Graham Corporation 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 |
For the quarterly period ended December 31, 2007
OR
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o |
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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)
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DELAWARE
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16-1194720 |
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(State or other jurisdiction of
incorporation or organization)
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(I.R.S. Employer
Identification No.) |
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20 Florence Avenue, Batavia, New York
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14020 |
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(Address of principal executive offices)
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(Zip Code) |
Registrants telephone number, including area code 585-343-2216
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 is a large accelerated filer, an accelerated
filer or a non-accelerated filer. See definition of accelerated filer and large accelerated
filer in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o Accelerated filer o Non-accelerated filer þ
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act).
Yes o No þ
As of January 28, 2008, there were outstanding 4,960,945 shares of the registrants common
stock, par value $.10 per share.
Graham Corporation and Subsidiaries
Index to Form 10-Q
As of December 31, 2007 and March 31, 2007 and for the Three and Nine-Month Periods
Ended December 31, 2007 and 2006
2
GRAHAM CORPORATION AND SUBSIDIARIES
FORM 10-Q
DECEMBER 31, 2007
PART I FINANCIAL INFORMATION
(Amounts in thousands, except per share data)
3
Item 1. Condensed Consolidated Financial Statements
GRAHAM CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
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December 31, |
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March 31, |
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2007 |
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2007 |
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(Amounts in thousands, except per share data) |
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Assets |
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Current assets: |
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Cash and cash equivalents |
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$ |
3,118 |
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$ |
1,375 |
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Investments |
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29,890 |
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13,676 |
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Trade accounts receivable, net of allowances ($66 and
$48 at December 31, and March 31, 2007, respectively) |
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7,611 |
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11,859 |
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Unbilled revenue |
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4,286 |
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4,793 |
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Inventories |
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4,509 |
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4,682 |
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Prepaid expenses and other current assets |
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1,390 |
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354 |
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Total current assets |
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50,804 |
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36,739 |
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Property, plant and equipment, net |
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8,754 |
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8,780 |
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Deferred income tax asset |
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2,901 |
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Prepaid pension asset |
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2,473 |
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445 |
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Other assets |
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28 |
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13 |
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Total assets |
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$ |
62,059 |
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$ |
48,878 |
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Liabilities and stockholders equity |
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Current liabilities: |
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Current portion of long-term debt |
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$ |
25 |
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$ |
37 |
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Accounts payable |
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3,371 |
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5,143 |
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Accrued compensation |
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3,582 |
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3,205 |
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Accrued expenses and other liabilities |
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1,853 |
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2,048 |
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Customer deposits |
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7,855 |
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6,100 |
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Deferred income tax liability |
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68 |
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87 |
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Total current liabilities |
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16,754 |
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16,620 |
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Long-term debt |
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40 |
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56 |
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Accrued compensation |
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294 |
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263 |
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Other long-term liabilities |
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154 |
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58 |
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Accrued pension liability |
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266 |
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251 |
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Accrued postretirement benefits |
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998 |
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976 |
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Total liabilities |
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18,506 |
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18,224 |
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Stockholders equity: |
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Preferred stock, $1 par value Authorized, 500 shares |
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Common stock, $.10 par value Authorized, 6,000 shares
Issued and outstanding, 4,961 and 4,859 shares at
December 31 and March 31, 2007, respectively |
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496 |
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389 |
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Capital in excess of par value |
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12,194 |
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10,008 |
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Retained earnings |
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33,174 |
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22,675 |
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Accumulated other comprehensive loss |
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(2,299 |
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(2,367 |
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Notes receivable from officers and directors |
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(12 |
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(51 |
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Total stockholders equity |
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43,553 |
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30,654 |
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Total liabilities and stockholders equity |
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$ |
62,059 |
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$ |
48,878 |
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See Notes to Condensed Consolidated Financial Statements.
4
GRAHAM CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND RETAINED EARNINGS
(Unaudited)
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Three Months Ended |
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Nine Months Ended |
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December 31, |
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December 31, |
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2007 |
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2006 |
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2007 |
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2006 |
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(Amounts in thousands, except per share data) |
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Net sales |
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$ |
20,625 |
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$ |
14,500 |
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$ |
63,672 |
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$ |
45,011 |
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Cost of products sold |
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11,978 |
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11,110 |
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38,449 |
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34,279 |
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Gross profit |
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8,647 |
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3,390 |
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25,223 |
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10,732 |
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Other expenses and income: |
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Selling, general and administrative |
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3,239 |
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2,530 |
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9,756 |
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7,441 |
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Interest income |
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(304 |
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(130 |
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(799 |
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(356 |
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Interest expense |
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1 |
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2 |
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9 |
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8 |
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Total other expenses |
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2,936 |
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2,402 |
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8,966 |
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7,093 |
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Income before income taxes |
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5,711 |
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988 |
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16,257 |
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3,639 |
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Provision for income taxes |
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1,948 |
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322 |
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5,414 |
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1,294 |
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Net income |
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3,763 |
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666 |
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10,843 |
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2,345 |
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Retained earnings at beginning of period |
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29,559 |
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18,787 |
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22,675 |
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17,301 |
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Dividends |
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(148 |
) |
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(97 |
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(344 |
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(290 |
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Retained earnings at end of period |
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$ |
33,174 |
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$ |
19,356 |
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$ |
33,174 |
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$ |
19,356 |
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Per Share Data: |
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Basic: |
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Net income |
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$ |
.76 |
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$ |
.14 |
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$ |
2.20 |
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$ |
.48 |
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Diluted: |
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Net income |
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$ |
.74 |
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$ |
.14 |
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$ |
2.16 |
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$ |
.48 |
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Weighted average common shares outstanding: |
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Basic: |
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4,972 |
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4,876 |
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4,936 |
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4,857 |
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Diluted: |
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5,062 |
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4,922 |
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5,018 |
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4,922 |
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Dividends declared per share |
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$ |
.03 |
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$ |
.02 |
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$ |
.07 |
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$ |
.06 |
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See Notes to Condensed Consolidated Financial Statements.
