Greetings, and welcome to Graham Corporation Third Quarter Fiscal Year 2019 Financial Results. At this time, all participants are in a listen-only mode. The 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, Karen Howard, Investor Relations for Graham Corporation.

Thank you, Dana, and good morning, everyone. We appreciate you joining us today to discuss Graham's fiscal 2019 third quarter and year-to-date 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's my pleasure to turn the call over to Jeff to begin. Jeff?

Thank you, Karen; and good morning, everyone. Turn your attention to Slide 4. Sales in the third quarter were $17.2 million, which was comparable to the same period last year. We did have a $1.1 million unfavorable impact in the quarter, due to the new revenue recognition standard. However, the impact was larger compared to what we expected entering the quarter. I noted on the prior call that we had a significant project in China, which we expected to ship in Q3. Unfortunately, it shipped on January 4, five days after the quarter ended. With it -- have that shipped by the end of the quarter, our revenue would have been around $20 million. Q3 net income was $95,000 or $0.01 per share. In Q3 of last year, we had a loss due to an intangible asset impairment charge as well as impacts related to the 2017 Tax Act. Without those adjustments, Q3 of last year would have been breakeven. Orders in the third quarter were $23.2 million with petrochem and refining orders in North America and Asia being the key contributors. Our backlog at the end of the third quarter improved to a record $133.7 million, though part of the $6 million gain in backlog in the quarter was obviously due to the lower revenue level. Our backlog is evenly split between navy and commercial projects. Importantly, the commercial backlog is nearly triple at $22.8 million at low point, which we saw in September of 2017. We're quite pleased with this increase in the commercial backlog. On to Slide 5. As I noted, Q3 sales were similar to last year's Q3. Sales in the quarter were 83% domestic, 17% international. In last year's third quarter, sales split was 65% domestic, 35% international. Gross profit increased to $3.7 million from…

Thank you, Jeff. Good morning, everyone, and we thank you for joining our third quarter conference call. I will begin on Slide 9. Revenue in the quarter was down slightly compared to the third quarter of last year. Revenue at $17.2 million in the quarter was below initial expectations, as Jeff had said, and also down sequentially from the second quarter due to two factors. First, shipment of a large international order was pushed into January. This particular order, due to new revenue recognition standards, followed the completed contract rather than percentage of completion revenue recognition accounting treatment. That was unusual, however it will be similar completed contract revenue standard orders in the future which might cause volatile revenue trends quarter-to-quarter when such orders are executed. This particular order, as Jeff said, has now shipped. Secondly, certain enabled market backlog conversions are slowing due to the pace at which we believe we can advance production. This is impacting revenue projections for the second half of fiscal 2019 and also fiscal 2020. And looking at revenue or end market, revenue to the crude oil refining market was $6.6 million, up $1.2 million year-over-year. Chemical and petrochemical market revenue was down $1.3 million at $2.9 million in the quarter. Power industry revenue was up $1 million, while revenue to other end markets, including the naval market, was down $1 million. We continue to have a concentration of domestic revenue with domestic end markets accounting for 83% of total revenue. However, our current backlog will result in an improvement to revenue in future quarters that is for international end markets. With our recently updated revenue guidance, fiscal 2019 is projected to provide 16% to 22% top-line growth compared to fiscal 2018. Moving on to slide 10. I'm pleased with the level of orders,…

At this time, we'll be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Joe Mondillo from Sidoti & Company. Please proceed with your question.

So on -- just to clarify on the delays in delivery in this quarter, on the naval side, you said that was due to pace of production. Is that production on your end or on the customer end?

It's tied to how the design releases and the approvals for fabrication flow from the shipyard back to us. It's being paced more by the customer than by our execution capability.

Okay. And so considering just the sort of navy backlog then considering that, is this going to just push everything out a little bit from

Indeed. It's affecting the second half of 2019 and we've made that adjustment with our revision to guidance. It's also slowing revenue conversion based upon how we first modeled internally fiscal 2020 financial projections. We tend to deploy that available labor into other contracts, not necessarily naval contracts, but it is affecting over the next 12 to 18 months our revenue conversion of our naval backlog and we've made those adjustments for fiscal '19 guidance and when we update our fiscal -- when we provide our fiscal '20 revenue range, it will reflect the slowing conversion pace with that particular segment of our naval backlog.

Okay. Is there any way you could help us rethink of how your navy backlog flows in terms of the cadence throughout the next 18 months? I know a couple of quarters ago you are talking about mid-teens, low to mid-teens area of backlog of work in fiscal '19 and going beyond $20 million in 2020. Is that just pulled back by a few million dollars each year or?

That's excellent question. As we think now about 2020, which is the more relevant question, where we had been expecting to push beyond $20 million for 2020's revenue from naval backlog, we now feel it will be comparable to the revenue level of our recent past in the mid-teens.

Okay. The backlog at the navy business actually picked up a little bit. Are you continuing to find more work beyond the core work and beyond the delays in the work that you're doing right now, because I know that has been a goal to try to maximize your work and find more work that you can do for the customer?

Sure. We have continued to win new naval work. It has been additional orders for components that we previously had in backlog, so similar components [indiscernible] the diversification efforts to expand our participation those are still under way or not necessarily comment that the additional backlog growth is tied to components, because it's repeat work of ones that we had previously done or are working on. I'm not categorizing that as overutilization of our diversification effort. That's still is under way. Not being realized yet in backlog growth or diversification of our backlog with the naval strategy.

Okay. And then, just shifting gear to your legacy business in oil refining and chem, petrochem. First off, what you're seeing in your short cycle part of your business that tends to be a leading indicator of what's going on, just given the volatility in oil prices and just in general economic metrics recently?

Sure, sure. That's a really good question. That's not always perceptible in our commentary or in our look or the way in which we provide backlog or order patterns. But for our short cycle work, we are seeing that, if I compare year-to-date today to year-to-date at this point last year, the short cycle new orders are up between 10% and 15%. Now that's nice, but that's off of a bottom, so just by a comparison they're down about 13% compared to 14% or 15%. So we are bouncing off the trough, we're not quite back to where they were in the '14 and '15 timeframe, but directionally they are moving more positively. That's our short cycle work as a whole. The sub-segment of our short cycle work is more exciting, which is our aftermarket or spare parts, and that is actually up about 20% year-on-year year-to-date compared to where we were last year and it's flattish compared to '15, '14 and '15 levels. So that's all very encouraging.

And would you say over the last six months or nine months on a sequential basis is that up until currently or is that an acceleration from six, nine months ago, or was it maybe stronger six months ago and you started to see any slowdown, just wondering within the last, say, three months or so, are you seeing any sense of slowdown given what we're seeing in the global economy?

I hate to make comments on a quarter-to-quarter sequential basis, because it can be misleading, that's why I chose to make the remark based on year-to-date, so three quarters in aggregate compared to three quarters in aggregate a year ago. But on a quarter-to-quarter basis, I'm suggesting it's not a great way to look at it, it's up 20% year-on-year and on a sequential basis it's sort of flattish to up 10%.

Okay. And could you sort of talk about the refining business, the chemical business, I know both of them have different fundamentals at times and sort of what you're seeing within those markets in general? And then on the geographic perspective, could you sort of address what you're hearing regarding that? I know China is a big market where you own sort of maybe 50% or so market share. What you're seeing in that market as well as maybe some of your other international markets?

