? And how that initiative is going?.

Sure. That initiative is going very well. We have a very effective, strong EPC-centric sales organization that does have some coverage of the end user. What we felt strongly about was, we want to get closer and provide greater coverage for the end user, because that’s where we see spending growing in the coming decade versus new capacity.

And we’ve made some investments as you commented upon, and as you’ve seen our SG&A, our S expense begin to expand. We are taking steps now to better prepare our organization for where we think spending will come in the 2020 to 2030 timeframe, which would be on the installed base.

And we’re seeing those investments that we’ve made in both North America coverage, as well as in the international markets, we’re not through that full spend yet, but we’ve taken a pretty good bite at it over the last 12 months..

I guess that involves adding new salespeople.

Is that correct, Jim?.

That’s probably an easier way to answer the question, yes. We’ve added sales personnel. We’ve added a good number already. And as I said, we’re not completely through that organizational build out.

We need to just be measured in that, and not get too far ahead of the corresponding revenue, but we’ve nearly come close to doubling our traditional chemical and refining focused direct sales force..

That direct sales force is focused primarily on the retrofit and replacement market?.

And also EPC..

And also EPC. So a salesman will do both that, he can – he or she can focus both, direct – on replacement as well as EPC..

Right. The sales people have to do that, but also underneath the sales organization, we’re building up a technical services or performance improvement organization that also complements the sales team in how we serve and ultimately create value for the end user.

We think the concentration is going to be on getting more out of the existing assets, the chemical industry has, and the refining industry has. So we’ve set up and we are setting up an organization of performance improvement specialists that will go in, and help our customers figure out how to get more out of what they currently have.

We’re in probably to be candid. We’ve made some strategic moves here, but I’d say we’re in inning number two or number three of a nine inning game on building out that org structure, but we are going after it, we’re investing in it.

We see that as the right move, as we look at the spend trends and the focus of the industry is on the installed base, and we’re getting in front of it early. But we’re not quite through the org build out on that..

Jim, are you – basically from a philosophical standpoint, you go out and hire experienced sales people? Or do you kind of bring in people and train them yourself in the way you want them to be trained and focused?.

Well, we do a combination of both. We do like to bring in diversity of experience and skill sets. So that brings in middle career folks. And then we also like to bring in some entry-level folks or people that have been in the industry, one to five years, where they’re more in the initial training phases.

We sell a complicated product and a complicated sales process. So unless you’ve grown up inside the Graham organization, we don’t see our competitors selling how we sell. We don’t think they bring the technical acumen to the table that we bring to the table..

[indiscernible] (24:08):.

I understand, it’s hard – it’s hard, it really is. I mean it’s hard, but it’s so important. So, good luck. I mean, that’s going to pay dividends long-term, I’m sure..

We know it will. Thank you very much, Bill, for your questions..

Thank you. Our next question comes from the line of Chris McCampbell with Hilltop Securities..

With record levels of cash in the cycle having bottomed, and no acquisitions on the horizon, why isn’t a buyback of our company’s shares not in the best interest of shareholders here?.

Well, we have a – that’s a consideration that we do talk at – pretty much at regular interval at the board meeting about capital deployed for external growth, internal growth as distribution is back to the shareholder in the form of dividends or buybacks. Right now, we have a building pipeline of M&A.

Well, you heard me comment that we’ve seen some expensive deals. We want to put that money to work toward growing our business, diversifying our revenue opportunities. We have this rich pipeline that’s in front of us.

Can we consummate a deal in the next six months to 12 months? I can’t comment on that, but we see a lot of opportunities, and we want the dry powder, ready to pull the trigger..

I understand that, although at a certain point, I would think some of the folks you’re looking at – talking with would probably want some stock in consideration, just because they’d want to benefit from the deal as well.

Just seems to me like, considering where you are in the cycle, and where the stock is relative to that, I’m just trying to understand why it wouldn’t make some sense to at least consider buying some along the way, if nothing else, I think, it would – it could help the volume even, from the standpoint of liquidity..

Sure. What I can share with and conclusion is, this is a topic that’s [helpfully] debated every quarter, between management and the board around deployment options, and then the timing of when an acquisition might materialize. So it is something that’s discussed quite comprehensively, every 90 days or so at the board level.

And the shareholders are clearly on the board and management’s mind as well as the size of our cash on the balance sheet, and the need to put that to work or do something different with it..

Okay.

And could you give a little bit more color on, maybe, the naval pipeline, on where we are in the process of new business there?.

That’s a very exciting segment for us, in terms of the pressure, I’d call it pressure, that we’re feeling for the cadence of demand out three to five years from now. The messaging was quite clear from the shipyards, and from the Navy, that the build cadence is going to step up.

There is an urgency with the shipyards, and the Navy to make sure the supply chain is ready. And we’re having very healthy conversations with our direct customer as well as the Navy to understand from their perspective, will we be ready, are we making the right moves early enough to be in a position to capitalize on the expanded demand.

So we’re very excited about this. It doesn’t move at a quarterly pace, it moves at a longer pace, a more measured pace. But we are feeling pressure to ensure we have readied the organization for a stepped up cadence of demand, and that’s quite real.

And we have a lot of discussion across the management team, and with our board around deploying capital, in support of that internal growth initiatives. So it’s a pretty exciting time in the naval sector or at least as we’ve talked to the shipyards, and the Navy..

Okay great, thanks guys..

Thanks Chris..

Thank you. Ladies and gentlemen, at this time there are no further questions. I would like to turn the floor back to management for closing comments..

Thank you, Jen, and thank you everyone for listening in on our conference call today, and for the questions that we did receive. We always appreciate your interest in Graham. And we look forward to updating you on our progress for the remainder of 2019, and how we see 2020 shaping up on the next conference call, end of January. Have a great day..

Thank you. Ladies and gentlemen, this concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation..