Greetings. Welcome to the Graham Corporation Second Quarter Fiscal Year 2020 Financial Results 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] Please note, this conference is being recorded. I will now turn the conference over to your host, Karen Howard, Investor Relations for Graham Corporation. You may begin.

Thank you, Daryl, and good morning, everyone. We appreciate you joining us today to discuss Graham's fiscal 2020 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-msg.com. On the call with me today are Jim Lines, our President and Chief Executive Officer; and Jeff Glajch, our Chief Financial Officer; and I also want to introduce you to Alan Smith, our Vice President and General Manager of our Batavia facility. Jim will start with a strategic overview of our business and provide our outlook for the remainder of the fiscal year. Jeff will review the financial results for the period and Alan will provide an operations overview. 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 Jim to begin. Jim?

Thank you, Karen. Good morning, everyone and we appreciate you joining our second quarter earnings call. I will begin with a strategic overview of what we are focused on. Our remarks start on slide four. The key element of our strategy is to strengthen and expand predictable revenue streams. This will reduce financial performance volatility caused by large capital projects cyclical demand within crude oil refining and chemical end markets. Refining and chemical end markets have had historical large variation in demand for our products and that is not expected to change in the coming years. To the contrary, we observed these markets to be more volatile today, with greater variation between cycle peaks and bottoms. Our strategy to increase participation and market share within the U.S. Navy Nuclear Propulsion Program will provide a predictable level of revenue. Navy work typically has long-lived backlog, providing vision into a multi-year revenue projection that is predictable and not subject to large variation. The Navy strategy has been successful, with current backlog for this segment at approximately $60 million. We are now on each of the three nuclear propulsion vessel programs. Participation is expanding, as the types of components provided increases. Over the next 12 months we hope to secure the supply of two new components, one for carriers and the other for one of the two submarine programs. We have executed well our naval strategy. Alan Smith & his team have executed superbly. An ongoing confirmation of our success in differentiating on execution, on-time delivery and quality is the expanding percentage of backlog that is one sole source. All our work for the first decade of the strategy was competitively bid. We now are seeing certain procurement done with sole-source bidding. Moreover, many of the orders were first-time fabrications for us of…

Thank you, Jim and good morning everyone. If you could turn to Slide 8, some brief highlights on the second quarter. Sales in the quarter were $21.6 million similar to the $21.4 million in the second quarter of last year. Q2 net income was $1.2 million or $0.12 a share down from $1.8 million or $0.19 a share last year. Included in last year's numbers were the -- were some losses related to the recently divested commercial nuclear business if we were to exclude those, the comparable net income last year would have been $2.4 million or $0.24 a share. Orders in the second quarter were strong at $32.6 million, driven by some key refining orders in Asia and the United States. Our backlog has improved to $127.8 million. The backlog level includes a tripling of our commercial backlog over the past 24 months. And when we back out the divested nuclear business from prior periods, this is our largest backlog ever. Move on to Slide 9, again, Q2 sales were $21.6 million versus $21.4 million last year. Sales in the second quarter were 73% domestic, 27% international fairly similar to last year which was 70% domestic, 30% international. Gross profit decreased to $4.9 million from $6.2 million last year due primarily to an unfavorable mix of projects. Gross margin was 22.9% down from 29% in the second quarter last year. EBITDA margin was 7.8%, down from 14.7% in last year's second quarter. And as I noted earlier, net income was $1.2 million or $0.12 a share, down from adjusted level of $2.4 million or $0.24 a share. On to Slide 10, looking at the first half of the year, sales in the first half were $42.2 million compared with $51 million in the first half last year. You might…

