GRAHAM CORP - Annual Report: 2006 (Form 10-K)

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

ANNUAL REPORT

PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

Commission file number 1-8462

 

GRAHAM CORPORATION

(Exact name of registrant as specified in its charter)

 

 

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

 

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

 

 

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

 

 

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

 

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

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  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 Act).  Yes o     No þ

 

The aggregate market value of the voting stock held by non-affiliates of the Registrant as of September 30, 2005, the last business day of the Company’s most recently completed second fiscal quarter, was $59,088,964. The market value calculation was determined using the closing price of the Registrant’s Common Stock on September 30, 2005, as reported on the American Stock Exchange for purposes of the foregoing calculation only, all directors, officers and the Registrant’s Employee Stock Ownership Plan of the registrant have been deemed affiliates.

 

As of May 31, 2006, there were outstanding 3,832,390 shares of common stock, $.10 par value, and 3,832,390 common stock purchase rights.

 

Documents Incorporated By Reference

 

Portions of the registrant’s definitive Proxy Statement, to be filed in connection with the registrant’s 2006 Annual Meeting of Stockholders, is incorporated by reference into Part III, Items 10, 11, 12, 13 and 14 of this filing.

 

 

Table of Contents

GRAHAM CORPORATION
Annual Report on Form 10-K
Year Ended March 31, 2006

 

 

 

(Dollar amounts in thousands except per share data)

 

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

 

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

 

 

We were incorporated in Delaware in 1983 and are the successor to Graham Manufacturing Co., Inc., which was incorporated in 1936. Our principal business location is in Batavia, New York. We also maintain two wholly-owned subsidiaries, Graham Europe Limited in the United Kingdom and, as of May 2006, Graham Vacuum and Heat Transfer Technology (Suzhou) Co., Ltd. in Suzhou, China. As of March 31, 2006, we had 250 full-time employees, inclusive of employees of our United Kingdom subsidiary.

 

We previously had an additional subsidiary located in the United Kingdom that manufactured vacuum equipment. In March 2005, our Board of Directors approved a plan to discontinue the operations of this subsidiary and such subsidiary’s principal creditor appointed a receiver to liquidate its assets. In May 2005, the assets of this subsidiary were sold. As a result of this divestiture, the operations of our former United Kingdom subsidiary are presented as a discontinued operation in our consolidated financial statements included in this Annual Report on Form 10-K for our fiscal years ended March 31, 2005 and 2004.

 

Our Fiscal 2006 Highlights

 

Highlights for our fiscal year ended March 31, 2006, which we refer to as fiscal 2006, include:

 

 

 

The principal market drivers that we believe are contributing to sales growth include:

 

 

Our Customers and Markets

 

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

 

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

 

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

A breakdown of our net sales from continuing operations by geographic area for fiscal 2006, fiscal 2005 and our fiscal year ended March 31, 2004, which we refer to as fiscal 2004, is contained in Note 15 to our consolidated financial statements on page 46 to this Annual Report on Form 10-K. In fiscal 2006, total sales to one customer amounted to 11% of total net sales for the year. We presently have no plans to enter any new industry segments that would require the investment of a material amount of our assets or that we would otherwise consider to be material.

 

Our Strengths

 

Our core strengths are as follows:

 

 

Our Strategy

 

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

 

 

Competition

 

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

 

Intellectual Property

 

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

 

Availability of Raw Materials

 

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

 

Working Capital Practices

 

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

 

Environmental Matters

 

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

 

Seasonality

 

No material part of our business is seasonal in nature.

 

Research Activities

 

During fiscal 2006, fiscal 2005 and fiscal 2004, we spent approximately $27, $150 and $118, respectively, on research and development activities relating to the development of new products and services, or the improvement of existing products and services.

 

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

 

Risks related to our business

 

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

 

Historically, a substantial portion of our revenue has been derived from sales of our products to companies in the chemical, petrochemical, petroleum refining and power generating industries, or to firms that design and construct facilities for these industries. The core industries in which our products are used are, to varying degrees, cyclical and have historically experienced severe downturns. Although we are currently in an upturn of demand for our products in the petrochemical, petroleum refining and power generating industries, a downturn in one or more of these industries could occur at any time. In the event of such a downturn, we have no way of knowing if, when and to what extent there might be a recovery. A deterioration in any of the cyclical industries we serve would harm our

business and operating results because our customers would not likely have the resources necessary to purchase our products nor would they likely have the need to build additional facilities or improve existing facilities.

 

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

 

We believe that revenue from the sale of our products outside the United States will continue to account for a material portion of our total revenue for the foreseeable future. For fiscal 2006, our sales to geographic regions were as follows: 51% — United States; 16% — Asia; 9% — Canada; 8% — Mexico and South America; 14% — Middle East; and 2% — various other regions. No sales to the Middle East were to terrorist sponsoring nations. Our international sales operations are subject to numerous risks, including:

 

 

The occurrence of any one of the above risks could harm our business and results of operations. In addition, we are exposed to the risk of currency fluctuations between the U.S. dollar and the currencies of the countries in which we sell our products to the extent that such sales are not based on U.S. dollars. As such, fluctuations in currency exchange rates, which cause the value of the U.S. dollar to increase, could have an adverse effect on the profitability of our business. While we may enter into currency exchange rate hedges from time to time to mitigate these types of fluctuations, we cannot remove all fluctuations or hedge all exposures and our earnings are impacted by changes in currency exchange rates. At March 31, 2006 and 2005, we held no forward foreign currency exchange contracts.

 

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

 

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

 

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

 

We are dependent to a large degree on the services of William C. Johnson, our president and chief executive officer, J. Ronald Hansen, our vice president of finance and administration and chief financial officer, James R. Lines, our vice president and general manager, and Stephen P. Northrup, our vice president of Asia operations. Our operations may suffer if we were to lose the services of any of our senior executive officers. With the exception of Mr. Lines, we do not maintain key person insurance on any of our senior executive officers.

 

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

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

We face potential liability from asbestos exposure and similar claims.

 

We are a defendant in several lawsuits alleging illnesses from exposure to asbestos or asbestos-containing products and seeking unspecified compensatory and punitive damages. We cannot predict with certainty the outcome of these lawsuits or whether we could become subject to any similar, related or additional lawsuits in the future. In addition, because some of our products are used in systems that handle toxic or hazardous substances, any failure or alleged failure of our products in the future could result in litigation against us. Any litigation brought

against us, whether with or without merit, could result in substantial costs to us as well as divert the attention of our management, which could harm our business and results of operations.

 

Risks related to operating a subsidiary in China

 

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

 

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

 

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

 

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

 

Intellectual property rights are difficult to enforce in China.

 

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

 

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

 

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

 

Risks related to the ownership of our common stock

 

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

 

Provisions of our certificate of incorporation and bylaws, as well as our stockholder rights plan, could impede attempts by our stockholders to remove or replace our management and could discourage others from initiating a potential merger, takeover or other change of control transaction, including a potential transaction at a premium

over the market price of our common stock, that our stockholders might consider to be in their best interests. For example:

 

 

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

 

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

 

 

 

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

 

None.

 

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

 

Additionally, we lease a U.S. sales office in Houston.

 

Assets with a book value of $30,098 have been pledged to secure certain of our borrowings.

 

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

 

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

 

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

 

Our common stock is traded on the American Stock Exchange under the symbol “GHM”. As of June 1, 2006, there were approximately 3,832,390 shares of our common stock outstanding that were held by approximately 197 stockholders of record.

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

 

 

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

 

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

 

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

 

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

 

(Dollar amounts in thousands, except per share data)

 

Overview

 

Our corporate office and production facility are located in Batavia, New York. Our most recently completed fiscal year, which we refer to as fiscal 2006, began on April 1, 2005 and ended on March 31, 2006.

 

We are a designer, manufacturer and worldwide supplier of ejectors, 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, drugs, heating, ventilating and air conditioning.

 

The current level of inquiries for our products and services gives us reason to believe that we continue to be in a period of increased capital spending by customers and potential customers. We believe that such increased capital spending will continue to positively impact our business for the immediate future. Global growth and expansion in oil refineries, petrochemical plants and power generation facilities are driving current demand for our products and services. Because our products are capital goods, industrial downturns can have a material adverse impact on sales.

 

In May 2005, we disposed of our subsidiary located in the United Kingdom that manufactured vacuum pumps. This disposition is presented as a discontinued operation in the Consolidated Statements of Operations and Retained Earnings and Consolidated Statements of Cash Flows for each of fiscal 2005 and fiscal 2004.

 

Highlights

 

Highlights for fiscal 2006:

 

 

We believe the principal market drivers that are increasing capital spending and contributing to our sales growth include:

 

 

 

Forward-Looking Statements

 

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

 

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

 

 

Critical Accounting Policies, Estimates and Judgments

 

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

 

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

 

Revenue Recognition.  We recognize revenue on all contracts with a planned manufacturing process in excess of four weeks (which approximates 575 direct labor hours) using the percentage-of-completion method. The

percentage-of-completion method is determined by comparing actual labor incurred to a specific date to our estimate of the total labor to be incurred on each contract. Contracts in progress are reviewed monthly, and sales and earnings are adjusted in current accounting periods based on revisions in the contract value and estimated material and labor costs at completion. Losses on contracts are recognized immediately when known.

 

Revenue on contracts not accounted for using the percentage-of-completion method is recognized utilizing the completed contract method. The majority of the contracts we enter into have a planned manufacturing process of less than four weeks and the results reported under this method 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 contract after the revenue is recognized.

 

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

 

To the extent that actual results differ from assumptions, the differences are reflected as unrecognized gains and losses and are amortized to earnings over the estimated future service period of the plan participants to the extent such total net recognized gains and losses exceed 10% of the greater of the plan’s projected benefit obligation or the market-related value of assets. Significant differences in actual experience or significant changes in future assumptions would affect pension and postretirement benefit costs and obligations.

 

Income Taxes.  Deferred income tax assets and liabilities for the expected future tax consequences of events have been recognized in our financial statements or tax returns. Deferred income tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using current tax rates. We evaluate available information about future taxable income and other possible sources of realization of deferred income tax assets and record valuation allowances to reduce deferred income tax assets to an amount that represents our best estimates of the amounts of such deferred income tax assets that more likely than not will be realized.

 

Results of Operations

 

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

 

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

 

Fiscal 2006 Compared with Fiscal 2005

 

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

 

Gross profit percentage for fiscal 2006 was 29% compared with 18% for fiscal 2005. The improvement in gross profit margin in fiscal 2006 was due to greater sales volume as well as selling price increases. We were able to obtain greater volume and higher selling prices and at the same time be more selective in orders accepted as a result of improved product demand. We anticipate pressure on gross margin will increase in the future because of increasing materials, energy, labor and benefits costs. In addition, given the sales opportunities we believe exist in Asia and elsewhere, we have strategically increased our emphasis in those markets. Although we believe that such markets are likely to have lower margin potential because of their specific economic climates, we believe that the expansion of our operations into these markets will provide long-term benefits, including geographic proximity to our customers in Asia.

 

Selling, general and administrative expenses were 18% of sales for fiscal 2006, as compared with 19% for fiscal 2005. Actual expenses for fiscal 2006 increased 28% or $2,127 compared with fiscal 2005, primarily as a result of increased travel for sales activities, variable compensation expense relating to greater income from continuing operations, the addition of sales personnel in Europe and China to support long-term sales growth opportunities and consulting costs for employee training and Sarbanes-Oxley preparation costs.

 

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

 

Other expense for fiscal 2006 was $371. This expense was incurred in conjunction with the settlement of litigation whereby we sued a foreign pump competitor that had adopted the name “Graham”. Pursuant to the settlement agreement, such competitor agreed to discontinue using our name by the fall of 2006 in exchange for certain inventory items with a recorded amount plus packaging costs of $252. We incurred $119 in legal costs pertaining to this settlement. Other expense in fiscal 2005 of $1,049 related to transitioning two senior executives. Under the terms of an agreement reached with our former president and chief executive officer, he was retained by us as an independent consultant through November 8, 2008 for an estimated cost, including retainer and certain benefits, of $562. Another senior executive was transitioned in January 2005. The term of the agreement reached with this former executive included salary continuation for twelve months and certain medical benefits for thirty-six months, for an estimated cost of $157. Costs accrued as of March 31, 2005 to recruit and relocate executive replacements for such transitioned senior executives resulted in $251 of expense.

 

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

 

The effective income tax rate for fiscal 2006 was 38%, as compared with 18% for fiscal 2005. Fiscal year 2006’s rate approximated the statutory rate. The low effective rate for fiscal 2005 was due to lower net income

coupled with an exclusion of income on export sales permitted under U.S. tax law together with the minimal amount of income subject to income taxes for the period.