5
GRAHAM CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
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Nine Months Ended |
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December 31, |
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2007 |
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2006 |
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(Amounts in thousands) |
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Operating activities: |
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Net income |
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$ |
10,843 |
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$ |
2,345 |
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Adjustments to reconcile net income to net cash provided by operating activities: |
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Depreciation and amortization |
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706 |
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663 |
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Discount accretion on investments |
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(693 |
) |
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(315 |
) |
Stock-based compensation expense |
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125 |
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59 |
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Gain on disposal of property, plant and equipment |
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(13 |
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Deferred income taxes |
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3,035 |
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1,291 |
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(Increase) decrease in operating assets: |
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Accounts receivable |
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4,248 |
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(1,360 |
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Unbilled revenue |
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507 |
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1,189 |
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Inventories |
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173 |
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(351 |
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Domestic and foreign income taxes receivable/payable |
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(687 |
) |
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(158 |
) |
Prepaid expenses and other current and non-current assets |
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(376 |
) |
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(69 |
) |
Prepaid pension asset |
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(2,028 |
) |
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(2,109 |
) |
Increase (decrease) in operating liabilities: |
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Accounts payable |
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(1,866 |
) |
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1,750 |
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Accrued compensation, accrued expenses and other current and non-current
liabilities |
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214 |
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(726 |
) |
Customer deposits |
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1,745 |
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1,375 |
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Long-term portion of accrued compensation, accrued pension liability
and accrued postretirement benefits |
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68 |
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(71 |
) |
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Total adjustments |
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5,171 |
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1,155 |
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Net cash provided by operating activities |
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16,014 |
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3,500 |
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Investing activities: |
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Purchase of property, plant and equipment |
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(659 |
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(1,152 |
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Proceeds from sale of property, plant and equipment |
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44 |
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15 |
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Purchase of investments |
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(65,271 |
) |
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(22,446 |
) |
Redemption of investments at maturity |
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49,750 |
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21,500 |
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Net cash used by investing activities |
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(16,136 |
) |
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(2,083 |
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Financing activities: |
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Proceeds from issuance of long-term debt |
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69 |
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3,073 |
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Principal repayments on long-term debt |
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(97 |
) |
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(3,110 |
) |
Issuance of common stock |
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|
970 |
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|
413 |
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Collection of notes receivable from officers and directors |
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39 |
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13 |
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Dividends paid |
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(344 |
) |
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(290 |
) |
Excess tax deduction from exercise of stock options |
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1,198 |
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Net cash provided by financing activities |
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1,835 |
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|
99 |
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Effect of exchange rates on cash |
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30 |
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6 |
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Net increase in cash and cash equivalents |
|
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1,743 |
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|
1,522 |
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Cash and cash equivalents at beginning of period |
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1,375 |
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|
570 |
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Cash and cash equivalents at end of period |
|
$ |
3,118 |
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|
$ |
2,092 |
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|
See Notes to Condensed Consolidated Financial Statements.
6
GRAHAM CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2007 and 2006
(Unaudited)
(Amounts in thousands, except per share data)
NOTE 1 BASIS OF PRESENTATION:
Graham Corporations (the Companys) Condensed Consolidated Financial Statements include two
wholly-owned foreign subsidiaries, one located in the United Kingdom and one located in China, and
have been prepared in accordance with accounting principles generally accepted in the United States
(GAAP) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of
Regulation S-X, as promulgated by the Securities and Exchange Commission. The Condensed
Consolidated Financial Statements do not include all information and notes required by GAAP for
complete financial statements. The March 31, 2007 Condensed Consolidated Balance Sheet was derived
from the Companys audited Consolidated Balance Sheet as of March 31, 2007. For additional
information, please refer to the consolidated financial statements and notes included in the
Companys Annual Report on Form 10-K for the year ended March 31, 2007, referred to as fiscal year
2007. In the opinion of management, all adjustments, including normal recurring accruals
considered necessary for a fair presentation, have been included in the Companys Condensed
Consolidated Financial Statements.
The Companys results of operations for the three and nine months ended December 31, 2007 and
cash flows for the nine months ended December 31, 2007 are not necessarily indicative of the
results that may be expected for the year ending March 31, 2008, referred to as fiscal year 2008.
On October 26, 2007, the Companys Board of Directors declared a five-for-four stock split of
the Companys common stock and increased the quarterly cash dividend to $.03 per share, effective
for the dividend and 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 or about January 3, 2008. Fractional
shares were aggregated and sold by the Companys transfer agent on or about January 3, 2008 and the
cash received was paid to stockholders of record on November 30, 2007. All share and per share
amounts disclosed in the Statement of Operations and Retained Earnings and Notes 5 and 6 to the
Condensed Consolidated Financial Statements have been adjusted to reflect the five-for-four stock
split.
Certain reclassifications have been made to prior year amounts to conform with the current
year presentation. In the Condensed Consolidated Statements of Operations and Retained Earnings,
interest income was reclassed from Selling, General and
Administrative Expense to the separate
line item Interest Income for the three and nine months ended December 31, 2007 and 2006.
7
NOTE 2 REVENUE RECOGNITION:
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 Companys revenue is recognized under this methodology. The
percentage-of-completion method is determined by comparing actual labor incurred to a specific date
to managements 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 when probable. During the three and nine months ended December 31, 2007, and the three
months ended December 31, 2006, no loss provisions were recorded. During the nine months ended
December 31, 2006, a loss of $329 was recognized on a contract in process.
Revenue on contracts not accounted for using the percentage-of-completion method is recognized
utilizing the completed contract method. The majority of the Companys 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 material obligations under its contracts after the revenue is recognized.
NOTE 3 INVESTMENTS:
Investments consist of fixed-income debt securities issued by the United States Treasury and
other government-sponsored enterprises with original maturities of greater than three months and
less than one year. All investments are classified as held-to-maturity, as the Company has the
intent and ability to hold the securities to maturity. The investments are stated at amortized
cost which approximates fair value. All investments held by the Company at December 31, 2007 are
scheduled to mature between January 16, 2008 and April 3, 2008.
NOTE 4 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 Condensed Consolidated Balance Sheets. Unbilled revenue
in the Condensed 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
8
to the applicable contract, and the excess is presented as customer deposits in the Condensed Consolidated
Balance Sheets.
Major classifications of inventories are as follows:
|
|
|
|
|
|
|
|
|
|
|
December 31, |
|
|
March 31, |
|
|
|
2007 |
|
|
2007 |
|
Raw materials and supplies |
|
$ |
1,853 |
|
|
$ |
1,427 |
|
Work in process |
|
|
3,608 |
|
|
|
6,847 |
|
Finished products |
|
|
550 |
|
|
|
460 |
|
|
|
|
|
|
|
|
|
|
|
6,011 |
|
|
|
8,734 |
|
Less progress payments |
|
|
1,502 |
|
|
|
4,052 |
|
|
|
|
|
|
|
|
Total |
|
$ |
4,509 |
|
|
$ |
4,682 |
|
|
|
|
|
|
|
|
NOTE 5 STOCK-BASED COMPENSATION:
The Amended and Restated 2000 Graham Corporation Incentive Plan to Increase Shareholder Value
provides for the issuance of up to 688 shares of common stock in connection with grants of
incentive stock options, non-qualified stock options, stock awards and performance awards to
officers, key employees and outside directors; however, no more than 125 shares of common stock may
be used for awards other than stock options. Stock options may be granted at prices not less than
the fair market value at the date of grant and expire no later than ten years after the date of
grant.
Stock option awards in the three-and nine-month periods ended December 31, 2007 were 0 and 56,
respectively. Restricted stock awards in the three-and nine-month periods ended December 31, 2007
were 0 and 3 shares. Stock option awards vest 25% per year over a four year term. Restricted
shares vest over a four year term as follows: 10% on the first anniversary of the grant date, 20%
on the second anniversary of the grant date, 30% on the third anniversary of the grant date and 40%
on the fourth anniversary of the grant date. Prior to fiscal year 2008, all awards were in the
form of stock options. All options have a term of ten years from their grant date.
During the three and nine months ended December 31, 2007, the Company recognized stock-based
compensation costs of $47 and $125, respectively. The income tax benefit recognized related to
stock-based compensation was $16 and $43 for the three and nine months ended December 31, 2007,
respectively.
During the three and nine months ended December 31, 2006, the Company recognized stock-based
compensation costs of $26 and $59, respectively. The income tax benefit recognized related to
stock-based compensation was $11 and $25 for the three and nine months ended December 31, 2006,
respectively.
The weighted average fair value of stock options granted in the nine months ended December 31,
2007 and 2006 was $5.99 and $5.54, respectively. There were no options granted during the three
months ended December 31, 2007 and 2006. The fair value of each stock option grant was estimated
using the Black-Scholes option-pricing model with the following weighted average assumptions:
9
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended |
|
|
December 31, |
|
|
2007 |
|
2006 |
Expected life |
|
5 years |
|
5 years |
Expected volatility |
|
|
43.86 |
% |
|
|
48.44 |
% |
Risk-free interest rate |
|
|
4.83 |
% |
|
|
5.03 |
% |
Expected dividend yield |
|
|
.63 |
% |
|
|
.58 |
% |
The expected life represents an estimate of the weighted average period of time that options
are expected to remain outstanding given consideration to vesting schedules and the Companys
historical exercise patterns. Expected volatility is estimated based on the historical closing
prices of the Companys common stock over a period of five years. The risk free interest rate is
estimated based on the United States Federal Reserves historical data for the maturity of nominal
treasury instruments that corresponds to the expected term of the option. Expected dividend yield
is based on historical trends.
The fair value of a restricted share is equal to the market value of a share of the Companys
stock on the date of grant. The weighted average fair value of the restricted shares granted in
the nine months ended December 31, 2007 was $13.80.
The Graham Corporation Outside Directors Long-Term Incentive Plan (the Plan) provides for
awards of share equivalent units for outside directors based upon the Companys performance. Each
unit is equivalent to one share of the Companys common stock. Share equivalent units are credited
to each outside directors account for each of the first five full fiscal years of the directors
service when consolidated net income is at least 100% of the approved budgeted net income for the
year. The share equivalent units are payable in cash or stock upon retirement.
Compensation cost for share equivalent units is recorded based on the higher of the quoted
market price of the Companys stock at the end of the period up to $6.40 per unit or the stock
price at the date of grant. The cost of share equivalent units earned and charged to pre-tax
income under the Plan was $8 and $5 in the three month periods ended December 31, 2007 and 2006,
respectively and $23 and $25 in the nine month periods ended December 31, 2007 and 2006,
respectively. There were 37 share equivalent units in the Plan at December 31, 2007 and 2006, and
the related liability recorded was $304 and $285 at December 31, 2007 and 2006, respectively. The
expense to mark to market the share equivalent units was $0 and $18 in the three months ended
December 31, 2007 and 2006, respectively. The expense to mark to market the share equivalent units
was $8 and $19 in the nine months ended December 31, 2007 and 2006.
NOTE 6 INCOME PER SHARE:
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:
10
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
December 31, |
|
|
December 31, |
|
|
|
2007 |
|
|
2006 |
|
|
2007 |
|
|
2006 |
|
Basic income per share |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Numerator: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
3,763 |
|
|
$ |
666 |
|
|
$ |
10,843 |
|
|
$ |
2,345 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted common shares outstanding |
|
|
4,935 |
|
|
|
4,839 |
|
|
|
4,899 |
|
|
|
4,821 |
|
Share equivalent units (SEUs) |
|
|
37 |
|
|
|
37 |
|
|
|
37 |
|
|
|
36 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average common shares and SEUs |
|
|
4,972 |
|
|
|
4,876 |
|
|
|
4,936 |
|
|
|
4,857 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic income per share |
|
$ |
.76 |
|
|
$ |
.14 |
|
|
$ |
2.20 |
|
|
$ |
.48 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted income per share |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Numerator: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
3,763 |
|
|
$ |
666 |
|
|
$ |
10,843 |
|
|
$ |
2,345 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares and SEUs
outstanding |
|
|
4,972 |
|
|
|
4,876 |
|
|
|
4,936 |
|
|
|
4,857 |
|
Stock options outstanding |
|
|
90 |
|
|
|
46 |
|
|
|
82 |
|
|
|
65 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average common and potential
common shares outstanding |
|
|
5,062 |
|
|
|
4,922 |
|
|
|
5,018 |
|
|
|
4,922 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted income per share |
|
$ |
.74 |
|
|
$ |
.14 |
|
|
$ |
2.16 |
|
|
$ |
.48 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options to purchase 56 shares of common stock, outstanding at December 31, 2006, were not
included in the above computation of diluted income per share because their effect would be
anti-dilutive.
NOTE 7 PRODUCT WARRANTY LIABILITY:
The reconciliation of the changes in the product warranty liability is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
December 31, |
|
|
December 31, |
|
|
|
2007 |
|
|
2006 |
|
|
2007 |
|
|
2006 |
|
Balance at beginning of period |
|
$ |
451 |
|
|
$ |
356 |
|
|
$ |
357 |
|
|
$ |
330 |
|
Provision for product warranties |
|
|
86 |
|
|
|
48 |
|
|
|
316 |
|
|
|
172 |
|
Product warranty claims paid |
|
|
(87 |
) |
|
|
(49 |
) |
|
|
(223 |
) |
|
|
(147 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at end of period |
|
$ |
450 |
|
|
$ |
355 |
|
|
$ |
450 |
|
|
$ |
355 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The provision for product warranties is based upon a percentage of sales and historical claims
experience. The increase in the provision for product warranties is due to the increase in sales.
NOTE 8 CASH FLOW STATEMENT:
Interest paid was $9 and $8 for the nine months ended December 31, 2007 and 2006,
respectively. In addition, income taxes paid were $1,889 and $133 for the nine months ended
December 31, 2007 and 2006, respectively.
11
During the three and nine months ended December 31, 2007, stock option awards were exercised
and the related income tax benefit realized exceeded the tax benefit that had been recorded
pertaining to the compensation cost recognized. This excess tax deduction has been separately
reported under Financing activities in the Condensed Consolidated Statement of Cash Flows.
Non cash activities during the nine months ended December 31, 2007 included a reclassification
from Capital in excess of par value to Common stock for $99 which represents the par value of
the additional shares issued to effect the five-for-four stock split. (See Note 1).
NOTE 9 COMPREHENSIVE INCOME:
Total comprehensive income was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
December 31, |
|
|
December 31, |
|
|
|
2007 |
|
|
2006 |
|
|
2007 |
|
|
2006 |
|
Net income |
|
$ |
3,763 |
|
|
$ |
666 |
|
|
$ |
10,843 |
|
|
$ |
2,345 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign currency translation adjustment |
|
|
12 |
|
|
|
2 |
|
|
|
27 |
|
|
|
5 |
|
Deferred benefit pension and other
postretirement plans |
|
|
14 |
|
|
|
|
|
|
|
41 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total comprehensive income |
|
$ |
3,789 |
|
|
$ |
668 |
|
|
$ |
10,911 |
|
|
$ |
2,350 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As a result of the adoption of the effective provisions of Statement of Financial Accounting
Standard No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plans,
in the fourth quarter of fiscal year 2007, defined benefit pension and other postretirement plans
reflected the amortization of prior service costs and losses related to such plans during the
period.
NOTE 10 EMPLOYEE BENEFIT PLANS:
The components of pension cost are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
December 31, |
|
|
December 31, |
|
|
|
2007 |
|
|
2006 |
|
|
2007 |
|
|
2006 |
|
Service cost |
|
$ |
121 |
|
|
$ |
118 |
|
|
$ |
364 |
|
|
$ |
354 |
|
Interest cost |
|
|
278 |
|
|
|
264 |
|
|
|
832 |
|
|
|
792 |
|
Expected return on assets |
|
|
(409 |
) |
|
|
(351 |
) |
|
|
(1,225 |
) |
|
|
(1,020 |
) |
Amortization of: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrecognized prior service cost |
|
|
1 |
|
|
|
1 |
|
|
|
3 |
|
|
|
3 |
|
Actuarial loss |
|
|
56 |
|
|
|
88 |
|
|
|
167 |
|
|
|
262 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net pension cost |
|
$ |
47 |
|
|
$ |
120 |
|
|
$ |
141 |
|
|
$ |
391 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
12
The Company made a contribution of $2,000 to its defined benefit pension plan during the nine
months ended December 31, 2007. The Company expects its contribution to the plan for the balance
of fiscal year 2008 to be approximately $1,000.
The components of the postretirement benefit income are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
December 31, |
|
|
December 31, |
|
|
|
2007 |
|
|
2006 |
|
|
2007 |
|
|
2006 |
|
Service cost |
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
Interest cost |
|
|
14 |
|
|
|
16 |
|
|
|
44 |
|
|
|
48 |
|
Amortization of prior service cost |
|
|
(41 |
) |
|
|
(41 |
) |
|
|
(124 |
) |
|
|
(124 |
) |
Amortization of actuarial loss |
|
|
6 |
|
|
|
4 |
|
|
|
18 |
|
|
|
12 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net postretirement benefit income |
|
$ |
(21 |
) |
|
$ |
(21 |
) |
|
$ |
(62 |
) |
|
$ |
(64 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
The Company paid benefits of $22 related to its postretirement benefit plan during the nine
months ended December 31, 2007. The Company expects to pay benefits of approximately $118 for the
balance of fiscal year 2008.
NOTE 11 CONTINGENCIES AND COMMITMENTS:
The Company has been named as a defendant in certain lawsuits alleging 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 lawsuits and intends to vigorously defend itself against these
claims. The claims are similar to previous asbestos suits that named 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.
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 the Company is subject to legal
proceedings and potential claims. At December 31, 2007, other than noted above, management was
unaware of any other litigation matters.
In May 2006, the Company completed the formation of a wholly-owned Chinese subsidiary located
in Suzhou and committed to invest an aggregate of $2,100 over a two-year period. As of December
31, 2007, the Company had invested $1,464 in its Chinese subsidiary. In January 2008, the Company
funded the remainder of its commitment.
NOTE 12 INCOME TAXES:
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 has had no effect on the Companys financial position or results of
operations. The Company had no unrecognized tax benefits as of April 1, 2007 or
13
December 31, 2007 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 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 subject to
examination by the United States Internal Revenue Service for tax years 2005 through 2007 and tax
year 2006 is currently under examination. The Company is subject to examination in state and
international tax jurisdictions for tax years 2004 through 2007 and tax years 2006 through 2007,
respectively. It is the Companys policy to recognize any interest related to uncertain tax
positions in interest expense and any penalties related to uncertain tax positions in selling,
general and administrative expense. The Company had not recorded any interest or penalties related
to uncertain tax positions as of April 1, 2007 or December 31, 2007.
NOTE 13 DEBT:
On December 5, 2007, the Company entered into a new revolving credit facility agreement that
provides a line of credit up to $30,000, including letters of credit and bank guarantees, through
December 5, 2010. There are no sublimits in the agreement with regard to borrowings, issuance of
letters of credit or issuance of bank guarantees for the Companys Chinese subsidiary. The
agreement allows the Company to borrow at the banks prime rate minus a variable percentage that
may range from .50% to 1.25% or the LIBOR rate plus a variable percentage that may range from .50%
to 1.25%. The variable percentage is based upon the Companys ratio of total liabilities to
tangible net worth.
The agreement allows the Company at any time to convert balances outstanding not less than
$2,000 and up to $9,000 into a two-year term loan. Under this conversion feature, which is
available through December 5, 2010, the Company may convert the principal outstanding on the
revolving line of credit to a two-year term loan.
The Company is required to pay commitment fees on the unused portion of the domestic revolving
credit facility of 25 basis points less a variable percentage that may range from .25% to .125%.
The variable percentage is based upon the Companys ratio of total liabilities to tangible net
worth. The loan agreement contains provisions pertaining to the maintenance of a minimum total
liabilities to tangible net worth ratio of 1.35 to 1 as well as restrictions on the payment of
dividends to stockholders and incurrence of additional long-term debt. The dividend provision
limits the payment of dividends to stockholders to $1,200 per year.
NOTE 14 ACCOUNTING AND REPORTING CHANGES:
In September 2006, the FASB issued Statement of Financial Accounting Standards (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 is effective for fiscal years beginning after November 15,
2007. The Company is currently evaluating the potential impact SFAS No. 157 will have on its
financial position, results of operations and cash flows.
14
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and
Financial Liabilities. SFAS No. 159 permits entities to choose to measure various financial
instruments and certain other items at fair value in order to mitigate volatility in reporting
earnings caused by measuring related assets and liabilities differently. SFAS No. 159 is effective
for fiscal years beginning after November 15, 2007. The Company is currently evaluating the
potential impact SFAS No. 159 may have on its financial position, results of operations and cash
flows, in the event it chooses to adopt SFAS No. 159.
In fiscal year 2007, the Company adopted the effective provisions of SFAS No. 158, Employers
Accounting for Defined Benefit Pension and Other Postretirement Plans. The Company will adopt the
measurement provision of SFAS No. 158 as of March 31, 2009.
15
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
(Amounts in thousands, except per share data)
Overview
Graham Corporation (we, our or us) is a designer, manufacturer and worldwide supplier of
ejectors, liquid ring pumps, condensers and heat exchangers. The principal markets for our
equipment are the petrochemical, oil refinery and electric power generation industries, including
cogeneration and geothermal plants. Our equipment can also be found in diverse applications such
as metal refining, pulp and paper processing, shipbuilding, water heating, refrigeration,
desalination, food processing, pharmaceuticals, oil sands, heating, ventilating and air
conditioning.
Our corporate offices and production facilities are located in Batavia, New York. We have two
wholly-owned foreign subsidiaries, one located in the United Kingdom and one in China. Our United
Kingdom subsidiarys principle function is to support sales orders from Europe and the Middle East.
Our subsidiary in China serves to support sales orders from Asia and provide engineering support
and supervision of subcontracted fabrication. Our current fiscal year, which we refer to as fiscal
2008, began April 1, 2007 and ends March 31, 2008.
Highlights for the three and nine-month periods ended December 31, 2007 include:
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Net income and income per diluted share for the current quarter were $3,763 and
$0.74, compared with $666 and $0.14 for the three months ended December 31, 2006.
Net income and income per diluted share for the nine months ended December 31, 2007
were $10,843 and $2.16, compared with net income and income per diluted share for
the nine-month period ended December 31, 2006 of $2,345 and $0.48. |
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Net sales for the third quarter and first nine months of fiscal 2008 were
$20,625 and $63,672, up 42% and 41% respectively, compared with the third quarter
and first nine-months of fiscal 2007, when sales were $14,500 and $45,011,
respectively. |
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Orders placed with us in the quarter ended December 31, 2007 of $26,647 were up
56% from the three-month period ended December 31, 2006, when orders were $17,127.
Orders for the nine-month periods ended December 31, 2007 and 2006 were $72,018 and
$59,284, respectively, up 21% in fiscal 2008. |
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Backlog grew to $62,974 as of December 31, 2007, representing a 32% increase
compared with December 31, 2006, when backlog was $47,597. |
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Gross profit margins for the quarter and nine-month period ended December 31,
2007 were 42% and 40%, respectively, compared with 23% and 24%, respectively, for
the three and six-month periods ended December 31, 2006. |
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Operating margins for the quarter and nine-month period ended December 31, 2007
were 26% and 24%, compared with 6% and 7% for the three and nine-month periods
ended December 31, 2006. |
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On October 26, 2007, our Board of Directors declared a five-for-four stock
split. The new shares were distributed on or about January 3, 2008. Earnings per
share and share data included in this Quarterly Report on Form 10-Q reflect the
effects |
16
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of this stock split retroactively for all periods included in this Quarterly Report
on Form 10-Q where earnings per share and share data has been reported. |
We believe the principal market drivers that have led to increased capital spending by our
customers and that are contributing to our sales growth include the factors set forth below:
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Global consumption of crude oil is estimated to expand significantly during the
next decade. |
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It is generally believed that there is a shortage of global oil refining
capacity, which is being addressed through refinery upgrades, revamps and
expansions. |
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Known supplies of sweet crude oil are being depleted. Sour crude sources are
identified and believed to be plentiful. |
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There is a differential in raw material prices for higher quality sweet and
lower quality sour crude oil, which is more costly to refine than sweet crude
oil. To lower production costs, many refineries are upgrading facilities in order
to be able to process sour crude oil, which requires an upgrade of vacuum and heat
transfer equipment of the types we design and manufacture. |
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The expansion of the middle class in Asia is driving increasing demand for
gasoline, power and petrochemical products. |
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The high cost of natural gas in North America and Europe is leading to the
construction of new petrochemical plants in the Middle East and Asia, where natural
gas is plentiful and less expensive. |
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There is an increased need in certain regions for geothermal electrical power
plants to meet increased electricity demand. |
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Refineries in the United States are being upgraded to process synthetic crude
oil from Alberta oil sands. |
Forward-Looking Statements
This report and other documents we file with the Securities and Exchange Commission include
forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended.
These statements involve known and unknown risks, uncertainties and other factors that may
cause actual results to be materially different from any future results implied by the
forward-looking statements. Such factors include, but are not limited to, the risks and
uncertainties identified by us under the heading Risk Factors in Item 1A of our Annual Report on
Form 10-K for fiscal 2007. Forward-looking statements may also include, but are not limited to,
statements about:
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the current and future economic environments affecting us and the markets we
serve; |
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sources of revenue and anticipated revenue, including the contribution from the
growth of new products, services and markets; |
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plans for future products and services and for enhancements to existing products
and services; |
17
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estimates regarding our liquidity and capital requirements; |
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our ability to attract or retain customers; |
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the outcome of any existing or future litigation; and |
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our ability to manage our productivity and capacity. |
Forward-looking statements are usually accompanied by words such as anticipate, believe,
estimate, may, intend, expect and similar expressions. Actual results could differ
materially from historical results or those implied by the forward-looking statements contained in
this report.
Undue reliance should not be placed on these forward-looking statements. Except as required
by law, we undertake no obligation to update or announce any revisions to forward-looking
statements contained in this report, whether as a result of new information, future events or
otherwise.
Critical Accounting Policies
The discussion and analysis of our financial condition and results of operations are based
upon the condensed consolidated financial statements and the notes to the condensed consolidated
financial statements included in Item 1 of this Quarterly Report on Form 10-Q, which have been
prepared in accordance with accounting principles generally accepted in the United States.
Critical accounting policies are defined as those that reflect significant judgments and
uncertainties, and could potentially result in materially different results under different
assumptions and conditions.
Revenue Recognition. We recognize revenue on all contracts with a planned manufacturing
process in excess of four weeks (which approximates 575 direct labor hours) using the
percentage-of-completion method. The percentage-of-completion method is determined by comparing
actual labor incurred to a specific date to our estimate of the total labor to be incurred on each
contract. Contracts in progress are reviewed monthly, and sales and earnings are adjusted in
current accounting periods based on revisions in the contract value and estimated material and
labor costs at completion. Losses on contracts are recognized when probable.
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 Moodys or Citigroup Pension
Liability Index AA-rated corporate long-term bond yield rate.
18
The long-term expected rate of return on plan assets is based on the plans 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 financial statements
and related notes presented in this Quarterly Report on Form 10-Q and believe those policies to be
reasonable and appropriate. We believe that the most critical accounting estimates used in the
preparation of our 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.
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 Condensed
Consolidated Financial Statements included in Item 1 of this Quarterly Report on Form 10-Q.
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.
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 and have been disclosed in our Annual Report on Form 10-K for fiscal 2007.
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 2008 is 5.91% for our defined benefit pension and 5.65% for our other postretirement benefit
plan. A reduction in the discount rate of 50 basis points, with all other assumptions held
constant, would increase fiscal 2008 net periodic benefit expense for our defined benefit pension
and other postretirement benefit plan by approximately $151 and $0, respectively.
19
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 increase fiscal 2008 net periodic pension expense by
approximately $96.
As part of our ongoing financial reporting process, a collaborative effort is undertaken
involving our managers with functional responsibilities for financial, credit, tax, engineering,
manufacturing and benefit matters and outside advisors such as lawyers, consultants and actuaries.
We believe that the results of this effort provide management with the necessary information on
which to base their judgments and to develop the estimates and assumptions used to prepare the
financial statements.
We believe that the amounts recorded in the condensed consolidated financial statements
included with this Quarterly Report on Form 10-Q related to contingencies, revenue, pensions, other
post retirement benefits and other matters requiring the use of estimates and judgments are
reasonable, although actual outcomes could differ materially from our estimates.
Results of Operations
For an understanding of the significant factors that influenced our performance, the following
discussion should be read in conjunction with our condensed consolidated financial statements and
the notes to condensed consolidated financial statements included in Item 1 of this Quarterly
Report on Form 10-Q.
The following table summarizes our results of operations for the periods indicated:
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Three Months Ended |
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Nine Months Ended |
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December 31, |
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December 31, |
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2007 |
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2006 |
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2007 |
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2006 |
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Net sales |
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$ |
20,625 |
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$ |
14,500 |
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$ |
63,672 |
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$ |
45,011 |
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Net income |
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$ |
3,763 |
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$ |
666 |
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$ |
10,843 |
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$ |
2,345 |
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Diluted income per share |
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$ |
0.74 |
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$ |
0.14 |
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$ |
2.16 |
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$ |
0.48 |
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Total assets |
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$ |
62,059 |
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$ |
45,399 |
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$ |
62,059 |
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$ |
45,399 |
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Sales for the third quarter of fiscal 2008 were $20,625, a 42% increase, as compared with
sales of $14,500 for the third quarter of fiscal 2007. Sales for the nine months ended December
31, 2007 of $63,672 were up 41%, compared with the nine-month period ended December 31, 2006, when
sales were $45,011. The increase in sales in fiscal 2008 compared with fiscal 2007 came primarily
from ejector sales to the refinery markets, which reflect the demand for our products from both the
North American and global refinery markets. Ejector sales for the nine-month period ended December
31, 2007, compared with the nine months ended December 31, 2006, increased 122% and accounted for
87%, or $16,327, of the total increased sales in fiscal 2008. Sixty-nine percent of the increased
sales for the three months ended December 31, 2007, compared with the three months ended December
31, 2006, came from increased sales of condensers, largely to the petrochemical market, while 21%
of the increase in the current quarter came from aftermarket sales. Export sales accounted for 48%
and 44% of total sales for the quarter and nine months ended December 31, 2007, compared with 39%
and 52% for the three and nine-month periods ended December 31, 2006. The increase in export sales
of $4,614 for the nine-month period came from Asia, South America and Canada for oil projects.
Sales in the third quarter of fiscal 2008 and for the nine months ended December 31, 2007 were,
respectively, 38% and 46% to the refining industry, 42% and 31% to the chemical and
20
petrochemical industries and 20% and 23% to other industrial applications, including
electrical power. Sales in the third quarter and nine-month periods ended December 31, 2006 were,
respectively, 42% and 34% to the refining industry, 29% and 40% to the chemical and petrochemical
industries and 29% and 26% to other industrial applications, including electrical power. For
additional information, see Orders and Backlog below.
Our gross profit percentage for the third quarter and nine months ended December 31, 2007 was
42% and 40%, compared with 23% and 24% for the third quarter and nine month months ended December
31, 2006. Gross profit dollars for the third quarter of fiscal 2008 increased 155%, compared with
the third quarter of fiscal 2007 and 135% for the nine-month period ended December 31, 2007,
compared with the first nine months of fiscal 2007. Gross profit percentage and dollars increased
primarily due to improved product mix achieved by increased selectivity on orders accepted,
manufacturing outsourcing and improved engineering and manufacturing efficiencies. Our use of
manufacturing outsourcing and our improved operating efficiencies enabled us to achieve greater
sales volume during the first nine months of fiscal 2008. We believe we will continue to increase
capacity through outsourcing and improving operating efficiencies and that these efforts will
contribute to sales trending upward in fiscal 2009 compared with the current fiscal year.
Selling, general and administrative (SG&A) expenses for the third quarter of fiscal 2008 and
2007 were 16% and 17% of sales, respectively. SG&A expenses for the nine months ended December 31,
2007 and 2006 were 15% and 17%, respectively, of sales. The decline, expressed as a percentage of
sales, was due to greater sales in the current fiscal year. Actual costs for the third quarter of
fiscal 2008 increased $709, or 28%, compared with the third quarter of fiscal 2007. For the nine
months ended December 31, 2007, actual costs increased $2,315, or 31%, compared with the nine-month
period ended December 31, 2006. 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 the third quarters of fiscal 2008 and 2007 was $304 and $130,
respectively. For the nine months ended December 31, 2007 and 2006, interest income was $799 and
$356, respectively. Increased interest income followed increases in investments.
Interest expense was $1 and $2 in the third quarter of fiscal 2008 and 2007, respectively.
For the nine-month periods ended December 31, 2007 and 2006, interest expense was $9 and $8,
respectively. Interest expense increased slightly in fiscal 2008 due to more capital equipment
leasing activities.
Our effective tax rate in the third quarter of fiscal 2008 was 34%, compared with an effective
tax rate of 33% for the third quarter of fiscal 2007. The increase was due to greater annual
projected taxable income compared with fiscal 2007, resulting in a higher blended statutory tax
rate. Our effective tax rate used for the nine months ended December 31, 2006 was 36%, compared
with 33% for the nine months ended December 31, 2007. Our projected effective tax rate for fiscal
2008 is 34%. The current years rate is lower due to anticipated research and development tax
credits in fiscal 2008.
Net income for the third quarter of fiscal 2008 and 2007 was $3,763 and $666, respectively.
Income per diluted share was $0.74 and $0.14 for the respective periods. For the nine months ended
December 31, 2007 and 2006, net income was $10,843 and $2,345, respectively, and income per diluted
share was $2.16 and $0.48 for the same respective periods.
21
Liquidity and Capital Resources
The following discussion should be read in conjunction with our condensed consolidated
statements of cash flows:
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December 31, |
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2007 |
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2006 |
Cash and investments |
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$ |
33,008 |
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$ |
13,771 |
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Working capital |
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$ |
34,050 |
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$ |
17,818 |
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Working capital ratio(1) |
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3.0 |
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2.4 |
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Long-term leases |
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$ |
40 |
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$ |
9 |
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Long-term debt/capitalization(2) |
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0.1 |
% |
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0.0 |
% |
Long-term liabilities/capitalization(3) |
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4 |
% |
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9 |
% |
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(1) |
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Working capital ratio equals current assets divided by current liabilities. |
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(2) |
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Long-term debt/capitalization equals long-term debt divided by stockholders equity
plus long-term debt. |
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Long-term liabilities/capitalization equals total liabilities minus current liabilities
divided by stockholders equity plus long-term debt. |
Net cash provided by operating activities for the first nine months of fiscal 2008 was
$16,014, compared with $3,500 for the nine months ended December 31, 2006. The increase was due to
greater net income as well as the greater use of deferred tax assets in the nine-month period ended
December 31, 2007 (i.e., net operating losses and research and development credits), which was
enabled by greater income and less operating working capital. Operating working capital was lower
due to continued reduction in our cash conversion cycle.
We invest net cash generated from operations in excess of cash held for near-term needs in
marketable securities. Investments are United States government and government-sponsored Moodys
Investor Service, Inc. AAA rated instruments, generally with maturity periods of 91 to 120 days.
Investments at December 31, 2007 and March 31, 2007 were $29,890 and $13,676, respectively.
Other sources of cash for the nine-months ended December 31, 2007 included the issuance of
common stock to cover stock options exercised, which raised $970, as compared with $413 in the
first nine months of fiscal 2007, sales of equipment, which raised $44 as compared with $15 for the
nine months ended December 31, 2006, and repayments of notes outstanding for purchases of common
stock granted under our Long-Term Stock Ownership Plan of $39, compared with $13 for the nine
months ended December 31, 2006. In the current quarter, under financing activities, we recognized
a $1,198 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.
Other uses of cash for the nine months ended December 31, 2007 included dividend payments of
$344 and capital expenditures of $659, compared with $290 and $1,152, respectively, for the first
nine months of fiscal 2007. In the current nine-month period, we borrowed and repaid $69 to
finance working capital needs, as compared with $3,073 for the nine months ended December 31, 2006.
In the nine months ended December 31, 2007, we contributed $2,000 into our defined benefit pension
plan, compared with $2,500 for the nine months ended December 31, 2006.
22
Capital expenditures for fiscal 2008 are projected to be $1,500 and to consist largely of
continuing plant productivity and information technology enhancements.
On December 5, 2007, we entered into a new revolving credit facility with Bank of America,
N.A. that provides a line of credit of $30,000 including letters of credit and bank guarantees.
Borrowings under our banking facility are secured by all of our assets. Letters of credit
outstanding under our credit facility on December 31, 2007 and 2006 were $11,121 and $7,280,
respectively.
The new revolving credit agreement includes several changes compared with our former credit
facility, including an increase in the facility capacity limit from $20,000; a maximum annual
dividend payout of $1,200 compared with $600; elimination of facility sub-limits for borrowings,
the issuance of letters of credit or the issuance of bank guarantees on the obligations of our
Chinese subsidiary by Bank of Americas Shanghai China branch; expanded use of borrowings; and a
reduction in pricing. Under the new revolving credit agreement, we covenant to maintain a ratio of
total liabilities, excluding non-current portion of subordinated liabilities, to tangible net worth
not to exceed 1.35 to 1.
We had no borrowings outstanding on either December 31, 2007 or 2006. Our borrowing rate as
of December 31, 2007 was Bank of Americas prime rate minus 125 basis points, or 6%. We believe
that cash generated from operations, combined with our investments and available financing capacity
under our credit facility, will be adequate to meet our cash needs for the immediate future.
Orders and Backlog
Orders for the three-month periods ended December 31, 2007 and 2006 were $26,647 and $17,127,
respectively, up 56%. Orders for the nine-month period ended December 31, 2007 of $72,018 were up
21%, compared with the nine months ended December 31, 2006, when orders were $59,284. Orders
represent communications received from customers requesting us to supply products and services. We
experienced a significant increase in orders for vacuum pump systems, surface condensers and
aftermarket orders in the three-month period ended December 31, 2007, compared with the three-month
period ended December 31, 2006. This business included orders received outside of the oil refinery
sector, largely for fertilizer and ethanol applications as well as for significant capital
maintenance projects in the domestic refinery sector. As a result of expanded capacity in the
third quarter of fiscal 2008, we accepted orders from a broader industry group.
Domestic orders were up 101%, or $9,877, and export orders were down 5% in the third quarter
ended December 31, 2007, in each case compared with the third quarter of fiscal 2007. For the nine
months ended December 31, 2007, compared with the nine months ended December 31, 2006, domestic
orders were up 103%, or $26,310, and export orders were down 40%, or $13,576. Domestic refinery
orders are attributed to refinery capacity expansion, revamping of refineries to process heavier
feed stocks, and requirements to meet cleaner fuel standards. Export refinery orders from South
America and China were up in the nine months ended December 31, 2007 as compared with the nine
months ended December 31, 2006. This increase was driven by greater use of unconventional fuels
and by capacity expansion projects in Asia. Petrochemical and other process industry business was
driven largely from the global need to increase capacity and the expansion of emerging alternative
energy technologies.
The geographic origination of orders is largely a matter of order selection by us. Looking
ahead to fiscal 2009, we believe the global refinery and petrochemical markets we serve will
continue to be strong and could remain strong for the next several years. Our revenue is driven
significantly from major project work. As a result, the timing of when two or three orders within
23
a six-month period are released can have a significant impact on a future quarterly period. In
general, we believe the revenue outlook for our business remains on an upward trend for the
current and next few years, as we continue to expand our capacity to address growing demand,
however, we believe quarterly sales, orders, net income and other financial information, compared
on a year-over-year basis, will result in both increases and decreases, and decisions on upward or
downward financial trends from this data should not be reached because our quarterly financial
results can be very sensitive to a limited number of transactions.
Backlog was $62,974 at December 31, 2007, compared with $47,597 at December 31, 2006, a 32%
increase. Backlog is defined as the total dollar value of orders received for which revenue has
not yet been recognized. All orders in backlog represent orders from our traditional markets in
established product lines. Approximately 13% of orders currently in backlog are not expected to be
converted to sales within the next twelve months. Approximately 50% of our backlog can be
attributed to equipment for refinery project work, 23% to chemical and petrochemical projects, and
27% to 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 December 31, 2007, other than noted above, we were unaware of any other
pending litigation matters.
In May 2006, we completed the formation of a wholly-owned Chinese subsidiary located in
Suzhou, China, and committed to invest an aggregate of $2,100 over a two-year period. Through
December 31, 2007, we have invested $1,464 in our Chinese subsidiary.
New Accounting Pronouncements
In July 2006, the Financial Accounting Standards Board (FASB) issued Interpretation (FIN)
No. 48, Accounting for Uncertainty in Income Taxes. FIN No. 48 heightens the threshold for
recognizing and measuring tax benefits and requires enterprises to make explicit disclosures about
uncertainties in their income tax positions, including a detailed roll-forward of tax benefits
taken that do not qualify for financial statement recognition. FIN No. 48 was effective as of the
beginning of fiscal 2008, which commenced April 1, 2007. The adoption of FIN No. 48 had no effect
on our financial position or results of operations.
In September 2006, the 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 is effective as of the beginning of our 2009 fiscal year,
which commences April 1, 2008. We are currently evaluating the impact SFAS No. 157 will have on
our financial position, results of operations and cash flows.
In fiscal 2007, we adopted the effective provisions of SFAS No. 158, Employers Accounting for
Defined Benefit Pension and Other Postretirement Plans. We will adopt the measurement provisions
of SFAS No. 158 as of March 31, 2009.
24
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and
Financial Liabilities. SFAS No. 159 permits entities to choose to measure certain financial
instruments and certain other items at fair value in order to mitigate volatility in reported
earnings. SFAS No. 159 is effective as of the beginning of fiscal 2009. We are currently studying
the impact on our financial position, results of operations and cash flows for our fiscal year
ending March 31, 2009, if we choose to adopt SFAS No. 159.
Off Balance Sheet Arrangements
We did not have any off balance sheet arrangements as of December 31, 2007 or 2006 other than
operating leases.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The principal market risks (i.e., the risk of loss arising from changes in market rates and
prices) to which we are exposed are:
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foreign currency exchange rates; and |
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equity price risk (related to our Long-Term Incentive Plan). |
The assumptions applied in preparing the following qualitative and quantitative disclosures
regarding foreign currency exchange rate and equity price risk are based upon volatility ranges
experienced by us in relevant historical periods, our current knowledge of the marketplace, and our
judgment of the probability of future volatility based upon the historical trends and economic
conditions of the markets in which we operate.
Foreign Currency
International consolidated sales for the three and nine-month periods ended December 31, 2007
were 48% and 44% of total sales, compared with 39% and 52% for the three and nine-month periods
ended December 31, 2006. Operating in markets throughout the world exposes us to movements in
currency exchange rates. Currency movements can affect sales in several ways, the foremost being
our ability to compete for orders against foreign competitors that base their prices on relatively
weaker currencies. Business lost due to competition for orders against competitors using a
relatively weaker currency cannot be quantified. In addition, cash can be adversely impacted by
the conversion of sales made by us in a foreign currency to United States dollars. In each of the
three and nine-month periods ended December 31, 2007 and 2006, 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. Forward foreign currency exchange
contracts were not used in any reporting periods in fiscal 2007 or 2008, and as of December 31,
2007 and December 31, 2006, we held no forward foreign currency contracts.
We have limited exposure to foreign currency purchases. In the three-month and nine-month
periods ended December 31, 2007 and 2006, our purchases in foreign currencies represented 2% and
1%, and 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 any reporting periods in fiscal 2008 or 2007, and as of
December 31, 2007 and December 31, 2006, we held no forward foreign currency contracts.
25
Equity Price Risk
Our Long-Term Incentive Plan provides for awards of share equivalent units (SEUs) for our
non-employee directors based upon the performance of our common stock. SEUs are valued at fair
market value, thereby exposing us to equity price risk. Upward adjustment to market value is
limited to (a) $6.40 per unit if at the valuation date the fair market value was less than $6.40
per unit or (b) the fair market value at the valuation date if the fair market value on that date
was greater than $6.40 per unit. Gains and losses recognized due to market price changes are
included in results of operations. Based upon the plan provisions and SEUs outstanding at December
31, 2007 and 2006, and a $45 share price, an increase in our stock price would have no effect on
our income before income taxes because all SEUs outstanding were awarded at a fair market value of
less than $15. A 50% and 75% decrease in our stock price at December 31, 2007 and 2006 would
positively impact income before income taxes by $0 and $17, and $0 and $16, respectively.
Assuming required net income targets are met, certain awards would be provided, and based upon
a per share stock price of $45, a 50-75% decrease in our stock price would positively impact income
before income taxes in future periods ending December 31, as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2008 |
|
2009 |
|
2010 |
|
2011 |
|
2012 |
50% decrease |
|
$ |
17 |
|
|
$ |
34 |
|
|
$ |
47 |
|
|
$ |
59 |
|
|
$ |
66 |
|
75% decrease |
|
$ |
43 |
|
|
$ |
69 |
|
|
$ |
87 |
|
|
$ |
106 |
|
|
$ |
117 |
|
Item 4. Controls and Procedures
Conclusion regarding the effectiveness of disclosure controls and procedures
Our
president and chief executive officer (principal executive officer) and our vice
president of finance and administration and chief financial officer (principal financial officer)
each have evaluated our disclosure controls and procedures (as defined in Exchange Act Rules
13a-15(e) and 15d-15(e)) as of the end of the period covered by this Quarterly Report on Form
10-Q. Based on such evaluation, our president and chief executive officer and vice president of
finance and administration and chief financial officer concluded that our disclosure controls and
procedures were effective as of such date.
Changes in internal control over financial reporting
There has been no change to our internal control over financial reporting during the quarter
covered by this Quarterly Report on Form 10-Q that has materially affected, or that is reasonably
likely to materially affect, our internal control over financial reporting.
26
GRAHAM CORPORATION AND SUBSIDIARIES
FORM 10-Q
December 31, 2007
PART II OTHER INFORMATION
Item 6. Exhibits
See index to exhibits on page 29 of this report.
27
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
|
|
|
By: |
/s/ J. Ronald Hansen
|
|
|
|
J. Ronald Hansen |
|
|
|
Vice President of Finance and Administration and
Chief Financial Officer
(Principal Financial Officer and Principal Accounting Officer) |
|
Date: January 29, 2008
28
INDEX OF EXHIBITS
(3) |
|
Articles of Incorporation and Bylaws |
|
3.2 |
|
Amended and Restated Bylaws of Graham
Corporation, are incorporated herein by
reference to Exhibit 3.2 to the Companys
current Report on Form 8-K dated October 25,
2007. |
|
10.1 |
|
Loan Agreement between the Company and Bank
of America, N.A., dated as of December 5,
2007, is incorporated herein by reference to
Exhibit 99.1 to the Companys Current Report
on Form 8-K dated December 5, 2007. |
|
|
10.2 |
|
Security Agreement between the Company and
Bank of America, N.A., dated as of December
5, 2007, is incorporated herein by reference
to Exhibit 99.2 to the Companys Current
Report on Form 8-K dated December 5, 2007. |
|
|
10.3 |
|
Patent Security Agreement between the
Company and Bank of America, N.A., dated as
of December 5, 2007, is incorporated herein
by reference to Exhibit 99.3 of the
Companys current Report on Form 8-K dated
December 5, 2007. |
|
|
10.4 |
|
Trademark Security Agreement between the
Company and Bank of America, N.A., dated as
of December 5, 2007, is incorporated herein
by reference to the Companys Current Report
on Form 8-K dated December 5, 2007. |
(31) |
|
Rule 13a-14(a)/15d-14(a) Certifications |
|
31.1 |
|
Certification of Principal Executive Officer. |
|
|
31.2 |
|
Certification of Principal Financial Officer. |
(32) |
|
Section 1350 Certifications |
|
32.1 |
|
Section 1350 Certifications. |
29