Thanks Jeff. If you could please turn to Slide 13. Second quarter revenue was comparable to the same period last year. However, there was some end market variation. Refining industry sales in the quarter were down $3.4 million. This was due to a number of North American revamp or retrofit projects which were under execution last year. This does not signal any change in our end market fundamentals. On the other hand chemical industry sales were considerable relative to the same period last year. This was driven by domestic new capacity and investments in retrofit. Power industry sales are down due to the divestiture of Energy Steel whose revenue was in 2019 and is no longer part of the ongoing mix. We continue to have a high concentration of domestic revenue. It is 73% of our overall revenue. Such a high concentration is due to Navy revenue, the strength of the domestic and chemical end markets, and the revamped investments that are routinely occurring in the U.S.-based refineries. Please turn your attention to Slide 14. The highlight here is the strength and improvement in order levels from Graham's commercial end markets that are principally crude oil refining and the chemical markets. From the low watermark about two years ago, the level of trailing 12-month orders are up approximately 100%. We are expecting a book-to-bill ratio greater than one for FY 2020 implying that the order pattern is anticipated to be strong in the second half. There's a nice pipeline of bids for the U.S. Navy and our international crude oil refining market. Chemicals are expected to be stable but not as strong as orders from the U.S. Navy for our oil refining end markets. I'm now referring to Slide 15. We have a terrific high-quality backlog and the profitability of our backlog continues to strengthen. The backlog at September 30th was $127.8 million with approximately $60 million for the Navy and roughly $40 million for crude oil refining customers. It is also important to know that excluding Energy Steel, the backlog reported on September 30th represents a record high for our ongoing business. Our diversification efforts for the U.S. Navy have been effective and provide a strong level of multiyear baseload for our operation, 55% to 60% of our backlog is anticipated to convert within the next 12 months and 25% to 35% convert within two years and beyond. Daryl can you please open the line for questions? Thank you.

At this time we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Theodore O'Neill from Litchfield Hills Research. Please proceed with your question.

Thank you. Congratulations on a good quarter.

Thanks, Theo.

Thank you, Theo.

I just have a question here about Slide 5, where you're showing that the commercial revenue has grown in the last seven years relative to the previous seven years. And I understand that profit is -- the profit aspect of it, profit ought to be better. But does this imply that there's some kind of change in construction and new building of equipment building of facilities that you would serve us? Is there a cyclical component to this? Where they're not -- there's not as much new equipment anymore. They're just retrofitting and buying parts? And is this at all cyclical?

No it doesn't signal in our mind a long-term change. What we had identified or what our thesis was coming out of this downturn that expansion would be driven initially off of investment in the installed base. We thought that would come first and that actually played out as we had expected and we began to shift our customer-facing resources more towards the installed base because that's where the revenue would come first. As we look at our bid pipeline however, Theo from a global perspective we are beginning to see our bid pipeline fill with more new capacity work. It's more of a timing and it's typically how we come out of a downturn where our installed base gets focused on first before new global capacity starts to be invested. Now we have won some orders in the last year or so for new global capacity. But as we look at our bid pipeline it's beginning to expand and be more filled with global new refining capacity.

Okay. Thanks very much.

Our next question comes from the line of Tate Sullivan of Maxim Group. Please proceed with your question.

Hi. Thank you. A couple of follow-ups on your conversation about Navy work and aerospace and defense work in general. First what did you -- what do you refer to when you mentioned a quick-turn Navy order? Can you give more context to that please?

Yes, that's an order. If you track back -- a type of order if you track back to fiscal 2017 or fiscal 2018, we had acknowledged that there can be some quick-turn naval work that comes in and out in one or two quarters that can be rather significant. We are anticipating there might be one of those in fiscal in 2020. But I would ask you to maybe step back to the 2017, fiscal year or 2018, where we had a similar type of order happen and affect both those years we are expecting that to occur again. It's more of a material type order versus a fabrication.

Okay. And then with your -- and I pardon if I misphrase it, but you mentioned the annual revenue target? And you referred to as aerospace and defense of 20 to 30 -- $20 million to $30 million annually in the next two years. Does that imply moving beyond equipment work just for the submarine and aircraft programs? Or is that all still sub and aircraft programs?

No Tate that's a great question. That's with our current component mix that we're providing to carriers and the two submarine programs. Plus we hope to win additional components for those vessels but that comment really reflects where our current backlog is and its conversion schedule, plus what we anticipate to win that as I said is for carriers and submarines. So it's not branching into aerospace at all.

Okay. Okay. And then have you I can back into it but I think on your revenue and how you break it out it's -- there's another there's a line for other commercial industrial and defense work. I mean relative to that $20 million to $30 million annual target is trailing Navy work for about $18 million? Or can you give that number?

In the -- we haven't been definite about that. It's been between 10% and 15% of sales in a given year. That's been the range. And other elements -- other end markets that go into that other segment could be edible oils, could be pharma, but by far the most meaningful in what we group in other right now is Navy.

Okay. Thank you. And then are there -- and you sound optimistic on more future Navy orders and just based on other companies talking about the submarine and aircraft program are there orders subject to the procurement cycle? I mean, do you have visibility that you have them but you're waiting for the allocation and the procurement until you put it into backlog? Or how does that -- how will that work potentially?