 

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

 

Fiscal 2005 Compared with Fiscal 2004

 

Sales for fiscal 2005 were $41,333, up 10%, as compared with $37,508 for fiscal 2004. The increase in sales for fiscal 2005 was due to increased ejector and condenser sales and from one petrochemical vacuum system shipment that approximated 7% of annual sales.

 

Sales for the last six months of fiscal 2005 were up 29% over the same period in fiscal 2004. Sales for the last six months of fiscal 2005 were up 38% from the first half of such year. The increase in sales in the last half of fiscal 2005 was due to the early stages of recovery in the refinery and petrochemical markets.

 

Gross profit percentage for fiscal 2005 was 18%, as compared with 16% for fiscal 2004. The improvement in gross profit percentage for fiscal 2005 compared with fiscal 2004 was due to greater sales volume and lower plant utility, repair and maintenance costs.

 

Selling, general and administrative expenses were 19% of sales for fiscal 2005, as compared with 21% for fiscal 2004. Selling, general and administrative expenses were down in fiscal 2005 due to a reduction in sales commission rates and lower advertising and travel expenses.

 

Interest expense was $33 for fiscal 2005 and $46 for fiscal year 2004. Interest expense decreased due to reduced bank borrowings.

 

Other income for fiscal 2005 was $1,592 as compared with $522 for fiscal 2004. Fiscal 2005 other income is described above. Other income of $522, recognized for fiscal 2004, represents a non-recurring curtailment gain resulting from the discontinuation of postretirement medical benefits.

 

Other expense recognized for fiscal 2005 of $1,049 was substantially incurred in conjunction with transitioning two senior executives, as described above. There was no other expense for fiscal 2004.

 

The effective income tax rate for continuing operations for fiscal 2005 was 18%, as compared to a benefit of 42% for fiscal 2004. The effective tax rate for fiscal 2005 was due to a partial exclusion permitted under U.S. tax law of income on export sales. The benefit for income taxes recognized for fiscal 2004 was greater than the statutory tax rate due to our termination of split-dollar life insurance policies and distribution of the proceeds from such policies to the respective employees in October 2003.

 

Income from continuing operations for fiscal 2005 was $296 or $0.09 per diluted share. This compares to a loss from continuing operations of $832 or $0.25 per diluted share for fiscal 2004.

 

We incurred a net loss in fiscal 2005 of $2,906 or $0.85 per diluted share after recognition of the loss from discontinued operations for our U.K. subsidiaries of $3,202. This compares to a net loss of $1,161, or $0.35 per diluted share, for fiscal 2004, after recognition of the loss from U.K. discontinued operations of $329.

 

Stockholders’ Equity

 

 

Fiscal 2006 Compared with Fiscal 2005

 

Stockholders’ equity increased $10,529 or 64% for fiscal 2006 compared with fiscal 2005. In dollars and by percentages, this increase resulted from net income of $3,586 (34%), the sale of treasury stock which resulted in additional equity of $3,403 (32%), the issuance of common stock relating to options exercised which resulted in

increased equity of $2,149 (20%) and the reversal of the minimum pension liability that increased equity by $1,698 (16%) due to contributions made to the plan in fiscal 2006. Approximately 3% of the increase was returned to our stockholders’ in dividends. Net book value per share increased 45% to $7.07 compared with $4.88 as of March 31, 2005.

 

Fiscal 2005 Compared with Fiscal 2004

 

Stockholders’ equity decreased $1,524 or 8% for fiscal 2005 compared with fiscal 2004 due to the disposal of our U.K. operations (loss from discontinued operations of $3,202 less gain in foreign currency translation of $1,452, resulting in a net of $1,750). In addition, an increase to the minimum pension liability adjustment and an increase in dividends paid to stockholders further contributed to the decrease in equity. This decrease in equity was partially offset by net income from continuing operations and the issuance of common stock relating to the exercise of stock options. Net book value per share decreased 11% to $4.88 compared with $5.46 as of March 31, 2004.

 

Liquidity and Capital Resources

 

 

 

 

As of March 31, 2006, contractual and commercial obligations for the next five fiscal years ending March 31 and thereafter are as follows:

 

 

 

 

Fiscal 2006 Compared with Fiscal 2005

 

Net cash provided by continuing operating activities was $6,533 for fiscal 2006 compared with net cash used by operating activities of $4,394 for fiscal 2005. The change from cash used by operations to cash provided by operations was primarily due to net income of $3,586 for fiscal 2006 compared with a net income from continuing operations of $296 for fiscal 2005, a non-cash tax provision of $2,150 and the reduction of trade accounts receivable

during 2006. We have been able to accelerate cash collections on trade accounts receivable through various initiatives implemented in fiscal 2006.

 

During fiscal year 2006, net cash generated in excess of cash held for near-term needs was invested in marketable securities. Investments in marketable securities generally consist of U.S. government instruments with maturity periods of 91 to 120 days. Investments at March 31, 2006 increased $8,425 over investments at March 31, 2005. Investments decreased $3,303 from March 31, 2004 to March 31, 2005. The decrease in the prior year period was due to the sale of marketable securities to finance an operating cash deficit.

 

Other investing activities for fiscal 2006 included the purchase of plant and office equipment of $1,048, including computer hardware and capitalized software of $489. This compares with plant and office equipment purchased in fiscal 2005 of $224. Increased capital spending in fiscal 2006 compared with fiscal 2005 was incurred to increase engineering capacities and reduce operating cycle times. This trend is anticipated to continue in fiscal 2007.

 

The sale of 198,246 shares of common stock was completed by us in November 2005. The shares were offered for $18 per share pursuant to an effective registration statement filed with the Securities and Exchange Commission. These shares had been held as treasury shares before their sale and had been previously acquired by us at an average price of $7 per share. In total, the sale netted $3,403 after related costs of $166 and increased stockholders’ equity 21%, resulting in a net book value per share increase of $0.94. The shares were sold to raise additional working capital to support sales growth, diversify our stockholder base, broaden institutional ownership and provide greater public float.

 

Cash of $1,424 was generated from the issuance of common stock in conjunction with the exercise of stock options during fiscal year 2006. This compares with $390 generated from the exercise of stock options in fiscal 2005. Our average trading stock price for fiscal 2006 increased 192% as compared to fiscal 2005, which we believe led to the increased activity of exercising stock options. Other financing activities in fiscal year 2006 included the retirement of $1,872 in short-term debt.

 

We have a credit facility with Bank of America, N.A. for $13,000, borrowings under which are secured by all of our assets. We believe that cash generated from operations combined with investments and available financing capacity under this credit facility will be adequate to meet our cash needs, including planned capital spending, for the immediate future. As of March 31, 2006 we had standby letters of credit outstanding of $4,688 and no borrowings. As of March 31, 2006 the interest rate charged for borrowings under the terms of the facility would be prime minus 100 basis points or 6.75%.

 

There were no discontinued operation activities in fiscal 2006. Total cash used by the discontinued operation in the U.K. for fiscal 2005 was $396.

 

Orders and Backlog

 

Orders for fiscal 2006 were $66,225 compared with $49,857 for fiscal 2005, a 33% increase. Orders represent communications received from customers for the supply of products and services. We believe orders are a very important indicator of our future business prospects. The increase in orders was primarily due to increased orders for condensers and ejectors. Compared with fiscal 2005, orders for surface condensers increased 50% and ejector orders increased 31%. Increased condenser and ejector orders were due to the increased demand in major project work in the petrochemical and refinery sectors. Export orders were up 59% for fiscal 2006. Eighty percent of this increase was for orders for the Middle East and largely pertained to petrochemical projects. Domestic orders increased 10% in fiscal 2006 compared with the prior fiscal year.

 

Backlog was $33,083 at March 31, 2006, compared with $22,376 at March 31, 2005, a 48% 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 traditional markets in established product lines that are scheduled to be shipped in the next twelve months. Approximately 40% of backlog can be attributed to equipment for refinery project work, 40% to chemical and petrochemical projects, 4% to equipment sold to the power generation sector and 16% to other industrial or commercial applications. We believe that the demand coming from the refinery sector for our products and services is being driven by the shortages of refinery capacity resulting from increased usage of oil in China and

India, the need to upgrade existing refineries so that they can use lower cost, high sulfur “sour” crude, and the need to revamp refineries to meet environmental regulations in numerous countries pertaining to diesel fuel sulfur content requirements. Most refineries presently in operation are only able to process light, “sweet” (i.e., low sulfur) crude, which is less abundant and more expensive than heavier “sour” (i.e., high sulfur) crude. Orders from the petrochemical and power markets are mainly for foreign capacity expansion projects. We believe that these orders reflect the continued economic growth in Asia.

 

Contingencies

 

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 for minimal amounts below expected defense costs. Neither the outcome of these lawsuits nor the potential for liability can be determined at this time.

 

From time to time in the ordinary course of business, we are subject to legal proceedings and potential claims. As of March 31, 2006, we were unaware of any additional pending litigation matters.

 

New Accounting Pronouncements

 

In November 2004, the Financial Accounting Standards Board (the “FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 151, “Inventory Costs.” SFAS No. 151 amends Accounting Research Bulletin No. 43, Chapter 4, “Inventory Pricing”, to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material. SFAS No. 151 requires that those items be recognized as current period charges regardless of whether they meet the criterion of “abnormal” contained in such statement. In addition, SFAS No. 151 requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. SFAS No. 151 will become effective for inventory costs we incur during the fiscal year ending March 31, 2007. Although we believe that the adoption of SFAS No. 151 may result in the acceleration of recognizing indirect manufacturing expenses during times of below normal utilization of plant capacity, we do not anticipate below normal utilization of plant capacity in the immediate future.

 

In December 2004, The FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets.” This guidance amends Accounting Principles Board Opinion No. 29, “Accounting for Non-Monetary Transactions,” and establishes a general exception for exchanges of nonmonetary assets that do not have commercial substance (e.g., future cash flows of the entity are not expected to change significantly as a result of the exchange). Under SFAS No. 153 a nonmonetary exchange shall be measured based on the recorded amount of the nonmonetary asset relinquished. We adopted SFAS No 153 in the quarter ended March 31, 2006. The impact of adopting SFAS No. 153 was immaterial to our consolidated financial position, results of operations and cash flows.

 

In December 2004, the FASB issued SFAS No. 123(R), “Share-Based Payment.” SFAS No. 123(R) requires that all share-based payments to employees, including grants of employee stock options, be recognized in the financial statements based on their fair values for fiscal years beginning after June 15, 2005. In addition, SFAS No. 123(R) will cause unrecognized expense (based on the fair values determined for the pro forma footnote disclosure, adjusted for estimated forfeitures) related to options vesting after the date of initial adoption to be recognized as a charge to results of operations over the remaining vesting period. The adoption of SFAS No. 123(R) requires us to choose among various acceptable options in quantifying the compensation expense to be recognized for options granted. We have decided to use the Black-Scholes fair value model and to adopt the modified prospective method for expense recognition of options granted as of the adoption date of April 1, 2006. The modified prospective method requires that compensation expense be recorded for all unvested stock options and share awards at the beginning of the first quarter of adoption of SFAS No. 123(R). The initial effect of adopting SFAS 123(R) will be immaterial to our consolidated financial statements because all stock options currently issued and unexercised are fully vested.

 

In March 2005, the FASB issued Interpretation (“FIN”) No. 47, “Accounting for Conditional Asset Retirement Obligations,” an interpretation of SFAS No. 143. FIN No. 47 clarifies the term “conditional asset retirement

obligation” as used in SFAS No. 143, “Accounting for Asset Retirement Obligations”, and provides further guidance as to when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. We adopted FIN No. 47 in the quarter ended December 31, 2005. The impact of adopting FIN No. 47 was immaterial to our consolidated financial position, results of operations and cash flows.

 

In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections.” This Statement is a replacement of APB Opinion No. 20 and SFAS No. 3. This Statement establishes, unless impracticable, retrospective application as the required method for reporting a change in accounting principle in the absence of explicit transition requirements specific to the newly adopted accounting principle. Additionally, the pronouncement gives guidance in the reporting of a correction of an error by restating previously issued financial statements. The impact on previously issued financial statements can only be determined when specific events covered by this pronouncement are applicable. This Statement is effective for fiscal years beginning after December 15, 2005.

 

Off Balance Sheet Arrangements

 

We did not have any off balance sheet arrangements as of March 31, 2006 or 2005 other than operating leases.

 

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

 

 

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

 

Foreign Currency

 

International consolidated sales for fiscal 2006 and fiscal 2005 were 49% and 40%, respectively, of total sales. Operating in markets throughout the world, as we do, exposes us to movements in currency exchange rates. Currency movements can affect our sales in several ways, the foremost being our ability to compete for orders against foreign competitors who base their prices on relatively weaker currencies. Business lost due to competition for orders against competitors using a relatively weaker currency cannot be quantified. Secondly, cash can be adversely impacted by the conversion of sales in foreign currency to dollars. In both fiscal 2006 and fiscal 2005, we had no sales for which we were paid in foreign currencies. At certain times, we may enter into forward foreign currency exchange agreements to hedge exposure against unfavorable changes in foreign currency values on significant sales contracts negotiated in foreign currencies.

 

We have limited exposure to foreign currency purchases. For fiscal 2006 and fiscal 2005, purchases in foreign currencies represented 1% and 4%, respectively, of the cost of products sold. At certain times, we may utilize forward foreign currency exchange contracts to limit currency exposure.

 

At March 31, 2006 and 2005, we held no forward foreign currency exchange contracts.

 

Equity Price Risk

 

Our Long-Term Incentive Plan provides for awards of share equivalent units (“SEUs”) for outside Directors based upon the performance of our common stock. SEUs are valued at fair market value, thereby exposing us to equity price risk. Upward adjustment to market value is limited to (a) $8 per unit if at the valuation date the fair market value was less than $8 per unit or (b) the fair market value at the valuation date if the fair market value on that

date was greater than $8 per unit. Gains and losses recognized due to market price changes are included in results of operations. Based upon the plan provisions and SEUs outstanding at March 31, 2006 and 2005 and $20 per share price, a 50-75% change in the year-end common stock market price would positively or (negatively) impact income from continuing operations before income taxes as follows:

 

 

Assuming required net income targets are met, certain awards would be provided, and based upon a market price of $20 per share, a 50-75% change in the stock price would positively (negatively) impact income from continuing operations before income taxes in future years as follows:

 

 

Gross Margin Risk

 

Operating in a global marketplace requires us to compete with other global manufacturers which, in some instances, benefit from lower product costs and favorable foreign exchange rates. Currently we are experiencing rising costs, particularly for healthcare, employment costs, metals and other materials and energy. We may encounter greater pricing pressures preventing us from fully covering escalating costs. The rapid expansion in the oil and natural gas markets is expanding our potential customer base. This new customer base may be more cost sensitive as opposed to product value oriented. These additional customers could lead to lower gross margins. To mitigate these pressures, in addition to establishing a base of operations in China through the formation of a wholly-owned Chinese subsidiary, among other things, we are exploring alternative manufacturing models, increasing investments in information technology to improve productivity and adopting lean manufacturing principles.

 

INDEX TO FINANCIAL STATEMENTS

 

(References to years represent fiscal years ended March 31, 2006, 2005 and 2004)

 

 

See Notes to Consolidated Financial Statements.

 

 

See Notes to Consolidated Financial Statements.

 

 

See Notes to Consolidated Financial Statements.

 

 

See Notes to Consolidated Financial Statements.

 

(Dollar amounts in thousands)

 

Note 1 — The Company and Its Accounting Policies:

 

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

 

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

 

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

 

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

 

Translation of foreign currencies

 

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

 

Revenue recognition

 

Percentage-of-Completion Method

 

The Company recognizes revenue on all contracts with a planned manufacturing process in excess of four weeks (which approximates 575 direct labor hours) using the percentage-of-completion method. The Company has established the systems and procedures essential to developing the estimates required to account for contracts using the percentage-of-completion method. The percentage-of-completion method is determined by comparing actual labor incurred to a specific date to management’s estimate of the total labor to be incurred on each contract. Contracts in progress are reviewed monthly, and sales and earnings are adjusted in current accounting periods based on revisions in the contract value and estimated costs at completion. Losses on contracts are recognized immediately when known. Revenues recognized on contracts accounted for on percentage-of-completion are presented in net sales in the Consolidated Statement of Operations and unbilled revenue in the Consolidated Balance Sheets to the extent that the revenue recognized exceeds the amounts billed to customers. See “Inventories” below.

 

Completed Contract Method

 

Revenue not accounted for using the percentage-of-completion method is accounted for using the completed contract method. The Company recognizes revenue and all related costs on these contracts upon substantial completion or shipment to the customer. Substantial completion is consistently defined as at least 95% complete with regard to direct labor hours. Customer acceptance is generally required throughout the construction process and the Company has no further obligations under the contract after the revenue is recognized. The effect of

applying the completed contract method does not vary materially from the results of applying the percentage-of completion method.

 

Shipping and handling fees and costs

 

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

 

Investments

 

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

 

Inventories

 

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

 

A summary of all contracts in progress at March 31 is as follows: