FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 (Mark one) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934. For Quarterly Period Ended September 30, 2003 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the transition period from ____________ to ____________ Commission File Number 1-8462 GRAHAM CORPORATION (Exact name of registrant as specified in its charter) DELAWARE 16-1194720 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 20 FLORENCE AVENUE, BATAVIA, NEW YORK 14020 (Address of Principal Executive Offices) (Zip Code) Registrant's telephone number, including Area Code - 585-343-2216 (Former name, former address and former fiscal year, if changed since last report.) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES __X__ NO _____ Indicate by check mark whether the registrant is an accelerated filer (as defined by Rule 12b-2 of the Act). Yes __ __ No __X__ As of October 28, 2003, there were outstanding 1,629,656 shares of common stock, $.10 per share. 2 GRAHAM CORPORATION AND SUBSIDIARIES FORM 10-Q SEPTEMBER 30, 2003 PART I - FINANCIAL INFORMATION Unaudited consolidated financial statements of Graham Corporation (the Company) and its subsidiaries as of September 30, 2003 and for the three month and six month periods ended September 30, 2003 and 2002 are presented on the following pages. The financial statements have been prepared in accordance with the Company's usual accounting policies, are based in part on approximations and reflect all normal and recurring adjustments which are, in the opinion of management, necessary to a fair presentation of the results of the interim periods. The March 31, 2003 Consolidated Balance Sheet was derived from the Company's audited financial statements for the year ended March 31, 2003. This part also includes management's discussion and analysis of the Company's financial condition as of September 30, 2003 and its results of operations for the three and six month periods then ended. 3 GRAHAM CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
September 30, March 31, 2003 2003 ---- ---- Assets Current Assets: Cash and cash equivalents $ 280,000 $ 217,000 Investments 5,428,000 6,446,000 Trade accounts receivable, net 6,341,000 7,295,000 Domestic and foreign income taxes receivable 131,000 259,000 Deferred income tax asset 2,112,000 1,846,000 Prepaid expenses and other current assets 708,000 367,000 ----------- ----------- 24,330,000 26,771,000 Property, plant and equipment, net 9,481,000 9,808,000 Deferred income tax asset 1,491,000 1,610,000 Other assets 79,000 91,000 ----------- ----------- $35,381,000 $38,280,000 =========== =========== Liabilities and Shareholders' Equity Current liabilities: Short-term debt $ 1,575,000 $ 1,524,000 Current portion of long-term debt 51,000 80,000 Accounts payable 2,782,000 4,629,000 Accrued compensation 3,791,000 3,283,000 Accrued expenses and other liabilities 2,146,000 2,344,000 Customer deposits 2,084,000 2,132,000 ----------- ----------- 12,429,000 13,992,000 Long-term debt 116,000 127,000 Accrued compensation 272,000 244,000 Deferred income tax liability 51,000 49,000 Other long-term liabilities 60,000 76,000 Accrued pension liability 1,422,000 1,761,000 Accrued postretirement benefits 2,661,000 3,238,000 ----------- ----------- Total liabilities 17,011,000 19,487,000 ----------- ----------- Shareholders' equity: Preferred Stock, $1 par value - Authorized, 500,000 shares Common stock, $.10 par value - Authorized, 6,000,000 shares Issued, 1,728,779 shares at September 30, 2003 and 1,716,572 shares at March 31, 2003 173,000 172,000 Capital in excess of par value 4,849,000 4,757,000 Retained earnings 18,103,000 18,767,000 Accumulated other comprehensive loss (2,857,000) (2,990,000) ----------- ----------- 20,268,000 20,706,000
4 GRAHAM CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Concluded)
September 30, March 31, 2003 2003 ---- ---- Less: Treasury Stock (99,123 shares on September 30, 2003 and 68,323 shares on March 31, 2003) (1,385,000) (1,161,000) Notes receivable from officers and directors (513,000) (752,000) ----------- ----------- Total shareholders' equity 18,370,000 18,793,000 ----------- ----------- $35,381,000 $38,280,000 =========== ===========
See Notes to Consolidated Financial Statements. 5 GRAHAM CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS AND RETAINED EARNINGS
Three Months Ended Six Months Ended September 30, September 30, 2003 2002 2003 2002 ---- ---- ---- ---- Net Sales $12,457,000 $11,437,000 $20,892,000 $21,605,000 ----------- ----------- ----------- ----------- Cost and expenses: Cost of products sold 9,697,000 9,202,000 17,137,000 17,576,000 Selling, general and administrative 2,515,000 2,737,000 4,922,000 5,205,000 Interest expense 21,000 20,000 58,000 37,000 Other Income (522,000) ----------- ----------- ----------- ---------- 12,233,000 11,959,000 21,595,000 22,818,000 ----------- ----------- ----------- ---------- Income (loss) before income taxes 224,000 (522,000) (703,000) (1,213,000) Provision (benefit) for income taxes 68,000 (169,000) (201,000) (404,000) ----------- ----------- ----------- ---------- Net income (loss) 156,000 (353,000) (502,000) (809,000) Retained earnings at beginning of period 18,027,000 18,432,000 18,767,000 18,888,000 Dividends (80,000) (85,000) (162,000) (85,000) ----------- ----------- ----------- ---------- Retained earnings at end of period $18,103,000 $17,994,000 $18,103,000 $17,994,000 =========== =========== =========== =========== Per Share Data: Basic: Net income (loss) $.09 $(.21) $(.31) $(.49) ==== ===== ===== ===== Diluted: Net income (loss) $.09 $(.21) $(.31) $(.49) ==== ===== ===== =====