Well we have visibility into the bids that we've already made. We have dialogue with the counterparty of when they would begin to negotiate. It can be difficult to predict when they actually settle on the supplier and release a purchase order. However, we have a view based on the dialogue that we're having the bids are already very mature. That's a good book of opportunities should close in the next six months for the U.S. Navy.

Okay. And last one for me. And sorry if I missed it earlier in the prior quarter SG&A dropping to $3.8 million from $4.6 million in the prior quarter and keeping guidance unchanged, did I miss -- did you talk about some timing in that expense? And why should that increase in the second half of the year, please?

Sure. A couple of things Tate this is Jeff. First off, we do have energy steel in the numbers in the first quarter. So that's a piece of the drop off. There was also some timing of some things that did not occur in the second quarter that got pushed -- will get pushed to the second half of the year. And so there'll be a little bit of a -- that's part of what's driving the increases. We just had a very light quarter in the second quarter relative to what I would call a normal quarter. And that happens on occasion sometimes it -- it tends to happen more in the first quarter of this year the lightness happened to happen -- happened to occur in the second quarter.

Okay, thank you for your last detail. Happy to address…

Our next question comes from the line of Brian Lau of Sidoti. Please proceed with your question.

Hey, good morning everybody. Brian on for Joe this morning congrats on a solid quarter.

Thanks, Brian.

Thank you, Brian.

Just real quick I wanted to touch on the gross margin a little bit more. When you raised the guidance for the gross margin in the first quarter, did you kind of anticipate the result this quarter? And if not by reaffirming it are you kind of implying maybe there could be some surprise in the back half? And then also how does that gross margin compare on some of the more recent orders maybe in the backlog compared to some recent shipments?

So a couple of questions there. The first one is did we anticipate the margin this quarter relative to the guidance that we gave. This quarter was pretty much in line with what our expectations have been. So that was inherent in the guidance we gave for the full year. Secondly I believe your question was around the margin and backlog. We talked about this quarter having a bit of an unfavorable mix in it. What's in backlog, what's going into the backlog is -- we're continuing to see an improvement in margin and what's going into backlog versus what's coming out. So I think Alan mentioned, the high quality or the improving quality of our backlog. And part of that comment was clearly a better margin profile than what's recently come out of backlog.

Okay, great. Thank you. And then just as far as the bidding activity, it sounds like everything is still on track for that kind of $30 million in orders kind of that cadence going forward? Has anything really changed since last time we spoke? Or does -- is that sound about right?

Nothing has really changed Brian other than we thought we could have booked one or two of the orders that are now pushed out last quarter. It's just a typical customer delay. We do have some rather large projects. So it might look chunky in terms of how the order flow could be quarter-to-quarter because of the size of some of these projects in our pipeline between $5 million and some $15 million. However, our overall view is unchanged from commentary last quarter.

All right. And then last, but not least just on the M&A pipeline. It sounds like you guys are kind of honing in on some targets there. Have multiples come down at all just kind of with the general environment?

Not really. Unfortunately in the space that we're looking in you know the defense market and as well as in the -- some of the aftermarket on the commercial side, the multiples are still pretty frothy. And -- but we'll manage our way through that. But no they really have not come down.

Okay, well. Appreciate it. And again, good job on quarter.

Thank you, Brian.

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

Thank you and good morning. I was looking to see what the color you can offer regarding the initiatives you've undertaken to, I guess secure more of a global fabricating supply chain using third-party fabricators. Can you offer us some insight there Jim as to what that entails? Are you expanding relationships with existing fabricators? Or are you adding new fabricators. And if so, how do you do your due-diligence and vet those new fabricators? To...

Sorry. A great question. We do have a group of historic international fabrication partners that we will continue to leverage. And we furthermore intend to expand and add more fabrication partners. We do a very deliberate due-diligence process around financial capabilities, quality, customer-centric organization, similar sensibilities to Graham and once we select a vendor and move them on to our fabrication AVL, that doesn't mean we detach ourselves once we have an order that we'll put into that business. Our quality control, our manufacturing specialists are surveilling in those businesses fairly regularly to ensure fit form and function quality, contractual adherence and that it has the Graham badge and we're proud of what's being delivered. So we're very deliberate and very measured in that. If I thought about the strategy from a historical perspective, we were more opportunistic and we would snipe at this work when it suited us. Now how we thought about it the last 24 to 30 months is we want to aggressively reshape our position in certain segments of the market, change our market share, drive down our cost basis for that type of work by using more aggressively the global fabrication supply chain. And really end of the day is to take more global share within a different market pricing expectation, while driving an acceptable return for ourselves. So we're thinking about it differently. Ultimately, the lynchpin is, let's change our position, let's take more share, let's beat the installed base. And so far as I said in the prepared remarks, Bill we've had half a dozen contracts in the last 18 months that totaled something north of $30 million -- $35 million. We are executing with some of those contracts with old partners and we're executing some of those contracts with new partners.

Are you using these fabricators primarily for the global refining and petrochemical markets? Or is it primarily refining?

It's actually both, from a declarative point of view we want to own and be the dominant player in refining. Our attitude is we never want to lose refining budget. So I want to make sure we maintain that dominant position, but we also want to shift higher our market share in chemicals. So of those six projects that I cited just a moment ago as I said in the prepared remarks, four of those are refining projects and two of those are chemical industry projects.

Okay, very good. And you've got such extreme tolerances you have to meet in terms of some of your products. It's just -- do you have some of your own people sometimes that have to go -- have to go on-site there to make sure that the quality of the work has been -- I mean do these fabricators have the quality of people onboard to do the kind of work you could do there and your clients there in New York?

Well no one builds it like Graham, let me start with that. We are an exceptionally capable fabricator. However, we can push our expertise into certain fabricators not every fabricator is a good fit for us. We're not looking for optimizing price. We're looking for the right balance between outstanding quality and fabrication capabilities at an acceptable price. So we're not going to the secondary or tertiary fabrication supply chain. They won't -- they're sort of what you're citing here as a risk, they won't fit us. They won't match our brand and our quality requirements. So we are going into the top-tier fabricators if you will or the upper tier where their capabilities are strong, their ability to fabricate to our tolerances and of quality criteria, and the criterion of our customers is acceptable. So we're striking this balance. So we're not chasing lowest cost we're putting quality first execution -- execution and quality and delivering something consistent with our brand is the priority at an acceptable for us. So hopefully that answers the question.

Yes. It's a good insight. Are there any IP issues involved here that you have to protect when you're working with fabricators like this Jim? I mean are you giving them access to certain of your practices that you consider to be proprietary?

No certainly any time you embark on a strategy such as this. That's the first thing that comes to mind. That's the first thing that came to the mind of the management team of, how do we execute this and moat the critical IP that is unique and differentiates us and we have methodologies to do that. What we're parting into the fabricators is less critical IP and more commercially available technology that's not the secret differentiators of Graham. We reserve that we hold that, we moat that, and we don't put that into the fabricators' wheelhouse. A key criterion is, we do this with a clear vision that we will not create a competitor.

Exactly, exactly. Yes that's the last thing you want to do there. And lastly are you finding a sufficient number of these folks to talk to. I mean are there people out here that meet those criteria you have pretty much where you want to be located and where you'll need them?

It's a process we've just -- we've gone in and did an audit in a pretty large country that has a massive supply chain base of this type of fabricator and we've added five to our AVL. In that -- AVL sorry is an acronym for approved vendors list. So they've got audit standards and they passed the mustard and we envision putting work into 1, 2, 3, 4 5 of those shops. We found fabricators that want to associate with our brand because our brand gives market access. Our brand gives expanded opportunity. So we're finding a really keen receptiveness to work with us because they don't have the global market access that Graham does, and we don't have the execution and scalability that they provide. So it's a great partnership where both sides figure out how to do something together that neither can do independent of each other.

Right. Yes I would think they'd be knocking on your door with the installed base you got out there in your reputation. Well I'll tell you it's as you execute this it's going to be exciting to see what happens to your market share globally.

Yes we're very excited by it.

Thank you

Thank you, Bill.

Our next question comes from the line of Gerry Heffernan of Walthausen & Co. Q – Gerry Heffernan: Good morning everybody and thank you for taking the time to take my call here.

Hi, Gerry.

Jim, I was very interested in question set out by the last caller and did spud a couple of questions in my mind. In regards to the statement that you made of M&A. now we've been talking for many years here in M&A it's always been discussed though it's never been a real big part of the picture. So my question is it sounds as though there's perhaps a little bit more interesting news in that area of your efforts than in the past. And it had me thinking what is Graham's core competency? When you think of Graham, what is your core competency? And in regards to M&A, are you looking for someone that has that same core competency? Or are you looking to add a new competency?

Good question. There are five critical differentiators or core competencies that we possess, or we believe we possess that our customers value. First and foremost, is our customer-facing platform, in which we applicate and serve as a partner in the conceptual design and the facility design for our customers of how our equipment integrates into their process and how they're able to achieve their operating results. They need us. And we built a customer facing platform to provide immense amount of knowledge transfer, information sharing and optimization of their designs. So when they run their plants, they'll meet their operating objectives. So we think we differentiate on that front. Secondly, because of the segment of the market that we've chosen to serve, which is this highly complex critical piece of equipment that integrates into a very complex process. A second differentiator is the engineering organization, the process knowhow of how after we have an order, we're able to -- when we get an order and you probably have heard this before, all on the call have heard this before, designs rarely are frozen for a large project work. We go through a process with the customer to actually finalize the design and it's highly iterative. So we have to have an adaptive and flexible ops model in the office portion for executing these orders that something always arises there's design churn, design iteration we have to have an adeptness and a vision that that's the nature of this work and we don't make every problem a customer's problem, and they need us for that. So that's a second differentiator. The third differentiator is the custom fabrication of these complex very large weldments to exact intolerances a bit like what Bill Baldwin had questioned as we think about our fabrication partners…

Thanks Jim. Yes Gerry as we're looking at potential acquisition candidates. One of the things we're focused on is as Jim mentioned, we're not trying to buy capacity per se. We're actually trying to buy -- we're looking for a business that fits our type of operating model. So has the customer and quality focus that we believe we have for our customers. And that has a good management team that wants to remain with the organization. That's very -- that's key to us and we're not buying a -- we're buying a business, but we're buying the people in the business as well. And that's critical for us. We want someone who has a lot of the same attributes that Jim conveyed about Graham, but we're looking to how do we grow this business in parts of our markets that we believe are perhaps less cyclical than our core energy market. So -- and we talked earlier about the Navy space and we threw in aerospace because many of the companies that we're looking at that have a large Navy component also have an aerospace component maybe not as big but it certainly exists. And that is interesting to us if it product wise ties into what they do with the Navy. We're also looking at opportunities in the aftermarket -- in our commercial markets, because we believe the -- and our experience has been while the volatility of our capital investment by our large refining and petrochemical customers can vary 50%, 60 plus percent. The volatility of the aftermarket or short-cycle business tends to be much less volatile, perhaps more like 15% to 20%. So in a down cycle it's a business that's more sustainable. So that's really our focus on the acquisition side. But key for us is we want to find the companies that are well-run that have a lot of the same attributes as Graham and have a management team that wants to remain in that business post acquisition. I hope that's helpful. If I can clarify it further please let me know.

That was all very helpful, both Alan and Jim. Jim it strikes me when you go through those core competencies and going to the previous question of Mr. Baldwin there that concerned about the custom fabrication competency that you have. Are you giving anything away, if you're starting to utilize international players for that aspect of your service that that is just one of five items that you picked out and the other four are very much people-oriented as opposed to be just the artistry of working with the metallurgy.

That's correct. While there is risk in doing this, we think we've moated the most critical elements of our success factors.

Great. Thank you, very much.

Our final question comes from the line of Tate Sullivan of Maxim Group. Please proceed with your question.

Thank you. Thanks for taking quick follow-up. Just on numbers wise for orders in the most recent quarter of $32.6 million. And then in -- earlier in September, I think was when you announced most of the refining orders. What are other orders in the quarter? Is it design modifications that you mentioned before or maintenance or aftermarket? Can you -- what usually are the other orders besides the large equipment orders.

We had some chemical industry orders that came in. And then of course, our usual basket of short-cycle work, spare parts small product new equipment sales that typically come in and out in one, two, three or four months. So, that represented the remainder of it. There wasn't so much change orders. But more of the large project works where we had the order announcement of about $20 million of that. And then, we did announce several million dollars -- a few million dollars of chemical industry end market sales. And then our short-cycle business mix of the rest.

Tate, just to also clarify a couple of the larger orders as Jim has mentioned, we announced the one the $19 million or so in early September. We had a couple that came in fairly late in the quarter and our practice is if they come in that late, if we were to put an announcement it might confuse whether it was a second-quarter order or a third-quarter order. If we announced it in early October and we believe that it was -- it just makes sense to hold off on those as any kind of announcement like that and just talk about it on the quarterly call like this.

Okay. Thank you.

We have reached the end of our question-and-answer session. I will now turn the call back over to management for any closing remarks.

Well, thank you, Daryl, and thank you everyone for your time this morning and for your questions of the three of us. We appreciate your engagement and the interest with which you thought about the questions and we look forward to updating you on our progress in executing our strategies and our financial performance in January. Have a great day. Thank you.