Sure, Jo. Starting with refining, in the international markets, this is for bidding activity, we have very nice basket of opportunities in Asia and these projects are fairly large in the $5 million to $10 million value range and there's a few of those. So we see a nice basket of opportunities that are coming up in India, in Southeast Asia and also in China. China seems to be moving back toward a handful, a couple of refining projects a year starting to go ahead. We have those ideas, we're working on those early. We're involved in the early work on the India projects and we've been chasing some of the Southeast Asia projects and FEED and EPC bid for a couple of years and they're coming up to fruition now, it seems like. So we're feeling more enthusiastic about the outlook in the international markets for refining and this is principally new capacity commentary in international markets. So there's a very sizable amount of work that we've identified, we're participating in and feel generally pretty good about and the sales organization and engineering teams are doing the right things to get us in a position to have the right participation level and we believe the right success level for those projects. In Southeast, I'm sorry, Latin America, that's a slow period for us. There's not much going on there except for a couple of projects that will likely go ahead, but it's nothing like the identification of the project scope that we saw four or five years ago coming in Latin America, but there will be pockets of revamp and replacement to keep certain refineries up and running that have capital to do so. In the Middle East, we're not seeing anything readily right in front of us. That's more for purchase over the next two or three quarters, but there are some projects that are percolating for new capacity throughout the Middle East that we feel will participate on. Again, that's new capacity. And then in North America, I would say it's steady around revamp, debottleneck and the aftermarket elements of North America's refining base. So I generally feel, we generally feel good about the, of the oil refining outlook, both domestically and internationally, taking a longer term view or midterm view over the next couple of years. Petchem, the next wave is, the North America is sputtering along. By no measure is it as stout as the first wave. It's going to be more measured and coming not with the strong wave that we saw on the first wave. We won some of the work. We're bidding some of the other work that's coming up. I think that's going to be more of a periodic type of order environment than a steady flow and the international markets, I'd say that's comparatively steady versus the last couple of years for petchem and chem [indiscernible] yes.

Yes. No, I think that was great. So just to clarify, it doesn't sound like a whole lot has, given what we've seen in commodity prices and global economic activity, it doesn't seem like your picture of things has changed a whole lot, call it, three to five, compared to three to five months ago, is that fair?

I think that's, we've kept a balanced look. We've not been overly enthusiastic, but we definitely feel more positive about the near-term outlook and, but by no measure do we think it's anything like 2004 or 2005 or 2006 yet, but it's not bad.

Okay. And just to follow up again regarding the same-type question. When you're looking at your bidding and quoting activity, the pipeline there, has that been consistent over the last couple of quarters? Has anything changed recently? Anything to highlight there of interest?

No. Our view would be -- I do have those dialogue rather frequently with the sales and the application engineering group, it feels fairly steady at an okay level and again I go back to -- I'd like to compare and contrast the different periods of time in our history and trying to find that catalyst that's like 2003, '04, '05, but we're not quite at that level of activity, not quite is wrong, we're not at that level of activity but it is moving up from two or three years ago and is fairly steady.

Okay. And then I just wanted to ask regarding your backlog in terms of gross margins. The gross margin in the backlog, how do they compare relative to sort of the gross margins that you've been seeing over the last few quarters. If you take out the second quarter, second quarter you saw 29%, that was an outlier, but if you take out that you've been between 22% and 24%, how would you say the backlog compares to where you've been in terms of gross margins?

I would say, directionally it's upward compared to what's being relieved. I want to qualify that with -- we had some recent wins where there is a pretty sizable wins where we're going to do a large percentage of the work with international fabricators. So that has an effect of changing the drop down, but as we load up our asset base with work for Batavia, as an example to manufacturer, that incremental volume at a different margin profile drops down to operating profit just fine, it averages up. So the booked gross margin might look as though it's averaging down, but at the off-profit line, it averages up.

Okay. No, I understand. There is some mix issue, especially with navy starting to ramp up a little bit. I also wanted to ask you on SG&A levels. The last two years your SG&A have outpaced the growth rates at -- on the revenue line. Looking at fiscal '20, I'm not sure if you have a good idea at this time, but I know you did make some investments over the last two years, specifically in your sales force and elsewhere. Looking at fiscal '20, do you have any idea sort of how you're thinking about SG&A, if you're able to get the revenue growth that you sort of alluding to in fiscal 2020? How do you think SG&A sort of plays out?

Hey, Joe, this is Jeff. We have seen a pretty meaningful step up in SG&A in fiscal '19 as you noted and that was around a number of things. One is, we have added some significant resources, particularly in our sales organization and our support organizations, to support the level of growth that we're seeing now but more importantly level of growth that we expect to see going forward. And then we've had some low points on commissions and variable comp and things like that over the last couple of years, which has stepped up in fiscal '19. As we, we're not in a position to put out anything specific out for fiscal '20, I would say fiscal '20 relative to fiscal '19 would probably be higher but it shouldn't be the level of step up that we saw from '18 to '19 or from '17 and '18 to '19, so hope that's helpful.

