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 whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o     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.  o

 

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

 

 

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, 2008, the last business day of the registrant’s most recently completed second fiscal quarter, was $257,463,740. The market value calculation was determined using the closing price of the registrant’s common stock on September 30, 2008, as reported on the NYSE Amex 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 May 29, 2009, the registrant had outstanding 9,848,115 shares of common stock, $.10 par value, and 9,848,115 preferred stock purchase rights.

 

Documents Incorporated By Reference

 

Portions of the registrant’s definitive Proxy Statement, to be filed in connection with the registrant’s 2009 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, 2009

 

 

 

 

(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:

 

 

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 companies in such industries, 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 and 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.

 

Historically, 40% to 50% percent 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 significant 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 the Asian market will over time account for an increasing percentage of our revenue.

 

A breakdown of our net sales by geographic area and product class for our fiscal years ended March 31, 2009, 2008 and 2007, which we refer to as fiscal 2009, fiscal 2008 and fiscal 2007, respectively, is contained in Note 12 to our consolidated financial statements included in Item 8 of Part II of this Annual Report on Form 10-K. 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.

We were incorporated in Delaware in 1983 and are the successor to Graham Manufacturing Co., Inc., which was incorporated in New York in 1936. Our principal business location is in Batavia, New York. We also maintain a wholly-owned subsidiary, Graham Vacuum and Heat Transfer Technology (Suzhou) Co., Ltd., located in Suzhou, China. As of March 31, 2009, we had 270 full-time employees.

 

Our Strengths

 

Our core strengths are as follows:

 

 

Our Strategy

 

Our objective is to capture more market share within the geographies and industries we serve, expand our geographic markets and grow our presence in the energy industry and continually improve our results of operations. Our strategy to accomplish our objective is:

 

 

In order to effectively implement our strategy, we also must continually work to improve ourselves. These efforts include:

 

 

 

Competition

 

Our business is highly competitive. The principal bases on which we compete include technology, price, performance, reputation, delivery, and quality. Our competitors in our primary markets include:

 

NORTH AMERICA

 

 

INTERNATIONAL

 

 

During fiscal 2009, approximately 11% of our sales were attributable to the Bechtel-Jacobs CEP Port Arthur Joint Venture. No other customer accounted for more than 10% of our fiscal 2009 sales.

 

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 process. 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 believe that we are in material compliance with existing environmental laws and regulations. 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. However, our business is cyclical in nature as it depends on the willingness of our customers to invest in major capital projects.

 

Research and Development Activities

 

During fiscal 2009, fiscal 2008 and fiscal 2007, we spent approximately $3,347, $3,579 and $3,581, respectively, on research and development activities relating to 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 significant portion of our total revenue during our last three fiscal years. Approximately 37%, 46% and 50% of our revenues in fiscal 2009, fiscal 2008 and fiscal 2007, respectively, resulted from revenues from foreign sales. Revenue attributed to sales in Asia constituted approximately 13%, 15% and 17% of our revenues in fiscal 2009, fiscal 2008 and fiscal 2007, respectively. Revenue attributed to sales in the Middle East constituted approximately 8%, 11% and 23% of our revenue in fiscal 2009, fiscal 2008 and fiscal 2007, respectively.

 

Available Information

 

We are subject to the informational requirements of the Securities Exchange Act of 1934, as amended. Therefore, we file periodic reports, proxy statements and other information with the Securities and Exchange Commission (the “SEC”). The SEC maintains an Internet website (located at www.sec.gov) that contains reports, proxy statements and other information for registrants that file electronically. Additionally, such reports may be read and copied at the Public Reference Room of the SEC at 100 F Street NE, Washington, D.C. 20549.

 

We maintain an Internet website located at www.graham-mfg.com. On our website, we provide a link to the SEC’s Internet website that contains the reports, proxy statements and other information we file electronically. We do not provide this information on our website because it is more cost effective for us to provide a link to the SEC’s website. Copies of all documents we file with the SEC are available in print to any stockholder who makes a request. Such requests should be made to our Corporate Secretary at our corporate headquarters. The other information found on our website is not part of this or any other report we file with, or furnish to, the SEC.

 

 

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 or risks described below occur or materialize, our business and results of operations could be seriously 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 the sale 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 believe we are in a long-term expansion

of demand for our products in the petrochemical, petroleum refining and power generating industries, during fiscal 2009, we entered a sudden downturn in the demand for our products and services. Historically, previous cyclical downturns have lasted from one to several years. We have no way to predict or control the length or severity of this downturn. A sustained deterioration in any of the cyclical industries we serve would materially 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.

 

We serve markets that are capital intensive. The recent volatility and disruption of the capital and credit markets and adverse changes in the global economy may negatively impact our operating results. Such volatility and disruption may also negatively impact our ability to access additional financing.