See Notes to Consolidated Financial Statements. 6 GRAHAM CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended September 30, 2003 2002 ---- ---- Operating activities: Net loss $ (502,000) $ (809,000) ---------- ---------- Adjustments to reconcile net loss to net cash (used) provided by operating activities: Depreciation and amortization 488,000 435,000 Loss on sale of property, plant and equipment 23,000 (Increase) Decrease in operating assets: Accounts receivable 1,036,000 11,093,000 Inventory, net of customer deposits 1,075,000 (1,998,000) Prepaid expenses and other current and non-current assets (328,000) (208,000) Increase (Decrease) in operating liabilities: Accounts payable, accrued compensation, accrued expenses and other current and non-current liabilities (2,393,000) (2,882,000) Accrued compensation, accrued pension liability, accrued postemployment benefits (120,000) (104,000) Domestic and foreign income taxes 129,000 (1,507,000) Deferred income taxes (120,000) (68,000) ---------- ----------- Total adjustments (233,000) 4,784,000 ---------- ----------- Net cash (used) provided by operating activities (735,000) 3,975,000 ---------- ----------- Investing activities: Purchase of property, plant and equipment (120,000) (334,000) Proceeds from sale of property, plant and equipment 5,000 Collection of notes receivable from officers and directors 35,000 32,000 Purchase of investments (5,421,000) (17,227,000) Redemption of investments at maturity 6,472,000 11,000,000 ---------- ----------- Net cash provided (used) by investing activities 966,000 (6,524,000) ---------- -----------
GRAHAM CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (CONCLUDED)
Six Months Ended September 30, 2003 2002 ---- ---- Financing activities: Decrease in short-term debt (27,000) (13,000) Proceeds from issuance of long-term debt 5,350,000 Principal repayments on long-term debt (5,401,000) (47,000) Issuance of common stock 94,000 Dividends paid (162,000) Acquisition of treasury stock (20,000) ---------- ---------- Net cash used by financing activities (166,000) (60,000) ---------- ---------- Effect of exchange rate changes on cash (2,000) 5,000 ---------- ---------- Net increase (decrease) in cash and cash equivalents 63,000 (2,604,000) Cash and cash equivalents at beginning of period 217,000 2,901,000 ---------- ---------- Cash and cash equivalents at end of period $ 280,000 $ 297,000 ========== ===========
See Notes to Consolidated Financial Statements. GRAHAM CORPORATION AND SUBSIDIARIES NOTES TO FINANCIAL INFORMATION SEPTEMBER 30, 2003 NOTE 1 - INVENTORIES - ------------------------------------------------------------------------------- Major classifications of inventories are as follows:
9/30/03 3/31/03 ------- ------- Raw materials and supplies $ 1,714,000 $ 2,417,000 Work in process 10,014,000 14,968,000 Finished products 2,573,000 1,937,000 ----------- ----------- 14,301,000 19,322,000 Less - progress payments 4,873,000 8,907,000 - inventory reserve 98,000 74,000 ----------- ----------- $ 9,330,000 $10,341,000 =========== ===========
NOTE 2 - STOCK-BASED COMPENSATION: - -------------------------------------------------------------------------- In 2003, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 148, "Accounting for Stock- Based Compensation - Transition and Disclosure". This standard provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. Additionally, the standard also requires prominent disclosures in the Company's financial statements about the method of accounting used for stock-based employee compensation, and the effect of the method used when reporting financial results. The Company accounts for stock-based compensation in accordance with SFAS No. 123, "Accounting for Stock-Based Compensation". As permitted by SFAS No. 123, the Company continues to measure compensation for such plans using the intrinsic value based method of accounting, prescribed by Accounting Principles Board (APB), Opinion No. 25, "Accounting for Stock Issued to Employees". Accordingly, compensation cost for stock options is measured as the excess, if any, of the quoted market price of the Company's stock at the date of grant over the amount an employee must pay to acquire the stock. Compensation cost for share equivalent units is recorded based on the quoted market price of the Company's stock at the end of the period. Under the intrinsic value method, no compensation expense has been recognized for the Company's stock option plans, as all options have been granted with an exercise price equal to the fair market value of the stock on the date of grant. Had compensation cost for the Company's stock option plans been determined based on the fair value at the grant date for awards under those plans in accordance with the optional methodology prescribed under SFAS No. 123, the Company's net income (loss) and net income (loss) per share would have been the pro forma amounts indicated below:
Three Months Ended Six Months Ended September 30, September 30, 2003 2002 2003 2002 ---- ---- ---- ---- Net income (loss) as reported $156,000 $(353,000) $(502,000) $(809,000) Stock-based employee compensation cost of related tax benefits (1,000) (11,000) (2,000) -------- --------- --------- --------- Pro forma net income (loss) per share $156,0000 $(354,000) $(513,000) $(811,000) ========= ========= ========= ========= Basic income (loss) per share As reported Pro forma $.09 $(.21) $(.31) $(.49) $.09 $(.21) $(.31) $(.49) Diluted income (loss) per share As reported $.09 $(.21) $(.31) $(.49) Pro forma $.09 $(.21) $(.31) $(.49)
For purposes of the disclosure above, the fair value of each option grant is estimated on the date of the grant using the Black-Scholes option-pricing model with the following weighted- average assumptions used for grants in 2003 and 2002:
2003 2002 ---- ---- Expected life 5 years 5 years Volatility 50.06% 50.00% Risk-free interest rate 2.25% 2.81% Dividend yield 2.40% 2.35%
NOTE 3 - INCOME (LOSS) PER SHARE: - -------------------------------------------------------------------------------- Basic income (loss) per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding for the period. Common shares outstanding includes share equivalent units which are contingently issuable shares. Diluted income (loss) per share is calculated by dividing net income (loss) by the weighted average number of common and, when applicable, potential common shares outstanding during the period. A reconciliation of the numerators and denominators of basic and diluted income (loss) per share is presented below:
Three Months Ended Six Months Ended September 30, September 30, 2003 2002 2003 2002 ---- ---- ---- ---- Basic income (loss) per share Numerator: Net income (loss) $ 156,000 $ (353,000) $ (502,000) $ (809,000) --------- ---------- ---------- ---------- Denominator: Weighted common shares outstanding 1,629,000 1,648,000 1,624,000 1,648,000 Share equivalent units (SEU) outstanding 16,000 16,000 16,000 14,000 --------- ---------- --------- --------- Weighted average shares and SEU's outstanding 1,645,000 1,664,000 1,640,000 1,662,000 --------- ---------- --------- --------- Basic income (loss) per share $.09 $(.21) $(.31) $(.49) ==== ===== ===== ===== Diluted income (loss) per share Numerator: Net income (loss) $ 156,000 $ (353,000) $ (502,000) $ (809,000) --------- ---------- ---------- ---------- Denominator: Weighted average shares and SEU's outstanding 1,645,000 1,664,000 1,640,000 1,662,000 Stock options outstanding 12,000 --------- ---------- ---------- ---------- Weighted average common and potential common shares outstanding 1,657,000 1,664,000 1,640,000 1,662,000 --------- ---------- ---------- ---------- Diluted income (loss) per share $.09 $(.21) $(.31) $(.49) ==== ===== ===== =====
Options to purchase shares of common stock which totaled 136,250 for the three months ended September 30, 2003 were not included in the computation of diluted earnings per share as the effect would be antidilutive due to the options' exercise price being greater than the average market price of the common shares. All options to purchase shares of common stock at various exercise prices were excluded from the computation of diluted loss per share for the six month period in fiscal year 2004 and the three and six month periods in fiscal year 2003 as the effect would be antidilutive due to the net losses for the periods. NOTE 4 - PRODUCT WARRANTY LIABILITY - -------------------------------------------------------------------------------- The Company estimates the costs that may be incurred under its product warranties and records a liability in the amount of such costs at the time revenue is recognized. The reserve for product warranties is based upon past claims experience and ongoing evaluations of any specific probable claims from customers. The reconciliation of the changes in the product warranty liability is as follows:
Three Months Ended Six Months Ended September 30, September 30, 2003 2002 2003 2002 ---- ---- ---- ---- Balance at beginning of period $ 386,000 $ 360,000 $ 592,000 $ 182,000 Expense for product warranties 45,000 144,000 120,000 344,000 Product warranty claims paid (72,000) (33,000) (353,000) (55,000) --------- --------- --------- --------- Balance at end of period $ 359,000 $ 471,000 $ 359,000 $ 471,000 ========= ========= ========= =========
NOTE 5 - CASH FLOW STATEMENT - -------------------------------------------------------------------------------- Interest paid was $56,000 and $37,000 for the six months ended September 30, 2003 and 2002, respectively. In addition, income taxes (refunded) paid were $(210,000) and $1,171,000 for the six months ended September 30, 2003 and 2002, respectively. Non-cash activities during the six months ended September 30, 2003 and 2002 included capital expenditures totaling $11,000 and $22,000, respectively, which were financed through the issuance of capital leases. Dividends of $81,000 and $86,000 were recorded but not paid during the six months ended September 30, 2003 and 2002, respectively. NOTE 6 - COMPREHENSIVE INCOME - -------------------------------------------------------------------------------- Total comprehensive income (loss) was $154,000 and $(285,000) for the three months ended September 30, 2003 and 2002, respectively. Other comprehensive income for the three months ended September 30, 2003 and 2002 included foreign currency translation adjustments of $(2,000) and $68,000, respectively. Total comprehensive loss for the six months ended September 30, 2003 and 2002 was $369,000 and $556,000, respectively. Other comprehensive income for the six months ended September 30, 2003 and 2002 included foreign currency translation adjustments of $133,000 and $253,000, respectively. NOTE 7 - OTHER INCOME - -------------------------------------------------------------------------------- On February 4, 2003, the Employee Benefits Committee of the Board of Directors irrevocably terminated postretirement health care benefits for current U.S. employees. However, benefits payable to retirees of record on April 1, 2003 remained unchanged. As a result of the plan change, a curtailment gain of $522,000 was recognized. This gain is included in the caption "Other Income" in the Consolidated Statement of Operations and Retained Earnings. NOTE 8 - SEGMENT INFORMATION - ------------------------------------------------------------------------------- The Company's business consists of two operating segments based upon geographic area. The United States segment designs and manufactures heat transfer and vacuum equipment and the operating segment located in the United Kingdom manufactures vacuum equipment. Operating segment information is presented below:
Three Months Ended Six Months Ended September 30, September 30, 2003 2002 2003 2002 ---- ---- ---- ---- Sales from external customers U.S. $11,129,000 $10,478,000 $18,740,000 $19,473,000 U.K. 1,328,000 959,000 2,152,000 2,132,000 ----------- ----------- ----------- ----------- Total $12,457,000 $11,437,000 $20,892,000 $21,605,000 =========== =========== =========== =========== Intersegment sales U.S. $ 10,000 $ 9,000 $ 38,000 $ 29,000 U.K. 725,000 193,000 1,066,000 612,000 ----------- ----------- ----------- ----------- Total $ 735,000 $ 202,000 $ 1,104,000 $ 641,000 =========== =========== =========== =========== Segment net income (loss) U.S. $ 293,000 $ (199,000) $ (219,000) $ (765,000) U.K. 22,000 (145,000) (276,000) (158,000) ----------- ----------- ----------- ----------- Total segment net income (loss) $ 315,000 $ (344,000) $ (495,000) $ (923,000) =========== =========== =========== ===========
The segment net income (loss) above is reconciled to the consolidated totals as follows:
Three Months Ended Six Months Ended September 30, September 30, 2003 2002 2003 2002 ---- ---- ---- ---- Total segment net income (loss) $ 315,000 $ (344,000) $ (495,000) $ (923,000) Eliminations (159,000) (9,000) (7,000) 114,000 ----------- ----------- ----------- ----------- Net income (loss) $ 156,000 $ (353,000) $ (502,000) $ (809,000) =========== =========== =========== ===========
NOTE 9 - RELATED PARTY TRANSACTION - -------------------------------------------------------------------------------- On April 1, 2003, the Company acquired 30,800 shares of common stock previously issued under the Long-Term Stock Ownership Plan from two former officers. This transaction was accounted for as a purchase. The shares were redeemed at the original issue price of $7.25, as compared to a market price at the time of the closing of $7.55. This transaction resulted in a $224,000 increase to treasury stock, a $204,000 reduction in notes receivable from officers and directors and cash payments to former officers. The cash payments approximate amounts previously paid on the notes. GRAHAM CORPORATION AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS September 30, 2003 Graham Corporation consists of two operating segments as determined by geographic areas (USA: Graham Corporation, UK: Graham Vacuum and Heat Transfer, Limited and its wholly-owned subsidiary, Graham Precision Pumps, Ltd.). Certain statements contained in this document, including within this Management's Discussion and Analysis of Financial Condition and Results of Operations, that are not historical facts, constitute "Forward-Looking Statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Forward- looking statements, in general, predict, forecast, indicate or imply future results, performance or achievements and generally use words so indicative. The Company wishes to caution the reader that numerous important factors which involve risks and uncertainties, including but not limited to economic, competitive, governmental and technological factors affecting the Company's operations, markets, products, services and prices, and other factors discussed in the Company's filings with the Securities and Exchange Commission, in the future, could affect the Company's actual results and could cause its actual consolidated results to differ materially from those expressed in any forward-looking statement made by, or on behalf of, the Company. Results of Operations - --------------------- Consolidated sales increased 9% in the second quarter of fiscal year ending (FYE) March 31, 2004 compared to the same three month period one year ago. Sales from USA and UK operations for the current quarter (including intersegment sales) increased 6% and 78%, respectively. The significant increase in the UK is attributed to several large orders for China from the petrochemical industry. Consolidated sales for the six months ended September 30, 2003 as compared to 2002 were down 3%. The decrease in sales for the six months is a result of weakening activity in the principal markets served by USA operations. Cost of sales as a percent of sales for the second quarter was 78% compared to 80% a year ago. Costs of sales as a percent of sales for the USA operating segment for the current quarter was 78% compared to 82% for the quarter ended September 30, 2002. For the UK operating segment, cost of sales as a percent of sales was 73% as compared to 71% a year ago. Costs of sales for the six months ended September 30, 2003 was 82% as compared to 81% for the six months ended September 30, 2002. By operating segment, USA costs of sales was 83% versus 84% and UK costs of sales was 80% compared to 70% for the respective periods ended September 30, 2003 and 2002. Consolidated costs of sales for both the quarterly results and year-to-date results are approximately the same. Operating segment differences from one period to the next resulted largely from differences in product mix and market pricing on specific projects. There are no upward or downward trends on operating costs. Selling, general and administrative (SG&A) expenses for the quarter were 8% less than SG&A expenses for the quarter ended one year before and 5% lower for the comparative six months. The decrease is due to cost savings actions initiated previously. The elimination of postretirement medical benefits in FYE 2003 for all employees and former employees not retired and receiving medical benefits as of April 1, 2003 resulted in a curtailment gain of $522,000. This gain was reported as Other Income in the first quarter of FYE 2004. Other Income for the first quarter of FYE 2003 and for the six months ended September 30, 2003 and 2002 was zero. Interest expense increased from $20,000 for the second three month period in fiscal year 2003 to $21,000 in the current period. For the six months ended September 30, 2003, as compared to 2002, interest expense increased $21,000 or 57%. This increase came in the UK and relates to higher inventories and corresponding higher borrowings. Actions are being taken to reduce inventory in the UK operation. The effective income tax rate for the three and six months ended September 30, 2003 was 30% and 29%, respectively, as compared to 32% and 33% for the prior year respective periods. The lower effective six month rate is due to the anticipated impact of the extra territorial income exclusion benefit from foreign shipments. The net income for the quarter ended September 30, 2003 was $156,000 or $.09 per diluted share. This compared to a net loss of $353,000 or $.21 per share for the three months ended September 30, 2002. For the six months ended, the net loss as of September 30, 2003 was $502,000 or $.31 per diluted share, as compared to a net loss of $809,000 or $.49 per diluted share for the six months ended September 30, 2002. In summary, cost saving actions previously initiated are taking hold. Liquidity and Capital Resources - ------------------------------- Consolidated cash flow from operations was negative $735,000 for the six months ended September 30, 2003, as compared to the six months ended September 30, 2002 when cash flow from operations was positive $3,975,000. The swing is substantially due to reduced cash collection of $10,057,000 in the current period. In the comparative prior six month period, significant project cancellation fees were collected. As indicated in Note 7 to the Consolidated Financial Statements, the Employee Benefits Committee of the Board of Directors terminated postretirement medical benefits for current US employees. At September 30, 2003 a liability remains on the balance sheet, however, 61% of the accrued amount of $2,806,000 does not represent a cash obligation to anyone. This liability will be amortized into income over the next eleven years. The Company has the ability to convert the principal outstanding on its line of credit to a two year term loan. Therefore, outstanding balances on the line of credit are classified as long term debt. The Company utilized the line of credit continuously throughout the first quarter of the fiscal year to fund operations and working capital. This activity is reflected under financing activities in the Consolidated Statements of Cash Flows. The long-term debt to equity ratio remained approximately 1% at September 30 and March 31, 2003. The total liabilities to asset ratio was reduced from 51% at March 31, 2003 to 48% at September 30, 2003 and the current assets to current liabilities ratio improved to 2 to 1 from 1.9 to 1 for the same period. These key ratios are reflective of the continued stability and strength of the Company's financial condition. Management expects that the cash flow from operations, investments, and lines of credit will provide sufficient resources to fund the fiscal year 2004 cash requirements. New Orders and Backlog - ---------------------- Orders for the second quarter were down 30% at $7,854,000 compared to $11,294,000 for the same period last year. Prior to intercompany eliminations, orders in the United States were $4,971,000 compared to $9,912,000 for the same period in fiscal year 2003. Orders in the United Kingdom were $3,004,000 compared to $1,932,000 for the same quarter last year. The increase in orders in the UK reflects one order for $967,000 relating to a Russian offshore oil project. The decrease in orders in the USA is due to delays in order placements on active projects and competitive pricing. Orders for the six months ended September 30, 2003 were $19,087,000 as compared to $19,434,000 for the comparable six month period one year ago. The modest decrease in order entry indicates that weak demand will continue into the immediate future. Backlog of unfilled orders at September 30, 2003 is $23,545,000 compared to $28,002,000 at June 30, 2003 and $31,793,000 at September 30, 2002. Prior to intercompany eliminations, current backlog in the United States of $21,177,000 compares to $27,268,000 at June 30, 2003 and $30,568,000 at September 30, 2002. Current backlog in the United Kingdom of $3,410,000 compares to $2,404,000 at June 30, 2003 and $1,714,000 at September 30, 2002. Included in the USA backlog is $5,144,000 of orders for electric power plant business that have been suspended by the customer. These orders are protected by cancellation fees. The amount of the cancellation fees is based upon a specific formula contained in the contract. The current consolidated backlog, with the exception of about $7,186,000, is scheduled to be shipped during the next twelve months and represents orders from traditional markets in the Company's established product lines. Quantitative and Qualitative Disclosures about Market Risk - ---------------------------------------------------------- The Company is exposed to changes in interest rates, foreign currency exchange rates and equity prices, which may adversely impact its results of operations and financial position. The assumptions applied in preparing quantitative disclosures regarding interest rate, foreign exchange rate and equity price risk are based upon volatility ranges experienced in relevant historical periods, management's current knowledge of the business and market place, and management's judgment of the probability of future volatility based upon the historical trends and economic conditions of the business. The Company is exposed to interest rate risk primarily through its borrowing activities. Risk associated with interest rate fluctuations on debt is managed by holding interest bearing debt to the absolute minimum and carefully assessing the risks and benefits for incurring long-term debt. Based upon variable rate debt outstanding at September 30, 2003 and 2002, a 1% change in interest rates would impact annual interest expense by $16,000 and $11,000, respectively. Over the past three years, Graham's international consolidated sales exposure approximates 36% of annual sales. Operating in world markets involves exposure to movements in currency exchange rates. Currency movements can affect sales in several ways. Foremost is the ability to competitively compete for orders against competition having a relatively weaker currency. Business lost due to this cannot be quantified. Secondly, cash can be adversely impacted by the conversion of sales in foreign currency to local currency. The substantial portion of Graham's sales is collected in the seller's currency. In the second quarters of 2004 and 2003, sales in foreign currencies were 3% and 2%, respectively, of total sales. For the six months ended September 30, 2003 and 2002, sales in foreign currencies were 2% of total sales for both the six month periods ended September 30, 2003 and 2002. At certain times, the Company may enter into forward foreign exchange agreements to hedge its exposure against unfavorable changes in foreign currency values on significant sales contracts negotiated in foreign currencies. Graham historically has had limited exposure to foreign currency purchases. Long term, this trend is expected to continue. During the three month periods ended September 30, 2003 and 2002, purchases in foreign currencies were 13% and 3% of cost of goods sold, respectively and 11% and 4%, respectively, for the six months then ended. In FYE 2004, USA operations has entered a significant dollar volume of orders utilizing UK subsidiary products in conjunction with USA equipment. At certain times, forward foreign exchange contracts may be utilized to limit currency exposure. Foreign operations produced net income (loss) in the second quarter of 2003 and 2002 of $22,000 and $(145,000), respectively, and $(276,000) and $(158,000) for the six month periods ended September 30, 2003 and 2002, respectively. As currency exchange rates change, translations of the income statements of our UK business into US dollars affects year-over-year comparability of operating results. The Company does not hedge translation risks because cash flows from U.K. operations are mostly reinvested in the U.K. A 10% change in foreign exchange rates would have impacted the second quarter results by approximately $2,000 and $14,000 in fiscal years ended 2004 and 2003, respectively, and $28,000 and $16,000 for the six months ended September 30, 2003 and 2002, respectively. The Company has a Long-Term Incentive Plan, which provides for awards of share equivalent units (SEU) for outside directors based upon the Company's performance. The outstanding SEUs are recorded at fair market value thereby exposing the Company to equity price risk. Gains and losses recognized due to market price changes are included in the quarterly results of operations. Based upon the SEUs outstanding at September 30, 2003 and 2002 and the respective quarter end market price per share, a 50% to 75% change in the respective quarter end market price of the Company's common stock would positively or negatively impact the Company's second quarter operating results by $78,000 to $117,000 for FYE 2004 and $69,000 to $103,000 for FYE 2003. Assuming required net income of $500,000 to award SEUs is met and SEUs are granted to the seven outside directors in accordance with the plan over the next five years, based upon the September 30, 2003 market price of the Company's stock of $9.52 per share, a 50% to 75% change in the stock price would positively or negatively impact the Company's operating results by $132,000 to $198,000 in 2005, $150,000 to $225,000 in 2006, $163,000 to $245,000 in 2007, $177,000 to $265,000 in 2008 and $180,000 to $271,000 in 2009. Critical Accounting Policies - ---------------------------- The following discussion addresses the most critical accounting policies, which are those that are most important to the portrayal of the financial condition and results, and that require judgment. Revenue Recognition - ------------------- Percentage-of-Completion - The Company recognizes revenue and all related costs on contracts with a duration in excess of three months and with revenues of $1,000,000 and greater using the percentage-of-completion method. The percentage-of- completion method is determined by relating actual labor incurred to-date to management's estimate of total labor to be incurred on each contract. Contracts in progress are reviewed monthly, and sales and earnings are adjusted in current accounting periods based on revisions in contract value and estimated costs at completion. Completed Contract - Contracts with values less than $1,000,000 are accounted for on the completed contract method. The Company recognizes revenue and all related costs on these contracts upon substantial completion or shipment to the customer. Substantial completion is consistently defined as at least 95% complete with regard to direct labor hours. Customer acceptance is generally required throughout the construction process and the Company has no further obligations under the contract after the revenue is recognized. Use of Estimates - We have made a number of estimates and assumptions relating to the reporting of assets and liabilities, the disclosure of contingent assets and liabilities, and reported amounts of revenue and expenses in preparing our financial statements in conformity with accounting principles generally accepted in the United States of America. Actual results could differ from these estimates. GRAHAM CORPORATION AND SUBSIDIARIES FORM 10-Q SEPTEMBER 30, 2003 PART II - OTHER INFORMATION Item 4. Controls and Procedures a. Disclosure controls and procedures. As of the end of the period covered by this quarterly report, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures. Our disclosure controls and procedures are the controls and other procedures that we designed to ensure that we record, process, summarize and report in a timely manner the information we must disclose in reports that we file with or submit to the SEC. Alvaro Cadena, our Chief Executive Officer, and J. Ronald Hansen, our Chief Financial Officer, reviewed and participated in this evaluation. Based on this evaluation, Messrs. Cadena and Hansen concluded that, as of the date of their evaluation, our disclosure controls were effective. b. Internal controls. Since the date of the evaluation described above, there have not been any significant changes in our internal accounting controls or in other factors that could significantly affect those controls. Item 5. Other Information The Company's chief executive officer and chief financial officer have furnished to the SEC the certification with respect to this Form 10-Q that is required by Section 906 of the Sarbanes-Oxley Act of 2002. Item 6. Exhibits and Reports on Form 8-K. a. See index to exhibits. b. A Form 8-K was filed on July 28, 2003 and included Items 7 and 9. No financial statements were required to be filed as part of the report. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. GRAHAM CORPORATION /s/J. Ronald Hansen --------------------------------------- J. R. Hansen Vice President Finance and Administration / CFO (Principal Accounting Officer) Date 10/28/03 INDEX OF EXHIBITS (2) Plan of acquisition, reorganization, arrangement, liquidation or succession Not applicable. (3)(i) Articles of Incorporation of Graham Corporation (filed as Exhibit 3(b) to the Registrant's annual report on Form 10-K for the year ended December 31, 1989, and incorporated herein by reference.) (3)(ii) By-laws of registrant, as amended (4) Instruments defining the rights of security holders, including indentures (a) Equity securities The instruments defining the rights of the holders of Registrant's equity securities are as follows: Certificate of Incorporation, as amended of Registrant (filed as Exhibit 3(a) to the Registrant's annual report on Form 10-K for the fiscal year ended December 31, 1989, and incorporated herein by reference.) Stockholder Rights Plan of Graham Corporation (filed as Item 5 to Registrant's current report filed on Form 8-K on August 23, 2000 and Registrant's Form 8-A filed on September 15, 2000, and incorporated herein by reference.) (b) Debt securities Not applicable. (10) Material Contracts 1989 Stock Option and Appreciation Rights Plan of Graham Corporation (filed on the Registrant's Proxy Statement for its 1990 Annual Meeting of Stockholders and incorporated herein by reference.) 1995 Graham Corporation Incentive Plan to Increase Shareholder Value (filed on the Registrant's Proxy Statement for its 1996 Annual Meeting of Stockholders and incorporated herein by reference.) 2000 Graham Corporation Incentive Plan to Increase Shareholder Value (filed on the Registrant's Proxy Statement for its 2001 Annual Meeting of Stockholders and incorporated herein by reference.) Index to Exhibits (continued) Graham Corporation Outside Directors' Long-Term Incentive Plan (filed as Exhibit 10.3 to the Registrant's annual report on Form 10-K for the fiscal year ended March 31, 1998, and is incorporated herein by reference.) Employment Contracts between Graham Corporation and Named Executive Officers (filed as Exhibit 10.4 to the Registrant's annual report on Form 10-K for the fiscal year ended March 31, 1998, and is incorporated herein by reference.) Senior Executive Severance Agreements with Named Executive Officers (filed as Exhibit 10.5 to the Registrant's annual report on Form 10-K for the fiscal year ended March 31, 1998, and is incorporated herein by reference.) Long-Term Stock Ownership Plan of Graham Corporation (filed on the Registrant's Proxy Statement for its 2000 Annual Meeting of Stockholders and incorporated herein by reference.) (11) Statement re-computation of per share earnings Computation of per share earnings is included in Note 3 of the Notes to Financial Information. (15) Letter re-unaudited interim financial information Not applicable. (18) Letter re-change in accounting principles Not Applicable. (19) Report furnished to security holders None. (22) Published report regarding matters submitted to vote of security holders Index to Exhibits (continued) The 2003 Annual Meeting of Stockholders of Graham Corporation was held on July 22. The individuals named below were reelected to serve on the Company's Board of Directors:
Votes For Votes Withheld Helen H. Berkeley 1,518,168 13,524 Alvaro Cadena 1,504,471 27,221
Jerald D. Bidlack, William C. Denninger, Philip S. Hill, H. Russel Lemcke, James J. Malvaso and Cornelius S. Van Rees all continue as directors of the Company. The appointment of Deloitte & Touche LLP as independent auditors was ratified, with 1,523,070 shares voting for, 3,806 shares voting against, and 4,816 shares abstaining. (23) Consents of experts and counsel Not applicable. (24) Power of Attorney Not applicable. (31) Rule 13a-14(a)/15d-14a Certifications (32) Section 1350 Certifications (99) Additional exhibits None.