| GRAHAM CORP Item 1A Risk Factors 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 |
| A deterioration in any of the cyclical industries we serve would harm our 4 _________________________________________________________________ [55]Table of Contents 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: 51prca — United States; 16prca — Asia; 9prca — Canada; 8prca — Mexico and South America; 14prca — Middle East; and 2prca — various other regions |
| No sales to the Middle East were to terrorist sponsoring nations |
| Our international sales operations are subject to numerous risks, including: • it may be difficult to enforce agreements and collect receivables through some foreign legal systems; • foreign customers may have longer payment cycles than customers in the United States; • tax rates in some foreign countries may exceed those of the United States and foreign earnings may be subject to withholding requirements or the imposition of tariffs, exchange controls or other restrictions; • general economic and political conditions in the countries where we sell our products may have an adverse effect on our sales in those countries or not be favorable to our growth strategy; • foreign governments may adopt regulations or take other actions that could directly or indirectly harm our business and growth strategy; and • it may be difficult to enforce intellectual property rights in some foreign countries |
| 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 US dollar and the currencies of the countries in which we sell our products to the extent that such sales are not based on US dollars |
| As such, fluctuations in currency exchange rates, which cause the value of the US 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 |
| 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 |
| 5 _________________________________________________________________ [56]Table of Contents 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 6 _________________________________________________________________ [57]Table of Contents 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 7 _________________________________________________________________ [58]Table of Contents over the market price of our common stock, that our stockholders might consider to be in their best interests |
| For example: • We could issue shares of preferred stock with terms adverse to our common stock |
| Under our certificate of incorporation, our board of directors is authorized to issue shares of preferred stock and to determine the rights, preferences and privileges of such shares without obtaining any further approval from the holders of our common stock |
| Up to 440cmam000 of such undesignated shares of preferred stock are presently eligible for issuance |
| We could issue shares of preferred stock with voting and conversion rights that adversely affect the voting power of the holders of our common stock, or that have the effect of delaying or preventing a change in control of our company |
| • We maintain a stockholder rights, or “poison pill,” plan |
| Our stockholder rights plan has the effect of discouraging any person or group that wishes to acquire 15prca or more of our common stock from doing so without obtaining our agreement because such acquisition would cause such person or group to suffer substantial dilution |
| Such plan may have the effect of discouraging a change in control transaction that our stockholders would otherwise consider to be in their best interests |
| • Only a minority of our directors may be elected in a given year |
| Our bylaws provide for a classified board of directors, with only approximately one-third of our board elected each year |
| This provision makes it more difficult to effect a change of control because at least two annual stockholder meetings are necessary to replace a majority of our directors |
| • Our bylaws contain advance notice requirements |
| Our bylaws also provide that any stockholder who wishes to bring business before an annual meeting of our stockholders or to nominate candidates for election as directors at an annual meeting of our stockholders must deliver advance notice of their proposals to us before the meeting |
| Such advance notice provisions may have the effect of making it more difficult to introduce business at stockholder meetings or nominate candidates for election as director |
| • Our certificate of incorporation requires supermajority voting to approve a change of control transaction |
| Seventy-five percent of our outstanding shares entitled to vote are required to approve any merger, consolidation, sale of all or substantially all of our assets and similar transactions if the other party to such transaction owns 5prca or more of our shares entitled to vote |
| In addition, a majority of the shares entitled to vote not owned by such 5prca or greater stockholder are also required to approve any such transaction |
| • Amendments to our certificate of incorporation require supermajority voting |
| Our certificate of incorporation contains provisions that make its amendment require the affirmative vote of both 75prca of our outstanding shares entitled to vote and a majority of the shares entitled to vote not owned by any person who may hold 50prca or more of our shares unless the proposed amendment was previously recommended to our stockholders by an affirmative vote of 75prca of our board |
| This provision makes it more difficult to implement a change to our certificate of incorporation that stockholders might otherwise consider to be in their best interests without approval of our board |
| • Amendments to our bylaws require supermajority voting |
| Although our board of directors is permitted to amend our bylaws at any time, our stockholders may only amend our bylaws upon the affirmative vote of both 75prca of our outstanding shares entitled to vote and a majority of the shares entitled to vote not owned by any person who owns 50prca or more of our shares |
| This provision makes it more difficult for our stockholders to implement a change they may consider to be in their best interests without approval of our board |
| 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: • variations in our revenue and operating results from quarter to quarter; • developments or downturns in the industries in which we do business; • our ability to obtain and/or maintain securities analyst coverage; 8 _________________________________________________________________ [59]Table of Contents • changes in securities analysts’ recommendations or estimates of our financial performance; • changes in market valuations of companies similar to ours; • announcements by our competitors of significant contracts, new offerings, acquisitions, commercial relationships, joint ventures or capital commitments; and • general economic conditions |
| 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 |