UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

Form 10-K

 

ANNUAL REPORT

PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

Commission file number 1-8462

 

GRAHAM CORPORATION

(Exact name of registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code 585-343-2216

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act:

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o     No þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ

 

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 þ     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  þ

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer o     Accelerated filer o     Non-accelerated filer þ

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o     No þ

 

The aggregate market value of the voting stock held by non-affiliates of the Registrant as of September 30, 2006, the last business day of the Company’s most recently completed second fiscal quarter, was $7,709,064. The market value calculation was determined using the closing price of the Registrant’s Common Stock on September 30, 2006, as reported on the American Stock Exchange. For purposes of the foregoing calculation only, all directors, officers and the Employee Stock Ownership Plan of the registrant have been deemed affiliates.

 

As of June 1, 2007, there were outstanding 3,892,390 shares of common stock, $.10 par value, and 3,892,390 common stock purchase rights.

 

Documents Incorporated By Reference

 

Portions of the registrant’s definitive Proxy Statement, to be filed in connection with the registrant’s 2007 Annual Meeting of Stockholders, is incorporated by reference into Part III, Items 10, 11, 12, 13 and 14 of this filing.

 

 

Table of Contents

GRAHAM CORPORATION
Annual Report on Form 10-K
Year Ended March 31, 2007

 

 

 

PART I

 

(Dollar amounts in thousands except per share data).

 

Graham Corporation (“Graham,” the “Company,” “we,” “us” or “our”) designs, manufactures and sells custom-built vacuum and heat transfer equipment to customers worldwide. Our products include steam jet ejector vacuum systems, surface condensers for steam turbines, vacuum pumps and compressors, various types of heat exchangers, including helical coil heat exchangers marketed under the Heliflow^® name, and plate and frame exchangers. Our products produce a vacuum, condense steam or transfer heat, or perform a combination of these tasks. Our products are available in a variety of metals and non-metallic corrosion resistant materials.

 

Our products are used in a wide range of industrial process applications, including:

 

 

We were incorporated in Delaware in 1983 and are the successor to Graham Manufacturing Co., Inc., which was incorporated in 1936. Our principal business location is in Batavia, New York. We also maintain two wholly-owned subsidiaries, Graham Europe Limited in the United Kingdom and, as of May 2006, Graham Vacuum and Heat Transfer Technology (Suzhou) Co., Ltd. in Suzhou, China. As of March 31, 2007, we had 265 full-time employees, inclusive of employees of our United Kingdom and China subsidiaries.

 

Our Fiscal 2007 Highlights

 

Highlights for our year ended March 31, 2007, which we refer to as fiscal 2007, include:

 

 

 

We believe the principal market drivers that have led to increased capital spending by our customers and that are contributing to our sales growth include:

 

 

Our Customers and Markets

 

Our principal customers include large chemical, petrochemical, petroleum refining and power generating industries, which are end users of our products in their manufacturing, refining and power generation processes, large engineering companies that build installations for such companies, and original equipment manufacturers, who combine our products into their equipment prior to its sale to end users.

 

Our products are sold using a combination of sales engineers we employ directly, as well as independent sales representatives located worldwide. No part of our business is dependent on a single customer or a few customers, the loss of which would seriously harm our business, or on contracts or subcontracts that are subject to renegotiation or termination by a governmental agency.

 

A substantial portion of our revenue is generated from foreign sales, and we believe that revenue from the sale of our products outside the United States will continue to account for a material portion of our total revenue for the foreseeable future. We have invested significant resources in developing and maintaining our international sales operations and presence, and we intend to continue to make such investments in the future. As a result of the expansion of our presence in Asia, we expect that in future years Asia will account for a greater percentage of our revenue.

 

A breakdown of our net sales from continuing operations by geographic area for fiscal 2007, fiscal 2006 and our fiscal year end March 31, 2005, which we refer to as fiscal 2005, is contained in Note 15 to our consolidated financial statements on page 45 to this Annual Report on Form 10-K. In fiscal 2007 and fiscal 2006, total sales to one customer amounted to 12% and 11%, respectively, of total net sales for the year. We presently have no plans to enter any new industry segments that would require the investment of a material amount of our assets or that we would otherwise consider to be material.

 

Our Strengths

 

Our core strengths are as follows:

 

 

 

Our Strategy

 

We intend to grow our business and improve our results of operations by implementing the following core strategies:

 

 

Competition

 

Our business is highly competitive and a number of companies having greater financial resources are engaged in the manufacture of products similar to ours and provide services similar to those that we provide. The principal basis on which we compete include technology, price, performance, reputation, delivery, and quality.

 

Intellectual Property

 

Our success depends in part on our proprietary technology. We rely on a combination of patent, copyright, trademark, trade secret laws and confidentiality provisions to establish and protect our proprietary rights. We also depend heavily on the brand recognition of the Graham name in the marketplace.

Availability of Raw Materials

 

Although shortages of certain materials can from time to time affect our ability to meet delivery requirements for certain orders, historically, we have not been materially adversely impacted by the availability of raw materials.

 

Working Capital Practices

 

Our business does not require us to carry significant amounts of inventory or materials beyond what is needed for work in progress. We do not provide rights to return goods, or payment terms to customers that we consider to be extended in the context of the industries we serve.

 

Environmental Matters

 

We do not anticipate that our compliance with federal, state and local laws regulating the discharge of material in the environment or otherwise pertaining to the protection of the environment will have a material effect upon our capital expenditures, earnings or competitive position.

 

Seasonality

 

No material part of our business is seasonal in nature.

 

Research Activities

 

During fiscal 2007, fiscal 2006 and fiscal 2005, we spent approximately $3,580, $3,136 and $2,749, respectively, on research and development activities relating to the development of new products and services, or the improvement of existing products and services.

 

Information Regarding Our International Sales

 

The revenue from the sale of our products outside the United Sates has accounted for a material portion of our total revenue during our last three fiscal years. Approximately 50%, 49% and 40% of our revenues in fiscal 2007, 2006 and 2005, respectively, resulted from revenues from foreign sales. Revenues attributed to sales in Asia constituted approximately 17%, 16% and 15% of our revenues in fiscal 2007, 2006 and 2005, respectively. Revenues attributed to sales in the Middle East constituted approximately 23%, 14% and 4% of our revenues in fiscal 2007, 2006 and 2005, respectively.

 

Our international sales operations, including those in Asia and in other foreign countries, are subject to numerous risks. See “Risk Factors” in this annual report on Form 10-K for more information.

 

Former U.K. Operations

 

We previously had an additional subsidiary located in the United Kingdom that manufactured vacuum equipment. In March 2005, our Board of Directors approved a plan to discontinue the operations of this subsidiary and such subsidiary’s principal creditor appointed a receiver to liquidate its assets. In May 2005, the assets of this subsidiary were sold. As a result of this divestiture, the operations of our former United Kingdom subsidiary are presented as a discontinued operation in our consolidated financial statements for our year ended March 31, 2005 included in this Annual Report on Form 10-K.

 

Our business and operations are subject to numerous risks, many of which are described below and elsewhere in this Annual Report on Form 10-K. If any of the events described below occur, our business and results of operations could be harmed.

Risks related to our business

 

The industries in which we operate are cyclical, and downturns in such industries may adversely affect our operating results.

 

Historically, a substantial portion of our revenue has been derived from sales of our products to companies in the chemical, petrochemical, petroleum refining and power generating industries, or to firms that design and construct facilities for these industries. The core industries in which our products are used are, to varying degrees, cyclical and have historically experienced severe downturns. Although we are currently in an upturn of demand for our products in the petrochemical, petroleum refining and power generating industries, a downturn in one or more of these industries could occur at any time. In the event of such a downturn, we have no way of knowing if, when and to what extent there might be a recovery. A deterioration in any of the cyclical industries we serve would harm our business and operating results because our customers would not likely have the resources necessary to purchase our products nor would they likely have the need to build additional facilities or improve existing facilities.

 

Our international sales operations are subject to uncertainties that could harm our business.

 

We believe that revenue from the sale of our products outside the United States will continue to account for a material portion of our total revenue for the foreseeable future. For fiscal 2007, our sales to geographic regions were as follows: 50% — United States; 23% — Middle East; 17% — Asia; 4% — Canada; 2% — Mexico and South America; and 4% — various other regions. Our international sales operations are subject to numerous risks, including:

 

 

The occurrence of any one of the above risks could harm our business and results of operations. In addition, we are exposed to the risk of currency fluctuations between the U.S. dollar and the currencies of the countries in which we sell our products to the extent that such sales are not based on U.S. dollars, as we compete for orders against foreign competitors that base their prices on relatively weaker currencies. As such, fluctuations in currency exchange rates, which cause the value of the U.S. dollar to increase, could have an adverse effect on the profitability of our business. While we may enter into currency exchange rate hedges from time to time to mitigate these types of fluctuations, we cannot remove all fluctuations or hedge all exposures and our earnings are impacted by changes in currency exchange rates. At March 31, 2007 and 2006, we held no forward foreign currency exchange contracts.

 

If we fail to introduce enhancements to our existing products or to keep abreast of technological changes in our markets, our business and results of operations could be adversely affected.

 

Although technologies in the vacuum and heat transfer areas are well established, we believe our future success depends in part on our ability to enhance our existing products and develop new products in order to continue to meet customer demands. Our failure to introduce new or enhanced products on a timely and cost-competitive basis, or the development of processes that make our existing technologies or products obsolete, could harm our business and results of operations.

The loss of any of our senior executive officers or our inability to hire additional qualified management personnel could harm our business.

 

We are dependent to a large degree on the services of James R. Lines, our president and chief operating officer and J. Ronald Hansen, our vice president of finance and administration and chief financial officer. Our operations may suffer if we were to lose the services of either of our senior executive officers. We maintain key person insurance only on Mr. Lines.

 

In addition, competition for qualified management in our industry is intense. Many of the companies with which we compete for management personnel have greater financial and other resources than we do or are located in geographic areas which may be considered by some to be more desirable places to live. If we are not able to retain qualified management personnel or if a significant number of them were to leave our employ, our business could be harmed.

 

Our business is highly competitive. If we are unable to successfully implement our business strategy, we risk losing market share to current and future competitors.

 

Some of our present and potential competitors have or may have substantially greater financial, marketing, technical or manufacturing resources. Our competitors may also be able to respond more quickly to new technologies or processes and changes in customer demands. They may also be able to devote greater resources to the development, promotion and sale of their products than we can. In addition, our current and potential competitors may make strategic acquisitions or establish cooperative relationships among themselves or with third parties that increase their ability to address the needs of our existing customers. If we cannot compete successfully against current or future competitors, our business will be harmed.

 

If we are unable to make necessary capital investments or respond to pricing pressures, our business may be harmed.

 

In order to remain competitive, we need to invest continuously in research and development, manufacturing, customer service and support, and marketing. From time to time we also have to adjust the prices of our products to remain competitive. We may not have available sufficient financial or other resources to continue to make investments necessary to maintain our competitive position.

 

If third parties infringe our intellectual property or if we were to infringe the intellectual property of third parties, we may expend significant resources enforcing or defending our rights or suffer competitive injury.

 

Our success depends in part on our proprietary technology. We rely on a combination of patent, copyright, trademark, trade secret laws and confidentiality provisions to establish and protect our proprietary rights. If we fail to successfully enforce our intellectual property rights, our competitive position could suffer. We may also be required to spend significant resources to monitor and police our intellectual property rights. Similarly, if we were to infringe on the intellectual property rights of others, our competitive position could suffer. Furthermore, other companies may develop technologies that are similar or superior to our technologies, duplicate or reverse engineer our technologies or design around our patents.

 

In some instances, litigation may be necessary to enforce our intellectual property rights and protect our proprietary information, or to defend against claims by third parties that our products infringe their intellectual property rights. Any litigation or claims brought by or against us, whether with or without merit, could result in substantial costs to us and divert the attention of our management, which could harm our business and results of operations. In addition, any intellectual property litigation or claims against us could result in the loss or compromise of our intellectual property and proprietary rights, subject us to significant liabilities, require us to seek licenses on unfavorable terms, prevent us from manufacturing or selling certain products or require us to redesign certain products, any of which could harm our business and results of operations.

A decrease in supply or increase in cost of the materials used in our products could harm our profitability.

 

Any restrictions on the supply or the increase in the cost of the materials used by us in manufacturing our products could significantly reduce our profit margins. Efforts to mitigate restrictions on the supply or price increases of materials by entering into long-term purchase agreements, by implementing productivity improvements or by passing cost increases on to our customers may not be successful. Our profitability depends largely on the price and continuity of supply of the materials used in the manufacture of our products, which in many instances are supplied by a limited number of sources.

 

If we are unable to effectively outsource a portion of our production during times when we are experiencing strong demand, our results of operations might be adversely affected. In addition, outsourcing may negatively affect our profit margins.

 

Part of our business strategy calls for us to increase manufacturing capacity through outsourcing selected fabrication when we are experiencing strong demand for our products. We could experience difficulty in outsourcing if customers demand that our products be manufactured by us exclusively. Furthermore, our ability to effectively outsource production could be adversely affected by limited worldwide manufacturing capacity. If we are unable to effectively outsource our production capacity when circumstances warrant, our results of operations could be adversely affected and we might not be able to deliver products to our customers on a timely basis. In addition, outsourcing to complete our products and services can increase the costs associated with such products and services. If we rely too heavily on outsourcing and are not able to increase our own production capacity during times when there is high demand for our products and services, our gross margins may be negatively effected.

 

We face potential liability from asbestos exposure and similar claims.

 

We are a defendant in several lawsuits alleging illnesses from exposure to asbestos or asbestos-containing products and seeking unspecified compensatory and punitive damages. We cannot predict with certainty the outcome of these lawsuits or whether we could become subject to any similar, related or additional lawsuits in the future. In addition, because some of our products are used in systems that handle toxic or hazardous substances, any failure or alleged failure of our products in the future could result in litigation against us. Any litigation brought against us, whether with or without merit, could result in substantial costs to us as well as divert the attention of our management, which could harm our business and results of operations.

 

Risks related to operating a subsidiary in China

 

The operations of our Chinese subsidiary may be adversely affected by China’s evolving economic, political and social conditions.

 

The results of operations and future prospects of our Chinese subsidiary are subject to evolving economic, political and social developments in China. In particular, the results of operations of our Chinese subsidiary may be adversely affected by, among other things, changes in China’s political, economic and social conditions, changes in policies of the Chinese government, changes in laws and regulations or in the interpretation of existing laws and regulations, changes in foreign exchange regulations, measures that may be introduced to control inflation, such as interest rate increases, and changes in the rates or methods of taxation.

 

It may be difficult for our Chinese subsidiary to make dividend or other payments to us, which could adversely affect our results of operations.

 

Our ability to receive dividends and payments from, and transfer funds to, our Chinese subsidiary could be subject to restrictions under Chinese laws. Any such restrictions could negatively affect our results of operations and restrict our ability to act quickly in response to changing market conditions.

Intellectual property rights are difficult to enforce in China.

 

Chinese commercial law is relatively undeveloped compared to the commercial law in many of our other major markets and limited protection of intellectual property is available in China as a practical matter. Although we intend to take precautions in the operations of our Chinese subsidiary to protect our intellectual property, any local design or manufacture of products that we undertake in China could subject us to an increased risk that unauthorized parties will be able to copy or otherwise obtain or use our intellectual property, which could harm our business. We may also have limited legal recourse in the event we encounter patent or trademark infringers.

 

Uncertainties with respect to the Chinese legal system may adversely affect the operations of our Chinese subsidiary.

 

We conduct our business in China primarily through our wholly-owned Chinese subsidiary. Our Chinese subsidiary is subject to laws and regulations applicable to foreign investment in China. There are uncertainties regarding the interpretation and enforcement of laws, rules and policies in China. The Chinese legal system is based on written statutes, and prior court decisions have limited precedential value. Because many laws and regulations are relatively new and the Chinese legal system is still evolving, the interpretations of many laws, regulations and rules are not always uniform. Moreover, the relative inexperience of China’s judiciary in many cases creates additional uncertainty as to the outcome of any litigation, and the interpretation of statutes and regulations may be subject to government policies reflecting domestic political changes. Finally, enforcement of existing laws or contracts based on existing law may be uncertain and sporadic. For the preceding reasons, it may be difficult for us to obtain swift and equitable enforcement of laws ostensibly designed to protect companies like ours.

 

Risks related to the ownership of our common stock

 

Provisions contained in our certificate of incorporation, bylaws and our stockholder rights plan could impair or delay stockholders’ ability to change our management and could discourage takeover transactions that our stockholders might consider to be in their best interests.

 

Provisions of our certificate of incorporation and bylaws, as well as our stockholder rights plan, could impede attempts by our stockholders to remove or replace our management and could discourage others from initiating a potential merger, takeover or other change of control transaction, including a potential transaction at a premium over the market price of our common stock, that our stockholders might consider to be in their best interests. For example:

 

 

 

Our stock price may be volatile because of factors beyond our control.

 

The market price of our common stock may fluctuate significantly in response to a number of factors, many of which are beyond our control, including:

 

 

In the past, companies that have experienced volatility in the market price of their stock have been subject to securities class action litigation. A securities class action lawsuit against us, regardless of its merit, could result in substantial costs to us and divert the attention of our management, which in turn could harm our business and results of operations.

 

Not applicable.

 

Our corporate headquarters is located at 20 Florence Avenue, Batavia, New York, consisting of a 45,000 square foot building. Our manufacturing facilities are also located in Batavia, consisting of approximately thirty-three acres and containing about 216,000 square feet in several connected buildings, including 162,000 square feet in manufacturing facilities, 48,000 square feet for warehousing and a 6,000 square-foot building for product research and development.

Additionally, we lease a U.S. sales office in Houston and our Asian subsidiary leases a sales and engineering office in Suzhou, China.

 

We believe that our properties are generally in good condition, are well maintained, and are suitable and adequate to carry on our business.

 

This information required by this Item 3 is set forth in Note 16 to the Consolidated Financial Statements on page 46 of the Annual Report on Form 10-K and is incorporated herein by reference.

 

No matters were submitted to our security holders for a vote during the fourth quarter of the fiscal year covered by this Annual Report on Form 10-K.

 

PART II

 

(Dollar amounts in thousands, except per share data)

 

Our common stock is traded on the American Stock Exchange under the symbol “GHM”. As of June 1, 2007, there were 3,892,390 shares of our common stock outstanding that were held by 179 stockholders of record.

 

The following table shows the high and low per share prices of our common stock for the periods indicated, as reported by the American Stock Exchange. The table takes into account the effect of our two-for-one stock split in the nature of a dividend, which became effective October 3, 2005.

 

 

Subject to the rights of any preferred stock we may then have outstanding, the holders of our common stock are entitled to receive dividends as may be declared from time to time by our Board of Directors out of funds legally available for the payment of dividends. We have declared cash dividends of $.025 per share on our common stock quarterly since July 25, 2002. There can be no assurance that we will pay cash dividends in any future period or that the level of cash dividends paid by us will remain constant.

 

The senior credit facility to which we are a party contains provisions pertaining to the maintenance of minimum working capital balances, tangible net worth and financial ratios as well as restrictions on the payment of dividends to stockholders and incurrence of additional long-term debt. The facility also limits the payment of dividends to stockholders to $600 per year.

 

Our ability to receive dividends and payments from, and transfer funds to, our Chinese subsidiary could be subject to restrictions. Any such restrictions could negatively affect our results of operations and restrict our ability to act quickly in response to changing market conditions.

We did not sell equity securities that were not registered during the period covered by this Annual Report on Form 10-K.

 

 

(Dollar amounts in thousands, except per share data)

 

Overview

 

Our corporate offices and production facilities are located in Batavia, New York. We have two wholly-owned foreign subsidiaries, one located in the United Kingdom and the other in China. Our current fiscal year, which we refer to as fiscal 2007, began on April 1, 2006 and ended on March 31, 2007.

 

We are a designer, manufacturer and worldwide supplier of ejectors, liquid ring pumps, condensers and heat exchangers. The principal markets for our equipment are the petrochemical, oil refinery and electric power generation industries, including cogeneration and geothermal plants. Our equipment can also be found in diverse applications such as metal refining, pulp and paper processing, shipbuilding, water heating, refrigeration, desalination, food processing, pharmaceuticals, heating, ventilating and air conditioning.

 

Highlights for fiscal 2007 include:

 

 

 

We believe the principal market drivers that have led to increased capital spending by our customers and that are contributing to our sales growth include:

 

 

Forward-Looking Statements

 

This report and other documents we file with the Securities and Exchange Commission include “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.

 

These statements involve known and unknown risks, uncertainties and other factors that may cause actual results to be materially different from any future results implied by the forward-looking statements. Such factors include, but are not limited to, the risks and uncertainties identified by us under the heading “Risk Factors” in Item 1A of this Annual Report on Form 10-K. Forward-looking statements may also include, but are not limited to, statements about:

 

 

 

Forward-looking statements are usually accompanied by words such as “anticipate,” “believe,” “estimate,” “may,” “intend,” “expect” and similar expressions. Actual results could differ materially from historical results or those implied by the forward-looking statements contained in this report.

 

Undue reliance should not be placed on these forward-looking statements. Except as required by law, we undertake no obligation to update or announce any revisions to forward-looking statements contained in this report, whether as a result of new information, future events or otherwise.

 

Critical Accounting Policies, Estimates and Judgments

 

The discussion and analysis of our financial condition and results of operations are based upon the consolidated financial statements and the notes to consolidated financial statements included in this Annual Report on Form 10-K, which have been prepared in accordance with accounting principles generally accepted in the United States.

 

Critical accounting policies are defined as those that reflect significant judgments and uncertainties, and could potentially result in materially different results under different assumptions and conditions.

 

Revenue Recognition.  We recognize revenue on all contracts with a planned manufacturing process in excess of four weeks (which approximates 575 direct labor hours) using the percentage-of-completion method. The percentage-of-completion method is determined by comparing actual labor incurred to a specific date to our estimate of the 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 the contract value and estimated material and labor costs at completion. Losses on contracts are recognized immediately when known.

 

Revenue on contracts not accounted for using the percentage-of-completion method is recognized utilizing the completed contract method. The majority of the contracts we enter into have a planned manufacturing process of less than four weeks and the results reported under this method does not vary materially from the percentage-of-completion method. We recognize revenue and all related costs on the completed contract method upon substantial completion or shipment of products to the customer. Substantial completion is consistently defined as at least 95% complete with regard to direct labor hours. Customer acceptance is required throughout the construction process and we have no further material obligations under the contract after the revenue is recognized. The key estimate of percentage-of-completion accounting is total labor to be incurred on each contract and to the extent that this estimate changes, it may significantly impact revenue recognized in each period.

 

Pension and Postretirement Benefits.  Defined benefit pension and other postretirement benefit costs and obligations are dependent on actuarial assumptions used in calculating such amounts. These assumptions are reviewed annually and include the discount rate, long-term expected rate of return on plan assets, salary growth, healthcare cost trend rate and other economic and demographic factors. We base the discount rate assumption for our plans on Moody’s or Citigroup Pension Liability Index AA-rated corporate long-term bond yield rate. The long-term expected rate of return on plan assets is based on the plan’s asset allocation, historical returns and expectations as to future returns that are expected to be realized over the estimated remaining life of the plan liabilities that will be funded with the plan assets. The salary growth assumptions are determined based on long-term actual experience and future and near-term outlook. The healthcare cost trend rate assumptions are based on historical cost and payment data, the near-term outlook, and an assessment of the likely long-term trends.

 

Income Taxes.  Deferred income tax assets and liabilities for the expected future tax consequences of events have been recognized in our financial statements or tax returns.

 

Deferred income tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using current tax rates. We evaluate available information about future taxable income and other possible sources of realization of deferred income tax assets and record valuation allowances to reduce deferred income tax assets to an amount that represents our best estimates of the amounts of

such deferred income tax assets that more likely than not will be realized. At March 31, 2007 and 2006, no valuation allowance was recorded.

 

Results of Operations

 

For an understanding of the significant factors that influenced our performance, the following discussion should be read in conjunction with our consolidated financial statements and the notes to consolidated financial statements included in this Annual Report on Form 10-K.

 

The following table summarizes our results of operations for the periods indicated:

 

 

Fiscal 2007 Compared with Fiscal 2006

 

Sales for fiscal 2007 were $65,822, a 19% increase, as compared with $55,208 for fiscal 2006. Fifty-two percent of this increase came from greater export sales. The growth in export sales primarily came from the Middle East and Asia and involved both petrochemical and refinery projects. Sales in all product categories (e.g., heat exchangers, ejectors, condensers, vacuum pumps and aftermarket) increased compared with fiscal 2006, but the greatest dollar value increases came from sales of ejectors, heat exchangers and vacuum pumps.

 

Our heat exchanger products are: Heliflows, plate exchangers, desuperheaters and water heaters. Increased heat exchanger sales accounted for 31% of the increased sales. Heat exchanger sales were led upward by Heliflows and plate exchanger sales. Heat exchanger sales grew due to a broad based strategic effort, which included training, changing the supplier who provided the basic materials used to build plate exchangers, manufacturing efficiencies gained through the implementation of lean procedures, the introduction of software marketing tools and the addition of an expanded agency network. Increased ejector sales accounted for 26% of the increased sales and were due to the increased activity we continue to see from the refinery industry for oil refinery upgrades and capacity expansion projects. Increased vacuum pump sales accounted for 28% of the increased sales and came from domestic refinery applications. The remaining 15% increase in sales, compared with fiscal 2006, came from single digit gains in the other products we sell. We believe the demand for our products, and especially those applicable to the refinery sector, will continue to be strong at least through our fiscal year ending March 31, 2008, which we refer to as fiscal 2008. For additional information, see “Orders and Backlog” below.

