Dave, if you're finding that the contra won't back out while the engine's running, you'll have to do it with the engine stopped. Back out the compscrew to where you think it ought to be, prime the side of the piston, and give it a good hard flick. This will generally shift the contra, even if it won't back out with the engine running. Personally, I wouldn't worry about the "12.5 turns in" thing for the compression - just find a decent running setting for it, and you shouldn't need to vary it more than a quarter turn or so. It's not like a needle valve, and the less you have to move it, the better.
7000 rpm is way low for any of the props you mention. Is it misfiring, or running evenly? If it's not misfiring, then don't increase the comp yet. A diesel that's running slowly but not misfiring is either badly overcompressed, or very rich. I'd suggest backing the comp off until it it's misfiring, increase it just enough to clear the misfire, then gradually lean it out. Eventually it'll misfire again - you can increase the comp a little to stop this, and continue to lean it. When it's too lean, you'll get a harsher misfire, and/or the engine will just stop. (Don't get stressed by this - overcompressed is much worse than too lean.) You're aiming for a compression that's just enough for the engine not to misfire, and a needle setting a bit rich of peak.
For a healthy engine with a vaguely sensible compression setting to be running that slow, I'd normally assume that it's way rich. Only 1.25 turns out on the needle suggests otherwise, so I can see why Ray would be wondering if the engine's assembled correctly.
Steve