Okay, yes, definitely. And then just last question for me. I just wanted to know that $206,000 on other income, it's been a run rate for the last few quarters, what is that related to exactly?

Sure. There was change in how the pension accounting was handled and so if you think about pension income and pension expense, it was all, in the past, put together as one number and a portion of that number would be in cost of goods sold and the portion of that would be in SG&A. There's now a piece of the income side that is excluded from that cumulative number, accumulated number and that is now put down in other income. So what's happened is, in the SG&A and cost of goods sold, on a quarterly basis, our expense, or lack of income, I guess, is a better way to put it, is now higher in cost of goods sold and SG&A and then there's that other income line down in every quarter. The $206,000 it's in there, what's that number, would be that number and should be the exact number pretty darn close to it. For the fourth quarter, I don't know what that number will look like in fiscal '20, because you have to revalue all your pension information at the end of every fiscal year. So I will know in the middle of April whether that's $206,000, if it's a little bit higher or a little bit lower. I don't think it will change dramatically, but that number will now stay in other income and that has increased our cost by that same level on a quarterly basis, up above the line. Again, it's an accounting change that just kicked in this fiscal year.

Okay, that's good to know, and just to go back to my prior question regarding SG&A, almost about $800,000 is causing SG&A to ramp up to...

Some of that. There's a little of that in cost of goods sold too, but there's a lot of that in SG&A.

Okay. Perfect. Thanks a lot. Thanks for taking my questions.

[Operator Instructions] Our next question comes from the line of Bill Baldwin with Baldwin Anthony Securities. Please proceed with your question.

Good morning, Jeff and Jim. What do you kind of think laying on the petrochemical business right now in terms of management's kind of go on, I guess, you call it [spud] along, but kind of going slower, maybe, then perhaps we would have thought a while back, is it the macro picture or is it volatility in feedstock cost prices, or do you have a sense for what's kind of impacting their CapEx plans?

I have a view. If we think about the amount of incremental capacity that was added in the first wave, if it was massive on the order of almost 5% of global ethylene capacity was added in the first wave. That's still being digested. The supply and demand effect of how that influences prices of the goods that are being sold, I think it's a cause for pause and a more measured pace for Phase II of the expansion cycle. Phase II will be realized and I think we've always felt and always communicated that Phase II would be elongated in comparison to Phase I. And that was just a massive amount of step change in the North American capacity that came in under Phase I, which is now starting up, and that has an effect on commodity prices. And I think the project sponsors our watching on how that's play out and selecting their point in time to add more capacity.

All right. Are you talking primarily right now about cracker type activity, Jim, or are you getting more into derivative type plants?

I would say that that comment pertained to principally the crackers, the ethylene plant. However, the ethylene plant is built for the sole purpose of feeding the downstream derivative plants, so therefore they tend to go together. We are still seeing some activity of downstream work as it pertains to Phase I expansion, but we think that's largely run its course. And, again, we're staging for the second wave of expansion and we want some work. We're seeing some bidding activity and honestly, Bill, we've been watching this bidding activity up for some of these projects for two and three years already. Sponsors just aren't pulling the trigger. What happens in the Gulf Coast and I think this better than most is, when there is this concentration of new capacity in a tight labor market, skilled trades become scarcely available and the costs go up and that also slows the pace of further incremental capacity, because costs start to get out of control, schedule gets elongated and the sponsors just want to wait till things cool off a little bit and there's a more predictable cost and execution schedule. But that's normal for us, it's normal cycle flow. There's a surge, there's a backing off, there's a more measured pace when things ramp up and get more stable. So I think we're in that more stable period, but the skilled trade is affecting cost and is affecting schedule.

Ladies and gentlemen, we have reached the end of the question-and-answer session, and I would like to turn the call back to management for closing remarks.

Thank you, Dana and thank you everyone for your time this morning. We're pleased to update you on our third quarter, and we look forward to updating you on our year end results during our fourth quarter conference call and also providing our initial look for fiscal 2020 at that point in time. Have a great day. Thank you.

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