 

Although we believe that the fundamentals that have driven our growth over the past few years remain essentially unchanged and that our long-term growth prospects remain strong, we also expect that the current economic crisis in the capital and credit markets will cause a slow-down in spending by our customers as they evaluate the current and future economic impact of such crisis to their project plans. If adverse economic and credit conditions persist or worsen, we would likely experience decreased revenue from our operations attributable to decreases in the spending levels of our customers. Adverse economic and credit conditions might also have a negative adverse effect on our cash flows if customers demand that we accept smaller project deposits and less frequent progress payments. In addition, adverse economic and credit conditions could put downward pricing pressure on us. If any of the foregoing occurs, there would be an adverse effect on our results of operations.

 

Moreover, the current crises in the capital and credit markets could have an adverse effect on our ability to obtain additional financing on commercially reasonable terms, if at all, should we determine such financing is desirable to expand our business.

 

The larger markets we serve are the petroleum refining and petrochemical industries which are both cyclical in nature and dependent on the price of oil. As a result, volatility in the price of crude oil may negatively impact our operating results.

 

Although we believe that the global consumption of crude oil will increase over the course of the next twenty years and that there will be a shortage of global oil refining capacity, the price of crude oil has been very volatile. Many of our products are purchased in connection with oil refinery construction, revamps and upgrades. During times of significant volatility in the market for crude oil, our customers may refrain from placing large orders until the market stabilizes. During such times of high volatility, we could experience decreased revenue from our operations attributable to decreases in the spending levels of our customers.

 

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 significant portion of our total revenue for the foreseeable future. For fiscal 2009, our sales to geographic regions were 63% domestic and 37% international.

 

Our international sales operations are subject to numerous risks, including:

 

 

Should any one of the above risks materialize, our business and results of operations could be harmed.

A large percentage of our sales are in non-U.S. jurisdictions. As a result, we are subject to the economic, political, regulatory and other risks of international operations.

 

For fiscal 2009, approximately 37% of our revenue was from customers located in countries outside of the United States. Moreover, we maintain a subsidiary and have facilities in China. We intend to continue to expand our international operations to the extent that suitable opportunities become available. Our foreign operations and sales could be adversely affected as a result of:

 

 

We are subject to foreign currency fluctuations which may adversely affect our operating results.

 

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 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. In addition, if the counter-parties to such exchange contracts do not fulfill their obligations to deliver the contractual foreign currencies, we could be at risk for fluctuations, if any, required to settle the obligation. At March 31, 2009, 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 member of our executive management team and our inability to make up for such loss with a qualified replacement could harm our business.

 

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 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 customers. In addition, customer buying patterns can change as they become more price sensitive and accepting of low cost suppliers. 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.

 

We are subject to contract cancellations and delays by our customers, which may adversely affect our operating results.

 

Contract cancellations may occur, which could reduce the realizable value of our backlog and negatively impact the amount of revenue earned and the profitability of our business. Certain contracts in backlog may contain provisions allowing for the assessment of cancellation charges to our customers to substantially compensate us for costs incurred on cancelled contracts. Delay of contract execution by our customers can result in volatility in our operating results.

 

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, which could harm our results of operations. Any efforts we may engage in 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.

 

When we experience strong demand for our products, our business strategy calls for us to increase manufacturing capacity through outsourcing selected fabrication processes. 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 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.

 

We conduct our business in China primarily through our wholly-owned Chinese subsidiary. 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.

 

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.

 

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:

 

 

 

 

Not applicable.

 

 

Our corporate headquarters, located at 20 Florence Avenue, Batavia, New York, consists of a 45,000 square foot building. Our manufacturing facilities, also located in Batavia, consist of approximately thirty-three acres and contain 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 Chinese 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 contained in Note 15 to our consolidated financial statements included in Item 8 of Part II of this 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.

 

(Amounts in thousands, except per share data)

 

 

Our common stock is traded on the NYSE Amex exchange under the symbol “GHM”. As of May 29, 2009, there were 9,848 shares of our common stock outstanding that were held by approximately 155 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 NYSE Amex. The table and the disclosure below takes into account the effect of our two-for-one stock split in the nature of a dividend, which became effective October 6, 2008.

 

 

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. Dividends declared by our Board of Directors for the first, second, third and fourth quarters of fiscal 2009 were $.015, $.02, $.02 and $.02, respectively, and for the same respective quarters in fiscal 2008 were $.01, $.01, $.015 and $.015. 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 a minimum total liabilities to tangible net worth ratio 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 $1,200 per year.

 

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

 

Purchases of Equity Securities by the Issuer

 

On January 29, 2009, our Board of Directors authorized a stock repurchase program of up to 1,000 shares of our common stock to continue until the earlier of July 29, 2009, until such time that all 1,000 shares have been repurchased or until the Board of Directors terminates the program. Repurchases may be made from time to time either in the open market or through privately negotiated transactions. We have no obligation under the program to repurchase shares and the program may be suspended or discontinued at any time without prior notice. We intend to fund the purchase price for shares of our common stock acquired with current cash on hand and cash generated from operations. Common stock repurchases in the fourth quarter of the fiscal year ended March 31, 2009 were as follows:

 

 

 

 

 

(Amounts in thousands, except per share data)

 

Overview

 

Highlights for our fiscal year ended March 31, 2009, which we refer to as fiscal 2009, include:

 

 

We are a global designer and manufacturer of custom-engineered ejectors, vacuum systems, condensers, liquid ring pump packages and heat exchangers. Our equipment is used in critical applications in 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, soap manufacturing, food processing, pharmaceuticals, heating, ventilating and air conditioning.

 

Our corporate offices and production facilities are located in Batavia, New York. We also have a wholly-owned foreign subsidiary located in Suzhou, China. Our subsidiary in China serves to support sales orders from Asia and provides engineering support and supervision of subcontracted fabrication.

 

Market Conditions: Fiscal 2009 and the Near Term

 

Fiscal 2009 saw a shift for our customers and for Graham. In the first half of fiscal 2009, the continuation of increased capital spending by our customers resulted in strong orders for us. In mid fiscal 2009, the global financial crisis rapidly created a credit freeze and uncertainty resulting in a dramatic decline in capital spending and, hence, new orders for Graham dropped significantly. While this did not have a major adverse impact on fiscal 2009 revenues, it did affect second half orders and year-end backlog. Orders in the second half of fiscal 2009 were $28,622 compared with orders of $61,731 in the same period of fiscal 2008.

 

Looking at fiscal 2010, we believe the current downturn in the global economy, which is reflected in the refinery and petrochemical markets that we serve, will continue and pose a near term challenge for our customers to invest in major capital projects. We also believe that the significant increase in construction costs, including raw material costs, which has occurred over the past four to five years, is leading to a delay in new commitments by our customers as they expect construction costs to decrease (following the recent declines in commodity costs).

 

On a quarterly basis in fiscal 2010, we expect our new order levels to be volatile, resulting in both good and weak quarters. A good example of this was the third and fourth quarters of fiscal 2009, which had new order levels of $8,098 and $20,524, respectively. We believe looking at our order levels in one quarter will not provide an accurate indication of future expectations, rather looking at orders over a rolling four-quarter time period will be a better measure of our business.

Market View: Long Term View / Shift Back to International Growth

 

Over the long-term, we expect our customers’ markets to regain their historical strength and grow for the foreseeable future. We believe the long-term trends remain strong. The drivers of future growth are:

 

 

All of these markets offer long-term growth opportunity for us as major project work will be necessary to meet our customers’ expected capital project needs. In addition, we believe we can continue to grow our less cyclical smaller product lines and aftermarket businesses.

 

We believe that many of the drivers noted above are in the international arena. We expect that in the future, international opportunities will be more plentiful relative to domestic projects. Our domestic sales as a percentage of product sales increased over the past three fiscal years from 50% in fiscal 2007 to 54% in fiscal 2008 to 63% in fiscal 2009. The economic strength of the U.S., especially the U.S. refining market drove this trend. As we look forward, we believe this trend will reverse itself and international sales will be at a similar level as domestic sales over the next few years and could surpass domestic sales as early as 2010.

 

Forward Looking Statements

 

This Annual Report on Form 10-K 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.

 

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 our 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 2009 Compared with Fiscal 2008

 

Sales for fiscal 2009 were $101,111, a 17% increase, as compared with sales of $86,428 for fiscal 2008. This growth in sales came from all product lines; 32% of the gain came from pumps, 29% from spare parts, and the remaining 39% from condensers, ejectors and heat exchangers. International sales accounted for 37% of all sales for fiscal 2009, which was down from 46% in fiscal 2008. The strength of the U.S. refining market was primarily responsible for this shift in fiscal 2009. Domestic sales grew $16,838 in fiscal 2009. International sales declined by 5% in fiscal 2009, driven by sales declines in South America and the Middle East due to a slowdown in investment in new capacity. Sales for fiscal 2009 were 46% to the refining industry (up from 43% in fiscal 2008), 27% to the chemical and petrochemical industries (down from 31%) and 27% to other industrial applications (up from 26%), including electrical power.

 

Our gross profit percentage for fiscal 2009 was 41.3% compared with 39.5% for fiscal 2008. Gross profit dollars for fiscal 2009 increased 22% ($7,550) compared with fiscal 2008. Gross profit dollars increased due to increased volume, improved product mix achieved by increased selectivity on orders accepted, and improved engineering and manufacturing efficiencies. Our improved operating efficiencies, which are a continuation of the gains seen in fiscal 2008, enabled us to achieve greater sales volume in fiscal 2009 without spending significant capital (or increasing other fixed costs) to increase our manufacturing capacity.

 

Selling, general and administrative (“SG&A”) expenses for fiscal 2009 remained similar to the fiscal 2008 level of 15%. Actual costs in fiscal 2009 increased $1,751, or 13%, compared with fiscal 2008. SG&A expenses increased due to greater variable costs (e.g., sales commissions, variable compensation) related to higher sales and net income.

During fiscal 2009, we restructured our workforce, eliminating certain management, office and manufacturing positions. The restructuring resulted in a pre-tax charge to earnings of $559. This cost was reported as Other Expense. Our on-going annual cost savings as a result of the restructuring is expected to be approximately $2,700.

 

Interest income for fiscal 2009 was $416, down from $1,026 in fiscal 2008. This decrease was due to lower rates of return on our investments, which are primarily short-term U.S. Treasury securities.

 

Interest expense was $5 in fiscal 2009, down from $10 in fiscal 2008.

 

Our effective tax rate in fiscal 2009 was 35%, compared with an effective tax rate of 32% for fiscal 2008. The increase was due to a higher level of pre-tax income relative to our allowable level of tax deductions.

 

Net income for fiscal 2009 and fiscal 2008 was $17,467 and $15,034, respectively. Income per diluted share was $1.71 and $1.49 for the respective periods.

 

Fiscal 2008 Compared with Fiscal 2007

 

Sales for fiscal 2008 were $86,428, a 31% increase, as compared with sales of $65,822 for fiscal 2007. Ninety-two percent of the increase in sales in fiscal 2008 compared with fiscal 2007 came from ejector and spare part sales, which were primarily sold to the refinery market. Of the 92%, 75% related to ejectors and the balance related to spare parts. International sales accounted for 46% and 50% of total sales for fiscal 2008 and fiscal 2007, respectively. International sales year-over-year increased $6,731, or 21%. The increase in international sales came from Asia, South America and Canada. Sales for fiscal 2008 were 43% to the refining industry, 31% to the chemical and petrochemical industries and 26% to other industrial applications, including electrical power. Sales in fiscal 2007 were 35% to the refining industry, 39% to the chemical and petrochemical industries and 26% to other industrial applications, including electrical power.

 

Our gross profit percentage for fiscal 2008 was 39.5% compared with 25.6% for fiscal 2007. Gross profit dollars for fiscal 2008 increased 103% compared with fiscal 2007. Gross profit percentage and dollars increased primarily due to improved product mix achieved by increased selectivity on orders accepted, improved engineering and manufacturing efficiencies and greater leveraging of manufacturing costs. Our improved operating efficiencies enabled us to achieve greater sales volume in fiscal 2008 without increasing proportionally our cost of products sold.

 

SG&A expenses for fiscal 2008 and 2007 were 15% and 16% of sales, respectively. The decline, expressed as a percentage of sales, was due to greater sales in fiscal 2008. Actual costs in fiscal 2008 increased $2,268, or 21%, compared with fiscal 2007. SG&A expenses increased due to greater variable costs (e.g., sales commissions, variable compensation) related to higher sales and net income.

 

Interest income for fiscal 2008 and 2007 was $1,026 and $516, respectively. Increased interest income followed increases in investments of 144%.

 

Interest expense was $10 in both fiscal 2008 and 2007.

 

Our effective tax rate in fiscal 2008 was 32%, compared with an effective tax rate of 12% for fiscal 2007. The effective tax rate for fiscal 2008 was less than the statutory rate of approximately 34% due to the qualified production activities deduction and research and development (R&D) tax credit. The fiscal 2007 effective tax rate reflected the benefit of $1,607 in research and development tax credits. The total credit recognized represented qualifying R&D expenditures for fiscal years 1999 to 2007. The R&D tax credit recognized in fiscal 2008 was $234.

 

Net income for fiscal 2008 and 2007 was $15,034 and $5,761, respectively. Income per diluted share was $1.49 and $0.58 for the respective periods.

Stockholders’ Equity

 

The following discussion should be read in conjunction with our consolidated statements of changes in stockholders’ equity. The following table shows the balance of stockholders’ equity on the dates indicated:

 

 

Fiscal 2009 Compared with Fiscal 2008

 

Stockholders’ equity increased $12,575 or 26%, at March 31, 2009 compared with March 31, 2008. This increase was primarily due to net income, offset by a decline in the value of pension assets. In July 2008, we increased our dividend per share from 6 cents per share per year to 8 cents per year. Dividends paid in fiscal 2009 increased 53%, or $261, due to the above mentioned increase as well as an increase in mid-fiscal 2008. In fiscal 2009, we increased authorized shares from 6,000 to 25,500. In October 2008, we split our stock 2-for-1, increasing the actual outstanding shares to 10,125 shares. We subsequently repurchased 277 shares in the fourth quarter of fiscal 2009 pursuant to our publicly announced stock repurchase program.

 

On March 31, 2009, our net book value was $6.21 up 28% over March 31, 2008.

 

Fiscal 2008 Compared with Fiscal 2007

 

Stockholders’ equity increased $17,882, or 58%, at March 31, 2008 compared with March 31, 2007. Eighty-four percent of this increase was due to the increase in net income, 15% was due to stock options exercised, and 1% was for other reasons. In October 2007, we increased our dividend per share from 5 cents per share per year to 6 cents per year. Dividends paid in fiscal 2008 increased 27%, or $106, due to this increase and due to additional shares outstanding.

 

On March 31, 2008, our net book value was $4.86, up 54% over March 31, 2007.

 

Liquidity and Capital Resources

 

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

 

 

 

 

As of March 31, 2009, our contractual and commercial obligations for the next five fiscal years ending March 31 and thereafter were as follows:

 

 

 

 

Net cash provided by operating activities for fiscal 2009 was $11,046, compared with $19,702 for fiscal 2008. While net income was greater in fiscal 2009, favorable cash flow from timing of accounts receivable achieved in 2008 was not repeatable. We are continuing to work to reduce our overall operating working capital (operating working capital equals accounts receivable plus inventory minus accounts payable). Our cash conversion cycle is down to 17 days at March 31, 2009, compared to 31 days as of March 31, 2008 and 51 days as of March 31, 2007 (cash conversion cycle equals days sales outstanding plus days inventory on hand minus days payables outstanding). The decrease in our cash conversion cycle was accomplished through continued focus on accounts receivable and inventory balances during fiscal 2009. Sales in fiscal 2009 were managed with an average operating working capital level of 5% of sales compared with 9% in fiscal 2008 and 14% in fiscal 2007.

 

We invest net cash generated from operations in excess of cash held for near-term needs in U.S. government instruments, generally with maturity periods of up to 180 days. Investments at March 31, 2009 and March 31, 2008 were $41,059 and $34,681, respectively. This increase was responsible for the majority of the growth in working capital.

 

Significant sources of cash for fiscal 2009 included the issuance of common stock to cover stock options exercised, which raised $695, as compared with $1,116 in fiscal 2008. In addition, in fiscal 2009 we recognized a $1,696 increase in capital in excess of par value for the income tax benefit realized upon exercise of stock options in excess of the tax benefit amount recognized pertaining to the fair value of stock option awards treated as compensation expense. This amount compared with $1,473 for fiscal 2008.

 

Other significant uses of cash for fiscal 2009 included our stock repurchase program. Under this program, 277 shares of stock were purchased during the fourth quarter of fiscal 2009 at a cost of $2,288 (representing an average price of $8.25 per share). Dividend payments of $754 and capital expenditures of $1,492 were made in fiscal 2009, compared with $493 and $1,027, respectively, for fiscal 2008. In fiscal 2009, we contributed $7,500 into our defined benefit pension plan, compared with $3,000 for fiscal 2008. In fiscal 2009, we repaid $28 in excess of amounts borrowed for bank borrowings and capitalized leases, as compared with $37 for fiscal 2008.

 

Capital expenditures in fiscal 2009 were 76% for plant machinery and equipment and 24% for all other items. Seventy-eight percent of our capital spending was for productivity improvements and the balance was primarily for capitalized maintenance. Capital expenditures for fiscal 2010 are expected to be approximately $1,000, with the planned investment expected to be 65% for machinery and equipment, 28% for information technology and 7% for

all other items. We estimate 50% of our capital budget in fiscal 2010 will support productivity improvements with the balance primarily for capitalized maintenance projects.

 

Our revolving credit facility with Bank of America, N.A. provides a line of credit of $30,000, including letters of credit and bank guarantees. Borrowings under our credit facility are secured by all of our assets. Letters of credit outstanding under our credit facility on March 31, 2009 and 2008 were $8,759 and $11,292, respectively. Other utilization of our credit facility limits at March 31, 2009 and 2008 were $0. Our borrowing rate as of March 31, 2009 was Bank of America’s prime rate minus 125 basis points, or 2.00%. 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 during fiscal 2009 and fiscal 2008 were $73,874 and $107,102, respectively, representing a 31% decrease for fiscal 2009. Orders represent communications received from customers requesting us to supply products and services. Revenue is recognized on orders received in accordance with our revenue recognition policy included in Note 1 to the Consolidated Financial Statements. The decrease in orders occurred in the second half of fiscal 2009. Orders in the first half of fiscal 2009 were $45,252 compared with $45,371 in the same period of fiscal 2008. However, orders in the second half of fiscal 2009 were $28,622 compared with $61,731 in the second half of fiscal 2008. As previously discussed, during the second half of fiscal 2009, our customers were impacted by the global financial crisis and recession, causing them to reduce capital spending. This in turn had a negative impact on our orders.

 

Domestic orders were 43%, or $31,413, of our total orders and international orders were 57%, or $42,461, of our total orders in fiscal 2009. The international orders grew in Asia by $12,252 and represented 31% of all orders for the year, up from 10% in fiscal 2008.

 

Backlog was $48,290 at March 31, 2009 compared with $75,662 at March 31, 2008, a 36% decrease. Backlog is defined by us as the total dollar value of orders received for which revenue has not yet been recognized. During fiscal 2009, we were notified by customers that three projects with a value of $3,295 were cancelled and five orders with a value of $4,443 were placed on hold (suspended) pending further evaluation. Our backlog has been reduced for the cancelled projects, but continues to include orders placed on hold (suspended) (see Project Cancellation and Project Continuation Risk in Item 7A). All orders in backlog represent orders from our traditional markets in established product lines. Approximately 10% of orders currently in backlog is not expected to be converted to sales within the next twelve months. At March 31, 2009, approximately 38% of our backlog was attributed to equipment for refinery project work, 35% for chemical and petrochemical projects, and 27% for other industrial or commercial applications. At March 31, 2008, approximately 49% of our backlog was for refinery project work, 28% for chemical and petrochemical projects, and 23% for other industrial or commercial applications.

 

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, 2009, other than noted above, we were unaware of any other pending litigation matters.

 

Critical Accounting Policies

 

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 Item 8 of Part II of 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 as of 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 evident to management.

 

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 do 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 contracts after the revenue is recognized.

 

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 likely long-term trends.

 

Income Taxes.  We use the liability method to account for income taxes. Under this method, deferred tax liabilities and assets are recognized for the tax effects of temporary differences between the financial reporting and tax bases of liabilities and assets measured using the enacted tax rate.

 

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.

 

Critical Accounting Estimates and Judgments

 

We have evaluated the accounting policies used in the preparation of the consolidated financial statements and the notes to consolidated financial statements included in Item 8 of Part II of this Annual Report on Form 10-K and believe those policies to be reasonable and appropriate.

 

We believe that the most critical accounting estimates used in the preparation of our consolidated financial statements relate to labor hour estimates used to recognize revenue under the percentage-of-completion method, accounting for contingencies, under which we accrue a loss when it is probable that a liability has been incurred and the amount can be reasonably estimated, and accounting for pensions and other postretirement benefits.

 

As discussed above under the heading “Critical Accounting Policies,” we recognize the substantial amount of our revenue using the percentage-of-completion method. 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.

Contingencies, by their nature, relate to uncertainties that require us to exercise judgment both in assessing the likelihood that a liability has been incurred as well as in estimating the amount of potential loss. For more information on these matters see the notes to consolidated financial statements included in Item 8 of Part II of this Annual Report on Form 10-K.

 

Accounting for pensions and other postretirement benefits involves estimating the cost of benefits to be provided well into the future and attributing that cost over the time period each employee works. To accomplish this, extensive use is made of assumptions about inflation, investment returns, mortality, turnover, medical costs and discount rates. These assumptions are reviewed annually.

 

The discount rate used in accounting for pensions and other postretirement benefits is determined in conjunction with our actuary by reference to a current yield curve and by considering the timing and amount of projected future benefit payments. The discount rate assumption for fiscal 2009 is 6.75% for our defined benefit pension and 6.19% for our other postretirement benefit plan. A reduction in the discount rate of 50 basis points, with all other assumptions held constant, would have increased fiscal 2009 net periodic benefit expense for our defined benefit pension and other postretirement benefit plan by approximately $158 and $0, respectively.

 

The expected return on plan assets assumption of 8.5% used in accounting for our pension plan is determined by evaluating the mix of investments that comprise plan assets and external forecasts of future long-term investment returns. A reduction in the rate of return of 50 basis points, with other assumptions held constant, would have increased fiscal 2009 net periodic pension expense by approximately $108.

 

As part of our ongoing financial reporting process, a collaborative effort is undertaken involving our managers with functional responsibilities for financial, credit, tax, engineering, manufacturing and benefit matters, and outside advisors such as lawyers, consultants and actuaries. We believe that the results of this effort provide management with the necessary information on which to base their judgments and to develop the estimates and assumptions used to prepare the financial statements.

 

We believe that the amounts recorded in the consolidated financial statements included in Item 8 of Part II of this Annual Report on Form 10-K related to revenue, contingencies, pensions, other post retirement benefits and other matters requiring the use of estimates and judgments are reasonable, although actual outcomes could differ materially from our estimates.

 

New Accounting Pronouncements

 

In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“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. SFAS No. 157 was effective as of the beginning of fiscal 2009, except as it relates to non-recurring fair value measurements of nonfinancial assets and liabilities for which SFAS No. 157 is effective for fiscal years beginning after November 15, 2008 which commenced April 1, 2009. Our adoption of all provisions of SFAS No. 157 had no effect on our financial position, results of operations and cash flows.

 

On April 1, 2008, we adopted the measurement date provisions of SFAS No. 158, Employer’s Accounting for Defined Benefit Pension and Other Postretirement Plans, utilizing the remeasurement approach which required plan assets and benefit obligations to be remeasured as of the beginning of fiscal 2009. Our adoption of SFAS No. 158 had the effect of reducing our prepaid pension asset by $801, reducing our deferred income tax liability by $260, reducing our stockholders equity by $506 and decreasing our accrued post retirement benefits by $35.

 

In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities to enhance disclosures about how and why an entity uses derivative instruments, how derivative instruments and related hedged items are accounted for under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities and its related interpretations and how derivative instruments and related hedged items affect an entity’s financial position, financial performance and cash flows. SFAS No. 161 is effective for fiscal years and interim periods beginning after November 15, 2008. We do not believe the adoption of SFAS No. 161 will have a material effect on our financial statement disclosures, as we currently do not have any derivative instruments nor are we involved in any hedging activities.

In December 2008, the FASB issued FASB Staff Position (FSP) FAS 132R-1 Employers’ Disclosures about Postretirement Benefit Plan Assets. This FSP requires disclosure of (a) information about how investment allocation decisions are made, (b) the fair value of each major category of plan assets for defined benefit pension plans and other postretirement benefit plans, (c) information that enables financial statement users to assess the inputs and valuation techniques used to develop fair value measurements of plan assets and (d) information about significant concentrations of risk in plan assets. FSP FAS 132R-1 is effective for fiscal years ending after December 15, 2009. We are currently evaluating the effect FSP FAS 132R-1 may have on our consolidated financial statement disclosures.

 

Off Balance Sheet Arrangements

 

We did not have any off balance sheet arrangements as of March 31, 2009 or March 31, 2008 other than operating leases.

 

 

The principal market risks (i.e., the risk of loss arising from changes in the market) to which we are exposed are foreign currency exchange rates, price risk and project cancellation risk.

 

The assumptions applied in preparing the following qualitative and quantitative disclosures regarding foreign currency exchange rate, price risk and project cancellation 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 2009 were 37% of total sales compared with 46% for fiscal 2008. 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 fiscal 2009, fiscal 2008 and fiscal 2007, 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 2009, fiscal 2008 and fiscal 2007, our purchases in foreign currencies represented 2%, 2% and 3%, 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 2009 or fiscal 2008, and as of March 31, 2009 and 2008, respectively, we held no forward foreign currency contracts.

 

Price Risk

 

Operating in a global marketplace requires us to compete with other global manufacturers which, in some instances, benefit from lower production costs and more favorable economic conditions. Although we believe that our customers differentiate our products on the basis of our manufacturing quality and engineering experience and excellence, among other things, such lower production costs and more favorable economic conditions mean that certain of our competitors are able to offer products similar to ours at lower prices. Moreover, the cost of metals and other materials used in our products have experienced significant volatility. Such factors, in addition to the global

effects of the recent volatility and disruption of the capital and credit markets, have resulted in downward demand and pricing pressure on our products.

 

Project Cancellation and Project Continuation Risk

 

Recent economic conditions have led to a higher likelihood of project cancellation by our customers. We had three projects totaling $3,295 cancelled in fiscal 2009. While this risk continues to be evident, we structure contracts with our customers to maximize the likelihood that progress payments made to us for individual projects cover the costs we have incurred. We, therefore, believe we do not have a significant cash exposure to potentially cancelled projects.

 

Open orders are reviewed continuously through communications with customers. If it becomes evident that a project is delayed well beyond its original shipment date, management will move the project into “placed on hold” category. Furthermore, if a project is cancelled by our customer, we will remove this from our backlog.

 

INDEX TO FINANCIAL STATEMENTS

 

 

 

See Notes to Consolidated Financial Statements.

 

 

See Notes to Consolidated Financial Statements.

 

 

See Notes to Consolidated Financial Statements.

 

 

 

 

See Notes to Consolidated Financial Statements.

 

Note 1 — The Company and Its Accounting Policies:

 

Graham Corporation (the “Company”) and its operating subsidiary 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.

 

The Company’s fiscal years ended March 31, 2009, 2008 and 2007 are referred to as fiscal 2009, fiscal 2008 and fiscal 2007, respectively.

 

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 foreign subsidiary, Graham Vacuum and Heat Transfer Technology (Suzhou) Co., Ltd., located in China. All intercompany balances, transactions and profits are eliminated in consolidation.

 

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the U.S. 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 as of 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 evident to management. During fiscal 2007, losses of $404 were recognized on contracts in process. No loss provisions were recorded in fiscal 2009 or fiscal 2008. Revenue 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.

 

During fiscal 2009, the Company was notified by customers that three projects with a value of $3,295 were cancelled and five orders with a value of $4,443 were placed on hold (suspended) pending further evaluation. Cancellation charges were received from customers to substantially compensate the Company for costs incurred on the contracts. The Company’s backlog was reduced for the cancelled orders, however, the orders placed on hold (suspended) remain in backlog.

 

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 believes it 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, 2009 are scheduled to mature between April 9 and July 2, 2009.

 

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, 2009 and 2008 is as follows:

 

The above activity is included in the accompanying Consolidated Balance Sheets under the following captions at March 31, 2009 and 2008 or Notes to Consolidated Financial Statements:

 

 

Property, plant, equipment and depreciation

 

Property, plant and equipment are stated at cost net of accumulated depreciation and amortization. Major additions and improvements are capitalized, while maintenance and repairs are charged to expense as incurred. Depreciation and amortization are provided based upon the estimated useful lives, or lease term if shorter, under the straight line method. Estimated useful lives range from approximately five to eight years for office equipment, eight to twenty-five years for manufacturing equipment and forty years for buildings and improvements. Upon sale or retirement of assets, the cost and related accumulated depreciation are removed from the accounts and any resulting gain or loss is included in the results of operations. The Company assesses all of its long-lived assets for impairment when impairment indicators are identified. When the carrying value of an asset exceeds its undiscounted cash flows, the Company recognizes an impairment loss. The impairment is then calculated as the difference between the carrying value and the fair value of the asset. No such impairment losses were recorded in fiscal 2009, fiscal 2008 or fiscal 2007.

 

Product warranties

 

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. A reconciliation of the changes in the product warranty liability is presented in Note 4.

 

Research and development

 

Research and development costs are expensed as incurred. The Company incurred research and development costs of $3,347, $3,579 and $3,581 in fiscal 2009, fiscal 2008 and fiscal 2007, respectively.

 

Income taxes

 

The Company recognizes deferred income tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company’s 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 currently enacted tax rates. The Company evaluates the available evidence about future taxable income and other possible sources of realization of deferred income tax assets and records a valuation allowance to reduce deferred income tax assets to an amount that represents the Company’s best estimate of the amount of such deferred income tax assets that more likely than not will be realized. No valuation allowance was required at March 31, 2009 and 2008.

 

On April 1, 2007, the Company adopted the provisions of the Financial Accounting Standard Board (“FASB”) 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. The adoption of FIN No. 48 had no effect on the Company’s financial position or results of operations. The Company had no unrecognized tax benefits as of March 31, 2009 and is not aware of any tax positions for which unrecognized tax benefits would be recorded within the next twelve months.

The Company files federal and state income tax returns in several U.S. and non-U.S. domestic and foreign jurisdictions. In most tax jurisdictions, returns are subject to examination by the relevant tax authorities for a number of years after the returns have been filed. The Company is currently under examination by the U.S. Internal Revenue Service for tax years 2006 through 2008.

 

Stock splits

 

On July 31, 2008, the Company’s stockholders approved a proposal to increase the number of authorized common shares from 6,000 to 25,500. Subsequently, the Company’s Board of Directors declared a two-for-one stock split of the Company’s common shares and declared a post-split quarterly cash dividend of $.02 per share, effective for the dividend paid on October 6, 2008 to stockholders of record on September 5, 2008. The two-for-one stock split was effected as a stock dividend, and stockholders received one additional share of common stock for every share of common stock held on the record date of September 5, 2008. The new common shares were distributed on or about October 6, 2008. The par value of the Company’s common stock, $.10, remained unchanged as a result of the stock dividend. All share and per share amounts in periods prior to the stock split were adjusted to reflect the two-for-one stock split. The Statement of Shareholders’ Equity in fiscal 2009 reflects the stock split by reclassifying from “Capital in excess of par value” to “Common stock” an amount equal to the par value of the additional shares issued to effect the stock split.

 

On October 26, 2007, the Company’s Board of Directors declared a five-for-four stock split of the Company’s common stock and increased the quarterly cash dividend to $.03 per share, effective for the dividend payable on January 3, 2008 to stockholders of record on November 30, 2007. The five-for-four stock split was effected as a stock dividend, and stockholders received one additional share of common stock for every four shares of common stock held on the record date of November 30, 2007. The new common shares were distributed on January 3, 2008. Fractional shares were aggregated and sold by the Company’s transfer agent on January 3, 2008 and the cash received was paid to stockholders of record on November 30, 2007. The par value of the Company’s common stock of $.10 remained unchanged. All share and per share amounts in periods prior to the stock split were adjusted to reflect the five-for-four stock split. The Statement of Stockholders’ Equity in fiscal 2008 reflects the stock split by reclassifying from “Capital in excess of par value” to “Common stock” an amount equal to the par value of the additional shares issued to effect the stock split.

 

Stock-based compensation

 

The Company records compensation costs related to stock-based awards in accordance with Statement of Financial Accounting Standard (“SFAS”) No. 123(R), Share-Based Payment, which requires the cost of all share-based payments to be measured at fair value on the grant date and recognized in the Company’s Consolidated Statements of Operations over the period expected to vest. The Company uses the Black-Scholes valuation model as the method for determining the fair value of its equity awards. For restricted stock awards, the fair market value of the award is determined based upon the closing value of the Company’s stock price on the grant date. The amount of stock-based compensation expense recognized during a period is based on the portion of the awards that are ultimately expected to vest. The Company estimates the forfeiture rate at the grant date by analyzing historical data and revises the estimates in subsequent periods if the actual forfeiture rate differs from the estimates.

 

Income per share data

 

Basic income per share is computed by dividing net income by the weighted average number of common shares outstanding for the period. Common shares outstanding include share equivalent units which are contingently issuable shares. Diluted income per share is calculated by dividing net income by the weighted average number of common shares outstanding and, when applicable, potential common shares outstanding during the

period. A reconciliation of the numerators and denominators of basic and diluted income per share is presented below: