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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark one)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
For Quarterly Period Ended September 30, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
For the transition period from ____________ to ____________
Commission File Number 1-8462
GRAHAM CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 16-1194720
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
20 FLORENCE AVENUE, BATAVIA, NEW YORK 14020
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including Area Code - 585-343-2216
(Former name, former address and former fiscal year, if changed
since last report.)
Indicate by check mark whether the registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the registrant was required to
file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES __X__ NO _____
Indicate by check mark whether the registrant is an
accelerated filer (as defined by Rule 12b-2 of the Act).
Yes __ __ No __X__
As of November 12, 2004, there were outstanding 1,665,667
shares of common stock, $.10 per share.
2
Graham Corporation and Subsidiaries
Index to Form 10-Q
As of and for the Three and Six Month Periods Ended September 30, 2004
Page
Part I FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements 3
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 15
Item 3. Quantitative and Qualitative Disclosure About
Market Risk 22
Item 4. Controls and Procedures 24
Part II. OTHER INFORMATION
Item 5. Other Information 24
Item 6. Exhibits and Reports on Form 8-K 24
3
GRAHAM CORPORATION AND SUBSIDIARIES
FORM 10-Q
SEPTEMBER 30, 2004
PART I - FINANCIAL INFORMATION
(Dollar amounts in thousands except per share data)
Unaudited condensed consolidated financial statements of
Graham Corporation (the Company) and its subsidiaries as of
September 30, 2004 and for the three month and six month periods
ended September 30, 2004 and 2003 are presented on the following
pages. The financial statements have been prepared in accordance
with the Company's usual accounting policies, are based in part
on approximations and reflect all normal and recurring
adjustments which are, in the opinion of management, necessary to
a fair presentation of the results of the interim periods. The
March 31, 2004 Consolidated Balance Sheet was derived from the
Company's audited Balance Sheet for the year ended March 31,
2004.
This part also includes management's discussion and analysis
of the Company's financial condition as of September 30, 2004 and
its results of operations for the three and six month periods
ended September 30, 2004.
4
GRAHAM CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
September 30, March 31,
2004 2004
---- ----
Assets
Current Assets:
Cash and cash equivalents $ 611 $ 467
Investments 3,098 5,296
Trade accounts receivable, net of
allowances ($117 and $75 at September 30
and March 31, 2004, respectively) 6,681 8,950
Inventories, net 8,147 6,984
Domestic and foreign income taxes receivable 943 972
Deferred income tax asset 1,663 1,521
Prepaid expenses and other current assets 398 217
------- -------
Total current assets 21,541 24,407
Property, plant and equipment, net 8,808 9,227
Deferred income tax asset 2,259 2,048
Other assets 50 58
Total assets $32,658 $35,740
======= =======
Liabilities and Shareholders' Equity
Current liabilities:
Short-term debt $ 2,112 $ 1,925
Current portion of long-term debt 46 44
Accounts payable 3,124 3,230
Accrued compensation 3,307 3,866
Accrued expenses and other liabilities 1,251 1,562
Customer deposits 458 2,128
------- -------
Total current liabilities 10,298 12,755
Long-term debt 70 93
Accrued compensation 172 239
Deferred income tax liability 76 77
Other long-term liabilities 45 61
Accrued pension liability 2,159 1,873
Accrued postretirement benefits 2,477 2,540
------- -------
Total liabilities 15,297 17,638
------- -------
5
GRAHAM CORPORATION
CONSOLIDATED BALANCE SHEETS (CONCLUDED)
(UNAUDITED)
September 30, March 31,
2004 2004
---- ----
Shareholders' equity:
Preferred Stock, $1 par value -
Authorized, 500,000 shares
Common stock, $.10 par value -
Authorized, 6,000,000 shares
Issued, 1,764,790 shares at September 30,
2004 and 1,757,450 shares at March 31, 2004 176 176
Capital in excess of par value 5,153 5,097
Retained earnings 16,560 17,322
Accumulated other comprehensive loss
Minimum pension liability adjustment (1,456) (1,456)
Cumulative foreign currency translation
adjustment (1,502) (1,452)
------- -------
18,931 19,687
Less:
Treasury Stock (99,123 shares at September
30, and March 31, 2004) (1,385) (1,385)
Notes receivable from officers and directors (185) (200)
Total shareholders' equity 17,361 18,102
------- -------
Total liabilities and shareholders' equity $32,658 $35,740
======= =======
See Notes to Consolidated Financial Statements.
6
GRAHAM CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND RETAINED EARNINGS
(Unaudited)
Three Months Ended Six Months Ended
September 30, September 30,
2004 2003 2004 2003
---- ---- ---- ----
Net Sales $10,927 $12,554 $20,843 $21,124
------- ------- ------- -------
Cost and expenses:
Cost of products sold 9,461 9,718 18,385 17,356
Selling, general and
administrative 2,439 2,515 4,920 4,922
Interest expense 26 21 51 58
Other Income (1,592) (1,592) (522)
------- ------- ------- -------
Total costs and expenses 10,334 12,254 21,764 21,814
------- ------- ------- -------
Income (loss) before
income taxes 593 300 (921) (690)
Provision (benefit) for
income taxes 212 91 (325) (194)
------- ------- ------- -------
Net income (loss) 381 209 (596) (496)
Retained earnings at
beginning of period 16,262 18,023 17,322 18,810
Dividends (83) (80) (166) (162)
------- ------- ------- -------
Retained earnings at
end of period $16,560 $18,152 $16,560 $18,152
======= ======= ======= =======
Per Share Data:
Basic:
Net income (loss) $.23 $.13 $(.36) $(.30)
==== ==== ===== =====
Diluted:
Net income (loss) $.22 $.13 $(.36) $(.30)
==== ==== ===== =====
See Notes to Consolidated Financial Statements.
7
GRAHAM CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended
September 30,
2004 2003
---- ----
Operating activities:
Net loss $ (596) $ (496)
-------- -------
Adjustments to reconcile net loss to net
cash used by operating activities:
Depreciation and amortization 499 521
Discount accretion on investments (19) (33)
Loss on sale of property, plant and equipment 1
(Increase) decrease in operating assets:
Accounts receivable 2,234 1,036
Inventory, net of customer deposits (2,875) 1,062
Prepaid expenses and other current and non-
current assets (183) (328)
Increase (decrease) in operating liabilities:
Accounts payable, accrued compensation,
accrued expenses and other current and
non-current liabilities (541) (2,393)
Non-current accrued compensation, accrued
pension liability and accrued
postemployment benefits (270) (120)
Domestic and foreign income taxes 29 129
Deferred income taxes (364) (113)
-------- -------
Total adjustments (1,489) (239)
-------- -------
Net cash used by operating activities (2,085) (735)
-------- -------
Investing activities:
Purchase of property, plant and equipment (91) (120)
Collection of notes receivable from
officers and directors 15 35
Purchase of investments (4,585) (5,421)
Redemption of investments at maturity 6,802 6,472
-------- -------
Net cash provided by investing activities 2,141 966
-------- -------
Financing activities:
Increase (Decrease) in short-term debt 218 (27)
Proceeds from issuance of long-term debt 5,350
Principal repayments on long-term debt (21) (5,401)
Issuance of common stock 57 94
Dividends paid (166) (162)
Acquisition of treasury stock (20)
-------- -------
Net cash provided (used) by financing activities 88 (166)
-------- -------
8
Six Months Ended
September 30,
2004 2003
---- ----
Effect of exchange rate changes on cash (2)
-------- -------
Net increase in cash and cash equivalents 144 63
Cash and cash equivalents at beginning of period 467 217
-------- -------
Cash and cash equivalents at end of period $ 611 $ 280
======== =======
See Notes to Consolidated Financial Statements.
9
GRAHAM CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2004
NOTE 1 - CHANGE IN ACCOUNTING FOR REVENUE RECOGNITION
During the second quarter of fiscal year 2005, the Company
changed its method of recognizing revenue for certain contracts
from the completed contract to the percentage-of-completion
method. Formerly, only contracts with a planned manufacturing
process in excess of three months and with revenue of at least
$1,000 and 500 pounds sterling, in the USA and UK operating
segments, respectively, were accounted for under the percentage-
of-completion method. Now all contracts with a planned manufacturing
process of four weeks or more (575 hours) and without a dollar threshold
are accounted for using the percentage-of-completion method. The
Company believes this is a preferable accounting method for these
contracts because it measures revenue, costs of products sold and
related income on construction type contracts based on progress on
the contracts, thus providing a better measure of the earnings
process on a more timely basis. The Company extended its scope of
contracts accounted for using the percentage-of-completion method at
this time because management believes that the effects on the financial
statements of applying the completed contract method on these contracts
could begin to vary materially from the effects of applying the
percentage-of-completion method. The majority of the Company's contracts
have a planned manufacturing process of less than four weeks (575 hours),
and are accounted for using the completed contract method. Prior
period financial results have been restated to reflect this change.
The impact of the change on net sales, cost of products sold, provision
for income taxes and net income for all periods presented is as follows:
Three Months Ended
------------------
September 30,
-------------
2004 2003
---- ----
Amounts Reported Using Amounts Reported Using
---------------------- ----------------------
Percentage Percentage
of Completed of Completed
Completion Contract Completion Contract
Method Method Difference Method Method Difference
------ ------ ---------- ------ ------ ----------
Net Sales 10,927 10,292 635 12,554 12,457 97
Cost of
products sold 9,461 8,930 531 9,718 9,697 21
Provision for
income taxes 212 177 35 91 68 23
Net income 381 312 69 209 156 53
Net income
per share
Basic .23 .19 .04 .13 .09 .04
Diluted .22 .18 .04 .13 .09 .04
10
Six Months Ended
----------------
September 30,
-------------
2004 2003
---- ----
Amounts Reported Using Amounts Reported Using
---------------------- ----------------------
Percentage Percentage
of Completed of Completed
Completion Contract Completion Contract
Method Method Difference Method Method Difference Difference
------ ------ ---------- ------ ------ ----------
Net Sales 20,843 19,689 1,154 21,124 20,892 232
Cost of
products sold 18,385 17,478 907 17,356 17,137 219
(Benefit) for
income taxes (325) (382) 57 (194) (201) 7
Net (loss) (596) (786) 190 (496) (502) 6
Net (loss)
per share
Basic (.36) (.47) .11 (.30) (.31) .01
Diluted (.36) (.47) .11 (.30) (.31) .01
The effect of this change on retained earnings is as follows:
Three Months Ended Six Months Ended
September 30, September 30,
2004 2003 2004 2003
---- ---- ---- ----
Balance at beginning of period
as previously reported $16,189 $18,027 $17,370 $18,767
Add adjustment for the cumulative
effect on prior periods of
applying retroactively the
change in accounting method 73 (4) (48) 43
------- ------- ------- -------
Balance at beginning of period,
as adjusted 16,262 18,023 17,322 18,810
Net income (loss) 381 209 (596) (496)
Dividends (83) (80) (166) (162)
------- ------- ------- -------
Balance at end of period $16,560 $18,152 $16,560 $18,152
======= ======= ======= =======
11
NOTE 2 - INVENTORIES
Major classifications of inventories are as follows:
September 30, March 31,
2004 2004
---- ----
Raw materials and supplies $ 1,918 $ 1,745
Work in process 7,044 6,169
Finished products 2,480 2,500
------- -------
11,442 10,414
Less - progress payments 3,154 3,309
- inventory reserve 141 121
------- -------
$ 8,147 $ 6,984
======= =======
NOTE 3 - STOCK-BASED COMPENSATION:
The Company accounts for stock-based compensation in
accordance with SFAS No. 123, "Accounting for Stock-Based
Compensation". As permitted by SFAS No. 123, the Company
continues to measure compensation for such plans using the
intrinsic value based method of accounting, prescribed by
Accounting Principles Board (APB), Opinion No. 25, "Accounting
for Stock Issued to Employees". Accordingly, compensation cost
for stock options is measured as the excess, if any, of the
quoted market price of the Company's stock at the date of grant
over the amount an employee must pay to acquire the stock.
Compensation cost for share equivalent units is recorded based on
the quoted market price of the Company's stock at the end of the
period.
Under the intrinsic value method, no compensation expense
has been recognized for the Company's stock option plans. Had
compensation cost for the Company's stock option plans been
determined based on the fair value at the grant date for awards
under those plans in accordance with the optional methodology
prescribed under SFAS No. 123, the Company's net income (loss)
and net income (loss) per share would have been the pro forma
amounts indicated below:
12
Three Months Ended Six Months Ended
September 30, September 30,
2004 2003 2004 2003
---- ---- ---- ----
Net income (loss)
as reported $381 $209 $(596) $(496)
Stock-based employee
compensation cost
net of related tax
benefits (11)
---- ---- ----- -----
Pro forma net income
(loss) $381 $209 $(596) $(507)
==== ==== ===== =====
Basic income (loss)
per share As reported $.23 $.13 $(.36) $(.30)
Pro forma $.23 $.13 $(.36) $(.31)
Diluted income
(loss) per share As reported $.22 $.13 $(.36) $(.30)
Pro forma $.22 $.13 $(.36) $(.31)
For purposes of the disclosure above, the fair value of each
option grant is estimated on the date of the grant using the
Black-Scholes option-pricing model. During the six months ended
September 30, 2004, no options were granted. The following
weighted-average assumptions were used for grants in fiscal year
2004:
Expected life 5 years
Volatility 50.06%
Risk-free interest rate 2.25%
Dividend yield 2.40%
NOTE 4 - INCOME (LOSS) PER SHARE:
Basic income (loss) per share is computed by dividing net
income (loss) by the weighted average number of common shares
outstanding for the period. Common shares outstanding include
share equivalent units which are contingently issuable shares.
Diluted income (loss) per share is calculated by dividing net
income (loss) by the weighted average number of common and, when
applicable, potential common shares outstanding during the
period. A reconciliation of the numerators and denominators of
basic and diluted income (loss) per share is presented below:
13
Three Months Ended Six Months Ended
September 30, September 30,
2003 2004 2003 2004
---- ---- ---- ----
Basic income (loss) per share
Numerator:
Net income (loss) $ 381 $ 209 $ (596) $ (496)
------- ------ ------- -------
Denominator:
Weighted common shares
outstanding 1,662,432 1,628,454 1,660,391 1,623,562
Share equivalent units (SEU)
outstanding 16,735 16,437 16,587 16,297
------- ------ ------- -------
Weighted average shares and
SEUs outstanding 1,679,167 1,644,891 1,676,978 1,639,859
--------- --------- --------- ---------
Basic income (loss) per share $.23 $.13 $(.36) $(.30)
==== ==== ===== =====
Diluted income (loss) per share
Numerator:
Net income (loss) $ 381 $ 209 $ (596) $ (496)
------- ------- ------ ------
Denominator:
Weighted average shares and
SEUs outstanding 1,679,167 1,644,891 1,676,978 1,639,859
Stock options outstanding 22,388 11,774
Contingently issuable SEUs 140 172
--------- --------- --------- ---------
Weighted average common and
potential common shares
outstanding 1,701,695 1,656,837 1,676,978 1,639,859
--------- --------- --------- ---------
Diluted income (loss) per share $.22 $.13 $(.36) $(.30)
==== ==== ===== =====
Options to purchase shares of common stock which totaled
71,350 and 136,250 for the three months ended September 30, 2004
and 2003, respectively, were not included in the computation of
diluted earnings per share as the effect would be antidilutive
due to the options' exercise price being greater than the average
market price of the common shares.
14
All options to purchase shares of common stock at various
exercise prices were excluded from the computation of diluted
loss per share for the six month periods ended September 30, 2004
and 2003 as the effect would be antidilutive due to the net
losses for the periods.
NOTE 5 - PRODUCT WARRANTY LIABILITY
The reconciliation of the changes in the product warranty
liability is as follows:
Three Months Ended Six Months Ended
September 30, September 30,
2004 2003 2004 2003
---- ---- ---- ----
Balance at beginning
of period $ 266 $ 386 $ 242 $592
Expense for product (6) 45 56 120
warranties
Product warranty
claims paid (35) (72) (73) (353)
----- ----- ----- -----
Balance at end of
period $ 225 $ 359 $ 225 $ 359
===== ===== ===== =====
The decrease in expense for product warranties in the second
quarter of fiscal year 2005 resulted from the reversal of
provisions made that are no longer required based upon historical
claims history.
NOTE 6 - CASH FLOW STATEMENT
Interest paid was $51 and $56 for the six months ended
September 30, 2004 and 2003, respectively. In addition, income
taxes refunded were $10 and $210 for the six months ended
September 30, 2004 and 2003, respectively.
Non-cash activities during the six months ended September 30,
2004 and 2003 included dividends of $83 and $80, respectively,
which were recorded but not paid. In addition, in the six months
ended September 30, 2003, capital expenditures totaling $11 were
financed through the issuance of capital leases.
NOTE 7 - COMPREHENSIVE INCOME
Total comprehensive income was $365 and $207 for the three
months ended September 30, 2004 and 2003, respectively. Other
comprehensive income for the three months ended September 30,
2004 and 2003 included foreign currency translation adjustments
of $(16) and $(2), respectively. Total comprehensive loss for
the six months ended September 30, 2004 and 2003 was $646 and
$363, respectively. Other comprehensive (loss) income for the
six months ended September 30, 2004 and 2003 included foreign
currency translation adjustments of $(50) and $133, respectively.
15
NOTE 8 - EMPLOYEE BENEFIT PLANS
The components of pension cost are as follows:
Three Months Ended Six Months Ended
September 30, September 30,
2004 2003 2004 2003
---- ---- ---- ----
Service cost $ 118 $ 110 $ 236 $ 220
Interest cost 244 223 488 444
Expected return on assets (226) (182) (452) (363)
Amortization of:
Transition asset (4) (10) (8) (20)
Unrecognized prior
service cost 1 1 2 2
Actuarial loss 76 67 152 133
------- ------ ------- -------
Net pension cost $ 209 $ 209 $ 418 $ 416
======= ====== ======= =======
The Company made contributions of $270 and $572 to the
defined benefit pension plan in the three and six months ended
September 30, 2004, respectively. The Company expects its
contributions to the plan for the balance of 2005 to be
approximately $398.
The components of the postretirement benefit income are as
follows:
Three Months Ended Six Months Ended
September 30, September 30,
2004 2003 2004 2003
---- ---- ---- ----
Service cost $ 0 $ 3 $ 0 $ 6
Interest cost 18 17 36 33
Amortization of prior
service cost (42) (31) (83) (62)
Amortization of actuarial
loss 6 2 12 4
----- ----- ----- -----
Net postretirement benefit
income $ (18) $ (9) $ (35) $ (19)
===== ===== ===== =====
The Company paid benefits of $13 and $28 related to its
postretirement benefit plan in the three and six months ended
September 30, 2004, respectively. The Company expects to pay
benefits of approximately $128 for the balance of 2005.
16
NOTE 9 - OTHER INCOME
In September 2004, the Company settled a contract dispute
with a customer regarding cancellation charges. This settlement
agreement was executed prior to the end of the quarter, and the
unpaid settlement amount due of $183 was received on October 13, 2004.
As a result of the settlement, other income of $1,592 was recorded.
On February 4, 2003, the Company irrevocably terminated
postretirement health care benefits for current U.S. employees.
Benefits payable to retirees of record on April 1, 2003 remained
unchanged. As a result of the plan change, a curtailment gain of
$522 was recognized. This gain is included in the caption "Other
Income" in the Consolidated Statement of Operations and Retained
Earnings for the six months ended September 30, 2003.
NOTE 10 - SEGMENT INFORMATION
The Company's business consists of two operating segments
based upon geographic area. The United States segment designs
and manufactures heat transfer and vacuum equipment and the
operating segment located in the United Kingdom manufactures
vacuum equipment. Operating segment information is presented
below:
Three Months Ended Six Months Ended
September 30, September 30,
2004 2003 2004 2003
---- ---- ---- ----
Sales to external customers
U.S. $ 9,070 $11,226 $17,351 $18,972
U.K. 1,857 1,328 3,492 2,152
------- ------- ------- -------
Total $10,927 $12,554 $20,843 $21,124
======= ======= ======= =======
Intersegment sales
U.S. $ 94 $ 10 $ 118 $ 38
U.K. 157 725 358 1,066
------- ------- ------- -------
Total $ 251 $ 735 $ 476 $ 1,104
======= ======= ======= =======
Segment net income (loss)
U.S. $ 410 $ 346 $ (320) $ (213)
U.K. (44) 22 (351) (276)
------- ------- ------- -------
Total segment net income
(loss) $ 366 $ 368 $ (671) $ (489)
======= ======= ======= =======
17
The segment net income (loss) above is reconciled to the
consolidated totals as follows:
Three Months Ended Six Months Ended
September 30, September 30,
2004 2003 2004 2003
---- ---- ---- ----
Total segment net income
(loss) $ 366 $ 368 $ (671) $ (489)
Eliminations 15 (159) 75 (7)
------- ------- ------- -------
Net income (loss) $ 381 $ 209 $ (596) $ (496)
======= ======= ======= =======
NOTE 11 - RELATED PARTY TRANSACTION
On April 1, 2003, the Company acquired 30,800 shares of
common stock previously issued under the Long-Term Stock
Ownership Plan from two former officers. This transaction was
accounted for as a purchase. The shares were redeemed at the
original issue price of $7.25, as compared to a market price at
the time of the closing of $7.55. This transaction resulted in a
$224,000 increase to treasury stock, a $204,000 reduction in
notes receivable from officers and directors and cash payments to
former officers. The cash payments of $20 approximate amounts
previously paid on the notes.
NOTE 12 - CONTINGENCIES
The Company has been named as a defendant in certain
lawsuits wherein the respective plaintiffs allege personal injury
from exposure to asbestos contained in products made by the
Company. The Company is a co-defendant with numerous other
defendants in these suits. The Company has retained litigation
counsel to defend these claims. The claims are similar to
previous asbestos suits naming the Company as defendant, which
either were dismissed when it was shown that the Company had not
supplied products to the plaintiffs' places of work or were
settled for minimal amounts below the expected defense costs.
The lawsuits are at a very early stage, where the potential for
liability is not determinable.
From time to time, the Company is subject to legal
proceedings arising in the ordinary course of business. The
Company believes there is no other litigation pending against it
that could have, individually or in the aggregate, a material
adverse effect on its financial statements.
18
GRAHAM CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
September 30, 2004
OVERVIEW
Graham Corporation consists of two operating segments as
determined by geographic areas (USA: Graham Corporation, UK:
Graham Vacuum and Heat Transfer Limited and its wholly-owned
subsidiary, Graham Precision Pumps Limited).
In the quarter ended September 30, 2004, the Corporation
modified its method of recognizing revenue for certain contracts
from the completed contract to the percentage-of-completion
method. Formerly, only contracts with a planned manufacturing
process in excess of three months and with revenue of at least
$1,000 and 500 pounds sterling, in the USA and UK operating
segments, respectively, were accounted for under the percentage-
of-completion method. Now all contracts with a planned manufacturing
process of four weeks or more (575 hours) and without a dollar threshold
are accounted for using the percentage-of-completion method. The Company
believes this is a preferable accounting method for these contracts because
it measures revenue, costs of products sold and related income on
construction type contracts based on progress on the contracts, thus
providing a better measure of the earnings process on a more timely
basis. The Company extended its scope of contracts accounted for using
the percentage-of-completion method at this time because management
believes that the effects on the financial statements of applying
the completed contract method on these contracts could begin to
vary materially from the effects of applying the percentage-of-
completion method. The majority of the Company's contracts have
a planned manufacturing process of less than four weeks (575 hours),
and are accounted for using the completed contract method. Prior
period financial results have been restated to reflect this change.
The impact of the change on net sales, cost of products sold, provision
for income taxes and net income for all periods presented is as follows:
19
Three Months Ended
------------------
September 30,
-------------
2004 2003
---- ----
Amounts Reported Using Amounts Reported Using
---------------------- ----------------------
Percentage Percentage
of Completed of Completed
Completion Contract Completion Contract
Method Method Difference Method Method Difference
------ ------ ---------- ------ ------ ----------
Net Sales 10,927 10,292 635 12,554 12,457 97
Cost of
products sold 9,461 8,930 531 9,718 9,697 21
Provision for
income taxes 212 177 35 91 68 23
Net income 381 312 69 209 156 53
Net income
per share
Basic .23 .19 .04 .13 .09 .04
Diluted .22 .18 .04 .13 .09 .04
Six Months Ended
----------------
September 30,
-------------
2004 2003
---- ----
Amounts Reported Using Amounts Reported Using
---------------------- ----------------------
Percentage Percentage
of Completed of Completed
Completion Contract Completion Contract
Method Method Difference Method Method Difference Difference
------ ------ ---------- ------ ------ ----------
Net Sales 20,843 19,689 1,154 21,124 20,892 232
Cost of
products sold 18,385 17,478 907 17,356 17,137 219
(Benefit) for
income taxes (325) (382) 57 (194) (201) 7
Net (loss) (596) (786) 190 (496) (502) 6
Net (loss)
per share
Basic (.36) (.47) .11 (.30) (.31) .01
Diluted (.36) (.47) .11 (.30) (.31) .01
20
The effect of this change on retained earnings is as follows:
Three Months Ended Six Months Ended
September 30, September 30,
2004 2003 2004 2003
---- ---- ---- ----
Balance at beginning of period
as previously reported $16,189 $18,027 $17,370 $18,767
Add adjustment for the cumulative
effect on prior periods of
applying retroactively the
change in accounting method 73 (4) (48) 43
------- ------- ------- -------
Balance at beginning of period,
as adjusted 16,262 18,023 17,322 18,810
Net income (loss) 381 209 (596) (496)
Dividends (83) (80) (166) (162)
------- ------- ------- -------
Balance at end of period $16,560 $18,152 $16,560 $18,152
======= ======= ======= =======
Graham Corporation designs and builds vacuum and heat
transfer equipment for the process industries throughout the
world. The Company is a leader in vacuum technology. The
principal markets for our equipment are the chemical,
petrochemical, petroleum refining and electric power generating
industries, including cogeneration and geothermal plants. Other
markets served include metal refining, pulp and paper processing,
shipbuilding, water heating, refrigeration, desalination, food
processing, drug manufacturing, heating, ventilating and air
conditioning.
Ejectors, liquid ring and dry vacuum pumps, condensers, heat
exchangers and other products we sell, sold either as components
or as complete systems, are used by our customers to produce
synthetic fibers, chemicals, petroleum products (including
gasoline), electric power, processed food (including canned,
frozen and dairy products), pharmaceutical products, paper,
steel, fertilizers and numerous other products used everyday by
people throughout the world.
FORWARD-LOOKING STATEMENTS
Certain statements contained in this document, including in
this Management's Discussion and Analysis of Financial Condition
and Results of Operations, that are not historical facts,
constitute "Forward-Looking Statements" within the meaning of the
Private Securities Litigation Reform Act of 1995. Forward-
looking statements, in general, predict, forecast, indicate or
imply future results, performance or achievements and generally
use words so indicative. The Company wishes to caution the
reader that numerous important factors which involve risks and
uncertainties, including but not limited to economic,
competitive, governmental and technological factors affecting the
Company's operations, markets, products, services and prices, and
other factors discussed in the Company's filings with the
Securities and Exchange Commission, in the future, could affect
the Company's actual results and could cause its actual
consolidated results to differ materially from those expressed in
any forward-looking statement made by, or on behalf of, the
Company.
CRITICAL ACCOUNTING POLICIES, ESTIMATES AND JUDGMENTS
The discussion and analysis of our financial condition and
results of operations are based upon our consolidated financial
statements, which have been prepared in accordance with
accounting principles generally accepted in the United States of
America ("GAAP").
Critical accounting policies are defined as those that are
reflective of significant judgments and uncertainties, and could
potentially result in materially different results under
different assumptions and conditions. Management has discussed
each of these critical accounting policies and estimates with the
Audit Committee of the Board of Directors.
Revenue Recognition - The Corporation recognizes revenue on all
contracts with a planned manufacturing process in excess of four weeks
(575 hours) using the percentage-of-completion method. The percentage-
of-completion method is determined by relating actual labor
incurred to-date to management's estimate of total labor to be
incurred on each contract. Contracts in progress are reviewed
monthly, and sales and earnings are adjusted in current
accounting periods based on revisions in the contract value and
estimated costs at completion. (For additional information,
refer to page 7, Note 1 of Notes to Condensed Consolidated
Financial Statements and to page 14, Overview, Management's
Discussion and Analysis of Financial Condition and Operations).
Revenue not accounted for using the percentage-of-completion
method is accounted for on the completed contract method because
the majority of the Company's contracts have a planned manufacturing
process of less than four weeks (575 hours) and the results
reported under this method do not vary materially from the use
of the percentage-of-completion method. The Company recognizes
revenue and all related costs on the completed contract method
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 material obligations under the contract after the
revenue is recognized.
Pension and Postretirement Benefits - The Company's defined
benefit pension and other postretirement benefit costs and
obligations are dependent on actuarial assumptions used in
calculating such amounts. These assumptions, which are reviewed
annually by the Company, 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. The
Company bases the discount rate assumption for its plans on the
AA-rated corporate long-term bond yield rate. The long-term
22
expected rate of return on plan assets is based on the plan's
asset allocation, historical returns and management's expectation
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 the Company's 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.
To the extent that actual results differ from our
assumptions, the differences are reflected as unrecognized gains
and losses and are amortized to earnings over the estimated
future service period of the plan participants to the extent such
total net recognized gains and losses exceed 10% of the greater
of the plan's projected benefit obligation or the market-related
value of assets. Significant differences in actual experience or
significant changes in future assumptions would affect the
Company's pension and postretirement benefit costs and
obligations.
Use of Estimates - The preparation of these financial statements
requires us to make estimates and judgments that affect the
reported amounts of assets and liabilities, revenues and expenses
and related disclosure of contingent assets and liabilities at
the date of our financial statements. Actual results may differ
from these estimates under different assumptions or conditions.
Use of estimates include the recording of revenue, pension
obligations, and the underlying assumptions and valuation
reserves for uncollectible accounts, inventory obsolescence,
deferred taxes, warranty and liquidated damages.
Results of Operations
For an understanding of the significant factors that
influenced the Company's performance, the following discussion
should be read in conjunction with the quarterly consolidated
financial statements and the notes to consolidated financial
statements.
Three Months Ended
September 30, 2004 September 30, 2003
------------------ ------------------
USA UK USA UK
--- -- --- --
Sales $ 9,164 $ 2,014 $11,236 $ 2,053
Net Income (Loss) $ 410 $ (44) $ 346 $ 22
Diluted Income (Loss)Per Share $ 0.24 $ (0.03) $ 0.21 $ 0.01
Identifiable Assets $30,474 $ 6,019 $33,588 $ 5,626
23
Six Months Ended
September 30, 2004 September 30, 2003
------------------ ------------------
USA UK USA UK
--- -- --- --
Sales $17,469 $ 3,850 $19,010 $ 3,218
Net Income (Loss) $ (320) $ (351) $ (213) $ (276)
Diluted Income (Loss)Per Share $ (0.19) $ (0.21) $ (0.13) $ (0.17)
Amounts above are inclusive of intercompany amounts.
Consolidated sales (net of intercompany sales) for the
quarter were $10,927, as compared to $12,554 for the quarter
ended September 30, 2003. This represents a 13% decrease in
sales. Sales in the USA were down 18% from one year ago. Sales
from UK operations were down 2%.
Consolidated sales (net of intercompany sales) for the six
months were $20,843, as compared to $21,124 for the six months
ended September 30, 2003. This represents a 1% decrease in
sales. Sales in the USA were down 8% from one year ago. Sales
from UK operations were up 20%.
The decrease in USA and UK sales for the quarter and USA
sales for the six months ended September 30, 2004, as compared to
sales for the quarter and six months ended September 30, 2003,
reflected unusually low order volume for condensers and large
ejectors in prior quarters due to the lack of major project work.
Sales from UK operations were up for the six months due to an
increase in sales of vacuum pumps for offshore oil extraction and
for pump systems shipped in the quarter ended June 30, 2004.
The consolidated gross profit margin for the quarter was
13%, as compared to 23% for the quarter ended September 30, 2003.
By segment, USA operation's gross profit decreased from 22% for
the second quarter ended September 30, 2003 to 10% for the
current quarter and the UK's gross profit margin decreased from
27% for the quarter ended September 30, 2003 to 24% for the
current quarter.
The consolidated gross profit margin for the current six
months was 12%, as compared to 18% for the six months ended
September 30, 2003. By segment, USA operations' gross profit
decreased from 16% for the six months ended September 30, 2003 to
10% for the six months ended September 30, 2004, and the UK's
gross profit margin decreased from 20% to 16% for the six months
ended September 30, 2004.
Gross profit margins in both the USA and UK operations for
the current quarter and six months were down from the comparative
quarter and six months one year ago due to the inability to fully
recover increasing material costs and one major pump system
project bearing a very low profit margin. The Company is
addressing rising material costs through selling price increases.
Also, USA gross profit margins decreased due to lower sales for the
three and six months ended September 30, 2004 as compared to
24
September 30, 2003.
Selling, General and Administrative expenses (SG&A) were 22%
of sales for the current quarter, as compared to 20% for the
quarter ended September 30, 2003 and 24% of sales for the six
months ended September 30, 2004, as compared to 23% for the six
month period ended one year earlier. Percentage variances in
SG&A expenses are due to changes in sales levels in both the
quarterly and six-month comparative periods.
Interest expense was $21 for the quarter ended September 30,
2003 and $26 for the current quarter. For the six-month periods
ended September 30, 2004 and 2003, interest expense was $51 and
$58, respectively. Interest expense for the current fiscal year
to date decreased significantly in the USA, which resulted in a
consolidated decrease of interest expense.
Other income for the current quarter and six months ended
September 30, 2004 was $1,592 compared to $522 for the first
quarter ended June 30, 2003 and six months ended September 30,
2003. Other income of $1,592 recorded in the current quarter
resulted from a settlement of a contract dispute over
cancellation charges. The settlement of this matter ended a
complaint 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 money damages.
Other income recognized for the six months ended September 30, 2003
represents a non-recurring curtailment gain resulting from the
discontinuation of postretirement medical benefits.
The effective income tax rate for the quarter was 36%, as
compared to 30% at September 30, 2003. The effective income tax
rate for the six months ended September 30, 2004 was 35%, as
compared to 28% at September 30, 2003. The lower effective
income tax rates for the three and six-month periods ended
September 30, 2003 were attributable to a larger extra
territorial income exclusion benefit due to higher foreign
shipments.
Net income for the quarter was $381 or $0.22 per diluted
share. This compares to a net income of $209 or $0.13 per
diluted share for the quarter ended September 30, 2003. Net
losses for the six-month periods ended September 30, 2004 and
2003 were $596, or $0.36 per diluted share, and $496, or $.30 per
diluted share, respectively.
25
Liquidity and Capital Resources
As of and for the Six Months Ended
September 30, 2004 September 30, 2003
------------------ ------------------
USA UK USA UK
--- -- --- --
Working Capital $ 9,810 $ 1,746 $10,487 $ 1,726
Cash (Deficit) Flow from Operations $(2,102 $ 17 $ (816) $ 81
Cash and Investments $ 3,698 $ 11 $ 5,654 $ 54
Capital Expenditures $ 40 $ 51 $ 97 $ 23
Long-Term Bank Borrowings $ 0 $ 0 $ 0 $ 0
Capital Leases $ 116 $ 0 $ 165 $ 2
Working Capital Ratio(1) 2.4 1.5 2.1 1.6
Long-Term Debt/Equity(1) 0.6% 0.0% 0.8% 0.0%
(1)As of September 30
Consolidated cash flow from operations was negative $2,085
for the six months ended September 30, 2004 compared to negative
cash flow from operations of $735 for the six months ended
September 30, 2003. Negative cash flows for the six months ended
September 30, 2004 and 2003 were due to operating losses before
the reduction of losses for non-cash Other Income items of $1,592
and $522, respectively. The cash related to the income
recognized in the second quarter ended September 30, 2004 was
collected in a prior reporting period.
The Company expects to consume cash in excess of amounts
generated from operations over the next several months to cover a
significant increase in work-in-process inventory for greater
shipments scheduled in future quarters.
The primary source of liquidity is cash flow from
operations, investments in short-term treasury bills and secured
credit agreements.
Orders and Backlog
Orders for the current quarter were $10,355 as compared to
$7,854 for the quarter ended September 30, 2003, representing a
32% increase. Prior to intercompany elimination, orders in the
USA were $9,101 compared to $4,971 in the quarter ended September
30, 2003. Orders in the UK were $1,504, as compared to $3,004
one year ago.
Orders for the six months ended September 30, 2004 were
$25,513, as compared to $19,087 for the six months ended
September 30, 2003. This represents a 34% increase and is due to
the continuing recovery in the refinery and chemical markets.
26
Backlog was $21,225 at September 30, 2004 as compared to
$15,707 at September 30, 2003, representing a 35% increase.
Prior to intercompany eliminations, USA unfilled orders were
$18,894 and UK unfilled orders were $2,665 at September 30, 2004.
At September 30, 2003, USA and UK backlog amounts were $13,338
and $3,410, respectively. The prior year backlog amounts have
been restated to reflect contract cancellations and the
restatement of sales due to the change in the revenue recognition
accounting method. All orders in backlog represent orders from
traditional markets in the Company's established product lines.
Market Risk (Quantitative and Qualitative Disclosures)
The principal market risks (i.e., the risk of loss arising
from changes in market rates and prices) to which Graham is
exposed are:
- foreign exchange rates
- equity price risk
- material availability and price risk
The assumptions applied in preparing quantitative
disclosures regarding interest rate, foreign exchange rate and
equity price risk are based upon volatility ranges experienced in
relevant historical periods, management's current knowledge of
the business and market place, and management's judgment of the
probability of future volatility based upon the historical trends
and economic conditions of the business.
Graham's international consolidated sales for the past three
years approximates 43% of total sales. Operating in world
markets involves exposure to movements in currency exchange
rates. Currency movements can affect sales in several ways, the
foremost being the ability to compete for orders against
competition having a relatively weaker currency. Business lost
due to this cannot be quantified. Secondly, cash can be
adversely impacted by the conversion of sales in foreign currency
to U.S. dollars. The substantial portion of Graham's sales is
collected in the local currency (USA - dollars; UK - pounds
sterling). For the quarters ended September 30, 2004 and 2003,
sales in foreign currencies were 4% and 3% of sales,
respectively. For the six months ended September 30, 2004 and
2003, sales in foreign currencies were 4% and 2% of total sales,
respectively. At certain times, the Company may enter into
forward foreign exchange agreements to hedge its exposure against
unfavorable changes in foreign currency values on significant
sales contracts negotiated in foreign currencies.
Graham has limited exposure to foreign currency purchases.
For the three month periods ended September 30, 2004 and 2003,
purchases in foreign currencies were 7% and 13% of cost of goods
sold, respectively. For the six month periods ended September
30, 2004 and 2003, purchases in foreign currencies were 7% and
10% of cost of goods sold, respectively. In FYE 2004 and 2005,
USA operations recorded an unusually significant dollar volume of
orders utilizing UK subsidiary products in conjunction with USA
equipment. At certain times, forward foreign exchange contracts
may be utilized to limit currency exposure.
27
UK operations experienced a current quarter net loss of $44,
as compared to a quarterly net income of $22 for September 30,
2003. For the six months ended September 30, 2004 and 2003,
foreign operations produced net losses of $351 and $276.
respectively. As currency exchange rates change, translations of
the income statements of the UK business into US dollars affect
year-over-year comparability of operating results. The increase
in the foreign currency translation rate to convert pounds
sterling to US dollars increased all UK income statement items
and order amounts by 12% and all UK balance sheet and backlog
amounts by 9% for the six months ended September 30, 2004 over
2003. The Company does not hedge translation risks because cash
flows from UK operations are mostly reinvested in the UK. A 10%
change in foreign exchange rates would have impacted the UK
reported net loss by approximately $5 and $2 for the three months
ended September 30, 2004 and 2003, and $35 and $28 for the six
month periods, respectively.
The Company has a Long-Term Incentive Plan, which provides
for awards of share equivalent units (SEUs) for outside directors
based upon the Company's performance. The outstanding SEUs are
recorded at fair market value thereby exposing the Company to
equity price risk. Gains and losses recognized due to market
price changes are included in the Company's results of
operations. Based upon the SEUs outstanding at September 30,
2004 and 2003 and a $12 per share price, a 50-75% change in the
respective year end market price of the Company's common stock
would positively or negatively impact the Company's operating
results by $100 to $151 for the three and six months ended
September 30, 2004 and $99 to $148 for the three and six months
ended September, 2003. Assuming required net income of $500 is
met, and based upon a market price of the Company's stock of $12
per share, a 50-75% change in the stock price would positively or
negatively impact the Company's operating results by $155 to $233
in 2006, $173 to $260 in 2007, $186 to $279 in 2008, $200 to $299
in 2009 and $203 to $304 in 2010.
The risks associated with materials include availability and
price increases. Material shortages have affected the Company's
ability to meet delivery requirements for certain orders. The
Company has identified alternative vendors in such cases and
seeks to negotiate escalation provisions in its sales contracts
in the event that costs of materials increase. Profit margins on
sales would be reduced to the extent rising material costs could
not be passed on to Graham's customers.
Contingencies
The Company is a co-defendant with numerous other defendants
in matters of litigation alleging personal injury from exposure
to asbestos contained in some of the Company's products
previously manufactured. To date, it has been the Company's
experience that upon investigation the cases have been dismissed
or settled for minimal amounts. However, the magnitude of
potential damages on unsettled current claims is not
determinable.
28
GRAHAM CORPORATION AND SUBSIDIARIES
FORM 10-Q
SEPTEMBER 30, 2004
PART II - OTHER INFORMATION
Item 4. Controls and Procedures
The Company's President and Chief Executive Officer
and its Vice President-Finance and Chief Financial Officer each
have independently evaluated the Company's disclosure controls
and procedures as defined in Exchange Act Rules 13a-14(c) and 15d-
14(c) as of the end of the period covered by this quarterly
report on Form 10-Q and each regards such controls as effective.
There have been no significant changes to any such
controls or in other factors that could significantly affect such
controls, subsequent to the date of their evaluation by each of
the CEO and the CFO.
Item 5. Other Information
The Company's chief executive officer and chief
financial officer have furnished to the SEC the certification
with respect to this Form 10-Q that is required by Section 906 of
the Sarbanes-Oxley Act of 2002.
Item 6. Exhibits
a. See index to exhibits.
SIGNATURES
Pursuant to the requirements of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be
signed on its behalf by the undersigned thereunto duly
authorized.
GRAHAM CORPORATION
/s/ J. R. Hansen
J. R. Hansen
Vice President Finance and
Administration / CFO (Principal
Accounting Officer)
Date 11/18/04
29
INDEX OF EXHIBITS
(2) Plan of acquisition, reorganization, arrangement,
liquidation or succession
Not applicable.
(3)(i) Articles of Incorporation of Graham
Corporation (filed as Exhibit 3(b) to the Registrant's
annual report on Form 10-K for the year ended December
31, 1989, and incorporated herein by reference.)
(3)(ii) By-laws of registrant, as amended (filed as Exhibit
3(ii) to the Registrant's quarterly report on Form 10-Q
for the quarter ended June 30, 2004, and incorporated
herein by reference).
(4) Instruments defining the rights of security
holders, including indentures
(a) Equity securities
The instruments defining the rights of the holders
of Registrant's equity securities are as follows:
Certificate of Incorporation, as amended of
Registrant (filed as Exhibit 3(a) to the
Registrant's annual report on Form 10-K for the
fiscal year ended December 31, 1989, and
incorporated herein by reference.)
Stockholder Rights Plan of Graham Corporation
(filed as Item 5 to Registrant's current report
filed on Form 8-K on August 23, 2000 and
Registrant's Form 8-A filed on September 15,
2000, and incorporated herein by reference.)
(b) Debt securities
Not applicable.
(10) Material Contracts
1989 Stock Option and Appreciation Rights Plan of
Graham Corporation (filed on the Registrant's Proxy
Statement for its 1990 Annual Meeting of Stockholders
and incorporated herein by reference.)
1995 Graham Corporation Incentive Plan to Increase
Shareholder Value (filed on the Registrant's Proxy
Statement for its 1996 Annual Meeting of Stockholders
and incorporated herein by reference.)
30
Index to Exhibits (cont.)
2000 Graham Corporation Incentive Plan to Increase
Shareholder Value (filed on the Registrant's Proxy
Statement for its 2001 Annual Meeting of Stockholders
and incorporated herein by reference.)
Graham Corporation Outside Directors' Long-Term
Incentive Plan (filed as Exhibit 10.3 to the Registrant's
annual report on Form 10-K for the fiscal year ended March
31, 1998, and is incorporated herein by reference.)
Employment Contracts between Graham Corporation and
Named Executive Officers (filed as Exhibit 10.4 to the
Registrant's annual report on Form 10-K for the fiscal year
ended March 31, 1998, and is incorporated herein by
reference.)
Senior Executive Severance Agreements with Named
Executive Officers (filed as Exhibit 10.5 to the
Registrant's annual report on Form 10-K for the fiscal year
ended March 31, 1998, and is incorporated herein by
reference.)
Long-Term Stock Ownership Plan of Graham Corporation
(filed on the Registrant's Proxy Statement for its 2000
Annual Meeting of Stockholders and incorporated herein by
reference.)
(11) Statement re-computation of per share earnings
Computation of per share earnings is included in Note 4
of the Notes to Financial Information.
(14) Code of Ethics
Not applicable.
(15) Letter re-unaudited interim financial information
Not applicable.
(18) Letter re-change in accounting principles
Preferability letter is included as Exhibit 18.
(19) Report furnished to security holders
None.
(22) Published report regarding matters submitted to vote of
security holders
The 2004 Annual Meeting of Stockholders of Graham
Corporation was held on July 29.
The individuals named below were reelected to serve on
the Company's Board of Directors:
31
Votes For Votes Withheld
--------- --------------
Jerald D. Bidlack 1,549,508 4,027
James J. Malvaso 1,546,339 7,196
Helen H. Berkeley, Alvaro Cadena, William C. Denninger,
H. Russel Lemcke, and Cornelius S. Van Rees all continue as
directors of the Company.
The appointment of Deloitte & Touche LLP as independent
auditors was ratified, with 1,550,462 shares voting for,
1,140 shares voting against, and 1,933 shares abstaining.
(23) Consents of experts and counsel
Not applicable.
(24) Power of Attorney
Not applicable.
(31) Rule 13a-14(a)/15d-14(a) Certifications
(32) Section 1350 Certifications
(99) Additional exhibits
None.