 

Our gross profit percentage (i.e., sales, less costs of sales, divided by sales) for fiscal 2007 was 26% compared with 29% for fiscal 2006. Gross profit percentage decreased primarily due to greater material costs in fiscal 2007. Material costs, expressed as a percent of sales, were 43% and 37% for fiscal years 2007 and 2006, respectively. Gross profit dollars increased 5% compared with fiscal 2006, as a result of greater sales volume. Although we project continued pressure on gross margins because of increasing labor and benefit costs and our longer term strategic decision to expand into new geographic markets, we believe gross profit margin percentages will increase in fiscal 2008 compared with fiscal 2007. We believe such increase will occur because we have been able to be more selective on orders we accept and realized benefits from productivity gains in manufacturing that expanded engineering and manufacturing capacity.

 

Selling, general and administrative (SG&A) expenses for fiscal 2007 were 16% of sales compared to 18% for fiscal 2006. The decline, expressed as a percentage of sales, was due to greater sales in the current fiscal year. Actual costs increased $520 or 5% compared with fiscal 2006. SG&A expense increased due to the additional costs of our Company in China.

 

Interest expense was $10 for fiscal 2007 compared with $17 for fiscal 2006. Interest expense decreased due to reduced debt and a reduction in the applicable interest rate under our banking facility on a year over year basis.

Other expense for fiscal 2007 was $100 compared with $371 for fiscal 2006. Other expense for the current year represented a $100 provision made to cover the possible costs of an asbestos litigation suit currently in progress. We estimate the range of the possible expense, including legal costs, to be $25 to $375. Other expense for fiscal 2006 was incurred in conjunction with the settlement of litigation whereby we sued a foreign pump competitor that had adopted the name “Graham.” Pursuant to the settlement agreement, such competitor agreed to discontinue using our name by the fall of 2006 in exchange for certain inventory items with a recorded amount plus packaging costs of $252. We incurred $119 in legal costs pertaining to this settlement.

 

Other income for fiscal 2007 was $148 compared with $0 for fiscal 2006. Royalty income of $148 was earned under a license agreement we entered into in October 2005 that allows the licensee to use, market and sell specific products we manufacture. Future royalty income earned by us under this agreement will depend upon the sale of licensed products by the licensee.

 

In fiscal 2007, our effective tax rate was 12% compared with an effective tax rate of 38% for fiscal 2006. The fiscal 2006 rate approximated the statutory rate. The fiscal 2007 effective tax rate reflects the benefit of $1,607 in research and development (“R&D”) credits. The total credit recognized this fiscal 2007 represents qualifying expenditures for the fiscal years 1999 to 2007. Remaining federal loss carryforwards, significantly reduced to eliminate current federal taxes in fiscal 2007 and 2006, are projected to be fully utilized in fiscal 2008. Tax planning strategies leading to R&D credits recognized in the current year will be used to reduce current federal taxes payable in fiscal 2008 and after. Provided the R&D tax credit is extended by Congress beyond the current year and under the current formula, we expect the R&D credit for engineering applications in those years to be in the range of $150 to $250 per annum.

 

Net income for fiscal 2007 and 2006 was $5,761 and $3,586, respectively. Income per diluted share was $1.46, including $0.35 for non-recurring research and development tax credits, and $0.96 for the respective periods.

 

Fiscal 2006 Compared with Fiscal 2005

 

Sales for fiscal 2006 were $55,208, a 34% increase, as compared with $41,333 for fiscal 2005. Sixty-seven percent of the growth in sales came from greater export sales. Fifty-six percent of the increase in export sales came from sales to the Middle East and were mostly for petrochemical projects. Increased sales to Canada, for refinery and “oil-sands” projects (i.e., projects involving a process whereby tar-like sludgy heavy oil is extracted from sand), Asia, for petrochemical projects, and Mexico, for refinery applications, account for the remainder of the growth in export sales. By product, condenser sales for fiscal 2006 increased 84% over fiscal 2005 and ejector sales increased 48%. Increased sales of condenser products were mostly a result of capacity expansion projects in the petrochemical market. Increased ejector sales were primarily a result of oil refinery upgrades and expansion activities. The latter activity was largely due to the growing utilization of lower quality “sour” crude oil (instead of higher quality “sweet” crude oil) as the core raw material for refinery processes, as well as compliance with environmental regulations in numerous countries related to clean fuels and capacity additions. Increases in capacity in the petrochemical sector were being driven by greater worldwide demand for, and consumption of, oil and natural gas by-products.

 

Gross profit percentage for fiscal 2006 was 29% compared with 18% for fiscal 2005. Gross profit dollars increased $8,419 compared with fiscal 2005. The improvement in gross profit margin in fiscal 2006 was due to greater sales volume and selling price increases.

 

SG&A expenses were 18% of sales for fiscal 2006, as compared with 19% for fiscal 2005. Actual expenses for fiscal 2006 increased 28% or $2,127 compared with fiscal 2005, primarily as a result of increased travel for sales activities, variable compensation expense, the addition of sales personnel in Europe and China to support long-term sales growth opportunities and consulting costs for employee training and costs related to compliance with the Sarbanes-Oxley Act of 2002.

 

Interest expense was $17 for fiscal 2006 and $33 for fiscal year 2005. Interest expense decreased due to reduced bank borrowings.

 

Other expense for fiscal 2006 was $371. This expense was incurred in conjunction with the settlement of litigation whereby we sued a foreign pump competitor that had adopted the name “Graham.” Pursuant to the

settlement agreement, the competitor agreed to discontinue using our name by the fall of 2006 in exchange for certain inventory items with a recorded amount plus packaging costs of $252. We incurred $119 in legal costs pertaining to this settlement. Other expense in fiscal 2005 of $1,049 related to transitioning two senior executives. Under the terms of an agreement reached with our former president and chief executive officer, he was retained by us as an independent consultant through November 8, 2008 for an estimated cost, including retainer and certain benefits, of $562. Another senior executive was transitioned in January 2005. The term of the agreement reached with this former executive included salary continuation for twelve months and certain medical benefits for thirty-six months, for an estimated cost of $157. Costs accrued as of March 31, 2005 to recruit and relocate executive replacements for such transitioned senior executives resulted in $251 of expense.

 

There was no other income for fiscal 2006. Other income of $1,592 for fiscal 2005 resulted from a settlement of a contract dispute over cancellation charges. The settlement of this matter ended a complaint we filed in April 2004 in the United States District Court for the Northern District of California alleging breach of contract by a customer and a counterclaim filed by the customer seeking specific performance of the contract or monetary damages.

 

The effective income tax rate for fiscal 2006 was 38%, as compared with 18% for fiscal 2005. Fiscal year 2006’s rate approximated the statutory rate. The effective rate for fiscal 2005 was due to an exclusion of income on export sales, permitted under U.S. tax law.

 

Income from both continuing operations and net income for fiscal 2006 was $3,586 or $0.96 per diluted share. Income from continuing operations for fiscal 2005 was $296, or $0.09 per diluted share. Loss from discontinued operations and loss per diluted share was $3,202 and $0.93, respectively, for fiscal 2005. Net loss and loss per diluted share for fiscal 2005 was $2,906 and $0.85, respectively.

 

Stockholders’ Equity

 

The following discussion should be read in conjunction with our consolidated statements of changes in stockholders’ equity:

 

 

Fiscal 2007 Compared with Fiscal 2006

 

Stockholders’ equity increased $3,547 or 13% for fiscal 2007 compared with fiscal 2006. In September 2006, the Financial Accounting Standards Board issued SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans. This pronouncement required, as of March 31, 2007, that we measure the prepaid assets and liabilities appearing on our balance sheet pertaining to our defined benefit postretirement plans under the projected benefit obligation method and adjust asset and/or liability valuation changes through accumulated other comprehensive loss, which is a component of stockholders’ equity. The net effect of this accounting change was a reduction in stockholders’ equity of $2,373. Offsetting this reduction was net income for fiscal 2007 of $5,761. These two items accounted for 96% of the change in Stockholders’ equity in fiscal 2007 compared with fiscal 2006. As of March 31, 2007, our net book value per share increased to $7.89, up 11.6% from March 31, 2006.

 

Fiscal 2006 Compared with Fiscal 2005

 

Net of dividends, stockholders’ equity increased $10,529 or 64% in fiscal 2006 compared with fiscal 2005. Thirty-four percent of this increase was due to net income, 32% was due to the sale of treasury stock, 20% was due to the issuance of common stock for stock options exercised and 16% was due to reversing a minimum pension liability, which resulted from additional funding of our defined benefit pension plan. Dividends returned 3% of this increase to our stockholders. Our net book value per share increased 45% to $7.07 compared with $4.88 at March 31, 2005.

Liquidity and Capital Resources

 

The following discussion should be read in conjunction with our consolidated statements of cash flows:

 

 

 

 

As of March 31, 2007, contractual and commercial obligations for the next five fiscal years ending March 31 and thereafter are as follows:

 

 

 

 

Fiscal 2007 Compared with Fiscal 2006

 

Net cash provided by operating activities for fiscal 2007 was $5,193 compared with $6,533 for fiscal 2006. Cash generated from elements of the income statement in fiscal 2007 (e.g., net income plus depreciation, deferred income tax provision and other non-cash income statement cash flow items) increased $509 compared with fiscal 2006. From March 2005, operating working capital (i.e., current assets less cash, investments and current liabilities) was reduced 40% and 32% at March 2007 and March 2006, respectively, as a result of continuous improvements lowering our cash conversion cycle. Average operating working capital, expressed as a percent of sales, for fiscal 2007 and 2006 was 8.2% and 12.9%, respectively. Reducing operating working capital in fiscal 2007 generated cash flow of $723 compared with $2,696 for fiscal 2006. This comparative decrease resulted in the decrease in cash from

operations for the current year. The smaller decrease in operating working capital in fiscal 2007 primarily pertained to accounts receivable balances at March 31, 2007, 2006 and 2005 of $11,859, $5,978 and $10,026, respectively. These wide differences in accounts receivable balances on the year end dates reflected the progress billing stages of contracts at these particular points in time and not the continuous improvement in faster cash collection time, which from March 2005 has been reduced at March 2007 and March 2006 by 42% and 37%, respectively. Customer deposits (e.g., advance payments in excess of customer’s inventory in progress) increased $4,547 at March 31, 2007 compared with March 31, 2006 and $258 for fiscal 2006 compared with fiscal 2005 due to our ability to accelerate progress payment billings. See “Inventories” under Note 1 to Consolidated Financial Statements on page 28 for additional information on contracts in progress at March 31, 2007 compared with March 31, 2006.

 

We invest net cash generated from operations in excess of cash held for near-term needs in marketable securities. Investments are U.S. government instruments, generally with maturity periods of 91 to 120 days. Investments at March 31, 2007 of $13,676 compared with investments at March 31, 2006 increased 31%. Investments at March 31, 2006 and 2005 were $10,418 and $1,993, respectively.

 

Other sources of cash for fiscal 2007 included the issuance of common stock to cover stock options exercised, which raised $413, as compared with $1,424 in fiscal 2006, $25 in proceeds for the sale of capital assets, as compared with $8 for fiscal 2006, and repayments of notes outstanding for purchases of common stock granted under our Long-Term Stock Ownership Plan of $42 compared with $61 for fiscal 2006.

 

The sale by us of 198,246 shares of common stock was completed in fiscal 2006. The shares of common stock were offered pursuant to a registration statement we filed with the Securities and Exchange Commission that became effective on November 12, 2005 and were sold for $18 per share. These shares were held as treasury shares before the sale and were previously acquired at an average price of $7 per share. This sale netted $3,403.

 

In fiscal 2007, we contributed $2,500 into our defined benefit pension plan compared with $4,751 for fiscal 2006. Other uses of cash for the twelve months ended March 31, 2007 included dividend payments of $387 and capital expenditures of $1,637 compared to $452 and $1,048, respectively, for fiscal 2006. During fiscal 2007, we borrowed and repaid $3,896 to finance working capital needs, as compared with $3,070 for fiscal 2006. Cash was used to retire short-term debt of $1,872 in fiscal 2006 compared with $0 for the current fiscal year.

 

Capital expenditures for fiscal 2008 are projected to be $1,500 and to consist largely of continuing plant productivity and information technology enhancements.

 

On June 14, 2006, we increased our credit facility with Bank of America, N.A. from $13,000 to $20,000. We expanded our credit capacity based on our expectations of future working capital needs to finance business growth, largely resulting from an expected increase in major capital investment projects overseas requiring both standby letters of credit and anticipated greater working capital needs. On September 30, 2006, we amended our credit facility to provide for issuance of bank guarantees for the benefit of our Chinese subsidiary. On March 7, 2007, we amended our credit facility to reduce borrowing costs under our facility by an additional twenty-five basis points to prime minus 125 basis points when the total liabilities to tangible net worth ratio under the agreement is met. Borrowings under our banking facility are secured by all of our assets. Borrowings and standby letters of credit outstanding under our credit facility on March 31, 2007 were $0 and $8,578, respectively. Our borrowing rate as of March 31, 2007 was the bank’s prime rate minus 125 basis points, or 7.0%. We believe that cash generated from operations, combined with our investments and available financing capacity under our credit facility, will be adequate to meet our cash needs for the immediate future.

 

Orders and Backlog

 

Orders for fiscal 2007 were $86,540 compared with $66,225 for fiscal 2006, an increase of 31%. Orders represent communications received from customers requesting us to supply products and services. Although order demand is currently strong for all of our products, the increase in orders for fiscal 2007 over fiscal 2006 primarily resulted from increases in ejector orders. Ejector orders increased $18,601 in fiscal 2007 compared with fiscal 2006 and accounted for 92% of the total order increase. The increased ejector activity is largely due to major capital investment projects in the refinery sector worldwide. Heat Exchanger orders, lead by Heliflows, accounted for 9% of the fiscal 2007 order increase. Other orders for product categories (e.g., condensers, pumps and aftermarket)

were about the same dollar values when compared with fiscal 2006 (in aggregate down 1%). Export orders were up 26%, or $9,500 compared with fiscal 2006. The increase in export orders reflects the strong Asian economies, particularly in the refinery sector, and the strong petrochemical markets in the Middle East.

 

Backlog was $54,184 at March 31, 2007, compared with $33,083 at March 31, 2006, a 64% increase. Backlog is defined as the total dollar value of orders received for which revenue has not yet been recognized. All orders in backlog represent orders from our traditional markets in established product lines. Approximately 85% of orders currently in backlog are expected to be converted to sales within twelve months. Approximately 43% of our backlog can be attributed to equipment for refinery project work, 35% to chemical and petrochemical projects, and 22% to other industrial or commercial applications. We believe that the continuing demand from the refinery sector for our products is being driven by the shortages of refinery capacity resulting from increased global usage of oil.

 

Contingencies and Commitments

 

We have been named as a defendant in certain lawsuits alleging personal injury from exposure to asbestos contained in our products. We are a co-defendant with numerous other defendants in these lawsuits and intend to vigorously defend against these claims. The claims are similar to previous asbestos lawsuits that named us as a defendant. Such previous lawsuits either were dismissed when it was shown that we had not supplied products to the plaintiffs’ places of work or were settled by us for amounts below expected defense costs. Neither the outcome of these lawsuits nor the potential for liability can be determined at this time.

 

From time to time in the ordinary course of business, we are subject to legal proceedings and potential claims. As of March 31, 2007, we were unaware of any additional pending litigation matters.

 

In May 2006, we completed the formation of a wholly-owned Chinese subsidiary located in Suzhou and committed to invest an aggregate of $2,100 over a two-year period. Through March 31, 2007 we have invested $1,064 in our Chinese subsidiary.

 

New Accounting Pronouncements

 

Effective April 1, 2006, we adopted Statement of Financial Accounting Standard (“SFAS”) No. 123(R), Shared-Based Payments. SFAS No. 123(R) requires that all share-based payments to employees, including grants of employee stock options, be recognized in the financial statements based on their fair values. We decided to use the Black-Scholes fair value model to value option grants and to adopt the modified prospective method for expense recognition of options granted as of the adoption date of April 1, 2006. The effect of adopting SFAS 123(R) to our consolidated statements of operations and retained earnings for fiscal 2007 was a decrease in net income of $49.

 

Effective April 1, 2006, we adopted SFAS No. 151, Inventory Costs. SFAS No. 151 amends Accounting Research Bulletin No. 43, Chapter 4, Inventory Pricing, to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted materials. SFAS No. 151 requires that those items be recognized as current period charges regardless of whether they meet the criterion of “abnormal” contained in such statement. In addition, SFAS No. 151 requires that allocation of fixed production overhead to the costs of conversion be based on the normal capacity of the production facilities. SFAS No. 151 became effective for inventory costs incurred after April 1, 2006. The adoption of SFAS No. 151 in fiscal 2007 did not have an impact on our financial position, results of operations or cash flows.

 

In September 2006, the FASB issued SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of SFAS Nos. 87, 88, 106 and 132R. SFAS No. 158 requires the recognition of the over funded or under funded status of a defined benefit postretirement plan as an asset or liability in the statement of financial position and changes in that funded status in the year in which the changes occur through comprehensive income. SFAS No. 158 also requires the funded status of a plan be measured as of the date of its year-end statement of financial position. The adoption of SFAS No. 158 in fiscal 2007 resulted in a charge to stockholders’ equity through accumulated other comprehensive income of $2,373, an increase in postretirement liabilities of $3,708 and an increase in deferred tax assets net of deferred tax liabilities of $1,335. We will adopt the measurement provisions of SFAS No. 158 as of March 31, 2009.

In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin (“SAB”) No. 108, Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements, which addresses the process of quantifying financial statement misstatements. SAB No. 108 is effective for fiscal years ending after November 15, 2006. The adoption of SAB No. 108 did not have an impact on our financial position, results of operations or cash flows for fiscal 2007.

 

In July 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation (“FIN”) No. 48, Accounting for Uncertainty in Income Taxes. FIN No. 48 heightens the threshold for recognizing and measuring tax benefits and requires enterprises to make explicit disclosures about uncertainties in their income tax positions, including a detailed roll forward of tax benefits taken that do not qualify for financial statement recognition. FIN No. 48 is effective as of the beginning of our fiscal year 2008, which commenced April 1, 2007. We are currently evaluating the impact FIN No. 48 will have on our financial position.

 

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This Statement is effective as of the beginning of our fiscal year which commenced April 1, 2007. We are currently evaluating the impact SFAS No. 157 will have on our financial position, results of operations and cash flows.

 

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. SFAS No. 159 permits entities to choose to measure certain financial instruments and certain other items at fair value in order to mitigate volatility in reported earnings. This Statement is effective as of the beginning of our fiscal year which commenced April 1, 2008. We are currently studying the impact, if any, on our financial position, results of operations or cash flows for our fiscal year ending March 31, 2009.

 

Off Balance Sheet Arrangements

 

We did not have any off balance sheet arrangements as of March 31, 2007 or March 31, 2006 other than operating leases.

 

The principal market risks (i.e., the risk of loss arising from changes in market rates and prices) to which we are exposed are:

 

 

The assumptions applied in preparing the following qualitative and quantitative disclosures regarding foreign currency exchange rate and equity price risk are based upon volatility ranges experienced by us in relevant historical periods, our current knowledge of the marketplace, and our judgment of the probability of future volatility based upon the historical trends and economic conditions of the markets in which we operate.

 

Foreign Currency

 

International consolidated sales for fiscal 2007 were 50% of total sales compared with 49% for fiscal 2006. Operating in markets throughout the world exposes us to movements in currency exchange rates. Currency movements can affect sales in several ways, the foremost being our ability to compete for orders against foreign competitors that base their prices on relatively weaker currencies. Business lost due to competition for orders against competitors using a relatively weaker currency cannot be quantified. In addition, cash can be adversely impacted by the conversion of sales made by us in a foreign currency to U.S. dollars. In each of the fiscal years 2007, 2006 and 2005, we had no sales for which we were paid in foreign currencies. At certain times, we may enter into forward foreign currency exchange agreements to hedge our exposure against potential unfavorable changes in foreign currency values on significant sales contracts negotiated in foreign currencies.

We have limited exposure to foreign currency purchases. In fiscal years 2007, 2006 and 2005, our purchases in foreign currencies represented 3%, 1% and 4%, respectively, of the cost of products sold. At certain times, we may utilize forward foreign currency exchange contracts to limit currency exposure. Forward foreign currency exchange contracts were not used in fiscal 2007 or 2006, and as of March 31, 2007 and 2006, we held no forward foreign currency contracts.

 

Equity Price Risk

 

Our Long-Term Incentive Plan provides for awards of share equivalent units (“SEUs”) for our non-employee directors based upon the performance of our common stock. SEUs are valued at fair market value, thereby exposing us to equity price risk. Upward adjustment to market value is limited to (a) $8 per unit if at the valuation date the fair market value was less than $8 per unit or (b) the fair market value at the valuation date if the fair market value on that date was greater than $8 per unit. Gains and losses recognized due to market price changes are included in results of operations. Based upon the plan provisions and SEUs outstanding at March 31, 2007 and 2006, and an $18 per share market price, a 50-75% change in the year-end common stock market price would positively or (negatively) impact income before income taxes as follows:

 

 

Assuming required net income targets are met, certain awards would be provided, and based upon a market price of $18 per share, a 50-75% change in the stock price would positively (negatively) impact income before income taxes in future years ending March 31 as follows:

 

 

INDEX TO FINANCIAL STATEMENTS

 

(References to years represent years ended March 31, 2007, 2006 and 2005)

 

 

See Notes to Consolidated Financial Statements.

 

 

See Notes to Consolidated Financial Statements.

 

 

See Notes to Consolidated Financial Statements.

 

 

See Notes to Consolidated Financial Statements.

 

(Dollar amounts in thousands, except per share data)

 

 

Graham Corporation (the “Company”) and its subsidiaries are primarily engaged in the design, manufacture and supply of vacuum and heat transfer equipment used in the chemical, petrochemical, petroleum refining, and electric power generating industries and sell to customers throughout the world. The Company’s significant accounting policies are set forth below.

 

Principles of consolidation and use of estimates in the preparation of financial statements

 

The consolidated financial statements include the accounts of the Company and its wholly-owned domestic and foreign subsidiaries. All significant intercompany balances, transactions and profits are eliminated in consolidation.

 

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, as well as the related revenues and expenses during the reporting period. Actual amounts could differ from those estimated.

 

Translation of foreign currencies

 

Assets and liabilities of foreign subsidiaries are translated into U.S. dollars at currency exchange rates in effect at year-end and revenues and expenses are translated at average exchange rates in effect for the year. Gains and losses resulting from foreign currency transactions are included in results of operations. The Company’s sales and purchases in foreign currencies are minimal. Therefore, foreign currency transaction gains and losses are not significant. Gains and losses resulting from translation of foreign subsidiary balance sheets are included in a separate component of stockholders’ equity. Translation adjustments are not adjusted for income taxes since they relate to an investment, which is permanent in nature.

 

Revenue recognition

 

Percentage-of-Completion Method

 

The Company recognizes revenue on all contracts with a planned manufacturing process in excess of four weeks (which approximates 575 direct labor hours) using the percentage-of-completion method. The majority of the Company’s revenue is recognized under this methodology. The Company has established the systems and procedures essential to developing the estimates required to account for contracts using the percentage-of-completion method. The percentage-of-completion method is determined by comparing actual labor incurred to a specific date to management’s estimate of the 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 the contract value and estimated costs at completion. Losses on contracts are recognized immediately when known. During fiscal 2007, losses of $404 were recognized on contracts in process. No loss provisions were recorded in fiscal 2006 and fiscal 2005. Revenues recognized on contracts accounted for utilizing percentage-of-completion are presented in net sales in the Consolidated Statement of Operations and unbilled revenue in the Consolidated Balance Sheets to the extent that the revenue recognized exceeds the amounts billed to customers. See “Inventories” below.

 

Completed Contract Method

 

Revenue on contracts not accounted for using the percentage-of-completion method is recognized utilizing the completed contract method. The majority of the Company’s contracts have a planned manufacturing process of less

than four weeks and the results reported under this method do not vary materially from the percentage-of-completion 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.

 

Shipping and handling fees and costs

 

Shipping and handling fees billed to the customer are recorded in net sales and the related costs incurred for shipping and handling are included in cost of products sold.

 

Investments

 

Investments consist of fixed-income debt securities issued by the U.S. Treasury with original maturities of greater than three months and less than one year. All investments are classified as held-to-maturity, as the Company has the intent and ability to hold the securities to maturity. The investments are stated at amortized cost which approximates fair value. All investments held by the Company at March 31, 2007 are scheduled to mature between April 5 and July 5, 2007.

 

Inventories

 

Inventories are stated at the lower of cost or market, using the average cost method. For contracts accounted for on the completed contract method, progress payments received are netted against inventory to the extent the payment is less than the inventory balance relating to the applicable contract. Progress payments that are in excess of the corresponding inventory balance are presented as customer deposits in the Consolidated Balance Sheets. Unbilled revenue in the Consolidated Balance Sheets represents revenue recognized that has not been billed to customers on contracts accounted for on the percentage-of-completion method. For contracts accounted for on the percentage-of-completion method, progress payments are netted against unbilled revenue to the extent the payment is less than the unbilled revenue for the applicable contract. Progress payments exceeding unbilled revenue are netted against inventory to the extent the payment is less than or equal to the inventory balance relating to the applicable contract, and the excess is presented as customer deposits in the Consolidated Balance Sheets.

 

A summary of costs and estimated earnings on contracts in progress accounted for under the percentage of completion method at March 31, 2007 and 2006 is as follows: