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<SEC-DOCUMENT>0000950152-05-005345.txt : 20050623
<SEC-HEADER>0000950152-05-005345.hdr.sgml : 20050623
<ACCEPTANCE-DATETIME>20050623163140
ACCESSION NUMBER:		0000950152-05-005345
CONFORMED SUBMISSION TYPE:	10-K
PUBLIC DOCUMENT COUNT:		6
CONFORMED PERIOD OF REPORT:	20050331
FILED AS OF DATE:		20050623
DATE AS OF CHANGE:		20050623

FILER:

	COMPANY DATA:	
		COMPANY CONFORMED NAME:			GRAHAM CORP
		CENTRAL INDEX KEY:			0000716314
		STANDARD INDUSTRIAL CLASSIFICATION:	GENERAL INDUSTRIAL MACHINERY & EQUIPMENT [3560]
		IRS NUMBER:				161194720
		STATE OF INCORPORATION:			DE
		FISCAL YEAR END:			0331

	FILING VALUES:
		FORM TYPE:		10-K
		SEC ACT:		1934 Act
		SEC FILE NUMBER:	001-08462
		FILM NUMBER:		05912773

	BUSINESS ADDRESS:	
		STREET 1:		20 FLORENCE AVE
		STREET 2:		POST OFFICE BOX 719
		CITY:			BATAVIA
		STATE:			NY
		ZIP:			14020
		BUSINESS PHONE:		5853432216

	MAIL ADDRESS:	
		STREET 1:		20 FLORENCE AVENUE
		STREET 2:		POST OFFICE BOX 719
		CITY:			BATAVIA
		STATE:			NY
		ZIP:			14021-0719
</SEC-HEADER>
<DOCUMENT>
<TYPE>10-K
<SEQUENCE>1
<FILENAME>l13696ae10vk.txt
<DESCRIPTION>GRAHAM CORPORATION            10-K
<TEXT>
<PAGE>

- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                            ------------------------

                          FORM 10-K
[X]   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
     EXCHANGE ACT OF 1934

                   FOR THE FISCAL YEAR ENDED MARCH 31, 2005.

[ ]   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)

<Table>
<S>                                              <C>
                    DELAWARE                                        16-1194720
        (STATE OR OTHER JURISDICTION OF                          (I.R.S. EMPLOYER
         INCORPORATION OR ORGANIZATION)                        IDENTIFICATION NO.)



     20 FLORENCE AVENUE, BATAVIA, NEW YORK                            14020
    (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)                        (ZIP CODE)
</Table>

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

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

<Table>
<Caption>
                 TITLE OF CLASS                     NAME OF EACH EXCHANGE ON WHICH REGISTERED
<S>                                              <C>
         COMMON STOCK (PAR VALUE $.10)                       AMERICAN STOCK EXCHANGE
</Table>

          SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:

                                 TITLE OF CLASS

                          COMMON STOCK PURCHASE RIGHTS

     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 (the "Act") during the preceding 12 months (or for such shorter period that
the registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.  Yes  [X]  No  [ ]

     Indicate by check mark 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.  [X]

     Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).  Yes  [ ]  No  [X]

     The aggregate market value of the voting stock held by non-affiliates of
the Registrant as of September 30, 2004, the last business day of the Company's
most recently completed second fiscal quarter, was $17,615,879. The market value
calculation was determined using the closing price of the Registrant's Common
Stock on September 30, 2004, as reported on the American Stock Exchange.

     As of May 19, 2005, there were outstanding 1,727,932 shares of common
stock, $.10 par value. As of May 19, 2005, there were outstanding 1,727,932
common stock purchase rights.

                      DOCUMENTS INCORPORATED BY REFERENCE

(1) Notice of Meeting and Proxy Statement for the 2005 Annual Meeting of
    Stockholders is incorporated by reference into Part III of this filing.

     An Exhibit Index is located at page 49 of this filing under the sequential
numbering system prescribed by Rule 0-3(b) of the Act.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>

                               GRAHAM CORPORATION

                                FORM 10-K INDEX

<Table>
<Caption>
                                                                                    PAGE
                                                                                    ----
<S>              <C>  <C>                                                           <C>
PART I
  Item 1         --   Business....................................................    1
  Item 2         --   Properties..................................................    3
  Item 3         --   Legal Proceedings...........................................    4
  Item 4         --   Submission of Matters to a Vote of Security Holders.........    4

PART II
  Item 5         --   Market for Registrant's Common Equity, Related Stockholder
                      Matters and Issuer Purchases of Equity Securities...........    4
  Item 6         --   Selected Financial Data.....................................    5
  Item 7         --   Management's Discussion and Analysis of Financial Condition
                      and Results of Operations...................................    7
  Item 8         --   Financial Statements and Supplementary Data.................   18
  Item 9         --   Changes in and Disagreements with Accountants on Accounting
                      and Financial Disclosure....................................   44
  Item 9A        --   Controls and Procedures.....................................   44
  Item 9B        --   Other Information...........................................   44

PART III
  Item 10        --   Directors and Executive Officers............................   44
  Item 11        --   Executive Compensation......................................   44
  Item 12        --   Security Ownership of Certain Beneficial Owners and
                      Management and Related Stockholder Matters..................   45
  Item 13        --   Certain Relationships and Related Transactions..............   45
  Item 14        --   Principal Accountant Fees and Services......................   45

PART IV
  Item 15        --   Exhibits, Financial Statement Schedules and Reports on Form
                      8-K.........................................................   45
</Table>
<PAGE>

                                     PART I

              (Dollar amounts in thousands except per share data).

ITEM 1.  BUSINESS

(a) GENERAL DEVELOPMENT OF BUSINESS

     Graham Corporation (the "Company", "Graham", the "Corporation" or the
"Registrant") is a Delaware company incorporated in 1983. It is the successor to
Graham Manufacturing Co., Inc., which was incorporated in 1936. The Company's
business consists of one engineering and manufacturing operating segment, which
is located in Batavia, New York. Formerly, the Company had an operating segment
located in the United Kingdom that manufactured vacuum equipment. In March 2005,
Graham Corporation's Board of Directors approved a plan to dispose of the U.K.
operating segment, which resulted in the liquidation of the operation in May
2005. As a result of the disposition, this segment is presented as a
discontinued operation in the Consolidated Financial Statements.

     The Company is a well-recognized supplier of steam jet ejector vacuum
systems, surface condensers for steam turbines, vacuum pumps and compressors,
and various types of heat exchangers such as Heliflow and plate and frame
exchangers. It possesses expertise in combining these various products into
packaged systems for sale to its customers in a variety of industrial markets,
including oil refining, chemical, petrochemical, power, pulp and paper, other
process applications, and shipbuilding.

     Fiscal year 2005 sales were $41 million, an increase of 10% from the
previous fiscal year. The increase in sales over the previous year reflects an
increase in sales of condensers, Heliflow and plate heat exchangers and one
large petrochemical vacuum system sale.

     Orders in fiscal year 2005 were $49.9 million, up 47% from the previous
fiscal year. Backlog stood at $22.4 million on March 31, 2005, compared to $13.5
million on March 31, 2004, up 66%.

     The Company recognized Other Income of $1,592 in fiscal year 2005. This
income resulted from a settlement of a contract dispute over cancellation
charges.

     The Company recognized Other Expense in the current year of $1,049. These
expenses principally related to the transition of two senior executives.

     The Company is presently experiencing a recovery in its major markets.
Sales opportunities have improved over recent prior years, both domestically and
overseas.

     The Company's export sales represented 40% of sales in fiscal year 2005, as
compared to 54% of sales in the previous year.

     The Company had 243 employees in the United States as of March 31, 2005.

     On March 15, 2005, Graham Corporation's Board of Directors approved a plan
to discontinue its U.K. operations by making available for sale the Company's
wholly-owned subsidiary, Graham Vacuum and Heat Transfer Limited and all of its
subsidiaries, including Graham Precision Pumps Limited. On March 24, 2005, the
principal creditor of Graham's U.K. companies, National Westminster Bank,
exercised its right to appoint a receiver for Graham Vacuum and Heat Transfer
Limited and Graham Precision Pumps Limited. In May 2005, the assets of Graham
Precision Pumps Limited were sold. The divestiture of Graham Vacuum and Heat
Transfer Limited and its subsidiaries has been accounted for as a discontinued
operation in the accompanying financial statements.

CAPITAL EXPENDITURES

     The Company's capital expenditures for fiscal years 2005 and 2004 amounted
to $224 and $249, respectively.

                                        1
<PAGE>

(b)  FINANCIAL INFORMATION ABOUT SEGMENTS

  (1) Segments and (2) Information as to Lines of Business

     Graham Corporation operates in one business segment which is the design and
manufacture of vacuum and heat transfer equipment. Further geographical segment
information is set forth in Note 15 to the Consolidated Financial Statements on
page 40 of the Annual Report on Form 10-K.

(c)  NARRATIVE DESCRIPTION OF BUSINESS

  (1) Business Done and Intended to be Done

    Principal Products and Markets

     The Company designs, manufactures and supplies vacuum and heat transfer
equipment, primarily custom built. Its products include steam jet ejector vacuum
systems, surface condensers for steam turbines, vacuum pumps and compressors,
and various types of heat exchangers, including helical coil exchangers marketed
under the registered name "Heliflow" and plate and frame exchangers. These
products function to produce a vacuum or to condense steam or otherwise transfer
heat, or any combination of these tasks. All of the products named, other than
the pumps, accomplish these results without involving any moving parts. Graham's
products are available in a variety of metals and a number of non-metallic
corrosion resistant materials as well.

     This equipment is used in a wide range of industrial process applications:
power generation facilities, including fossil fuel plants and nuclear plants as
well as cogeneration plants and geothermal power plants that harness naturally
occurring thermal energy; petroleum refineries; chemical plants; pharmaceutical
plants; plastics plants; fertilizer plants; breweries; liquefied natural gas
production; soap manufacturing; air conditioning systems; food processing plants
and other process industries. Among these the principal markets for the
Company's products are the chemical, petrochemical, petroleum refining, and
electric power generating industries. The Company's equipment is sold by a
combination of direct company sales engineers and independent sales
representatives located throughout the world.

    Status of Publicly Announced New Products or Segments

     The Company has no plans for new products or for entry into new industry
segments that would require the investment of a material amount of the Company's
assets or that otherwise is material.

    Sources and Availability of Raw Materials

     Although certain material shortages can affect the Company's ability to
meet delivery requirements for certain orders from time to time, historically,
the Company's shipment schedules have not been materially impacted.

    Material Patents, Trademarks

     The Company holds no material patents, trademarks, licenses, franchises or
concessions, the loss of which would have a materially adverse effect upon the
business of the Company.

    Seasonal Variations

     No material part of the Company's business is seasonal.

    Working Capital Practices

     The Company's business does not require it to carry significant amounts of
inventory, or of materials beyond what is needed for work in progress. The
Company does not provide rights to return goods, or payment terms to customers
that would be considered extended in the context of the practices of its
industries.

    Principal Customers

     The Company's principal customers include the large chemical, petroleum and
power companies, which are end users of the Company's equipment in their
manufacturing and refining processes, large engineering

                                        2
<PAGE>

contractors who build installations for such companies and others, and original
equipment manufacturers, who combine our equipment with theirs prior to sale to
an end user.

     No material part of the Company's business is dependent upon a single
customer or on a few customers, the loss of any one or more of whom would have a
materially adverse effect on the Company's business. No customer of the Company
or group of related customers regularly accounts for as much as 10% of the
Company's consolidated annual revenue.

    Order Backlog

     Backlog of unfilled orders at March 31, 2005 was $22,376, as compared to
$13,482 at March 31, 2004.

    Government Contracts

     No material portion of the Company's business is subject to renegotiation
of profits or termination of contract or subcontracts at the election of the
government.

    Competition

     The Company's business is highly competitive and a number of companies
having greater financial resources are engaged in manufacturing similar
products. The principal bases of competition are technology, price, performance,
delivery and quality. However, the Company believes it is one of the leading
manufacturers of steam jet ejectors.

    Research Activities

     During the fiscal years ended March 31, 2005, 2004, and 2003 the Company
spent approximately $150, $118 and $144, respectively, on research activities
relating to the development of new products or the improvement of existing
products.

    Environmental Matters

     The Company does not anticipate that compliance with federal, state and
local provisions, which have been enacted or adopted regulating the discharge of
material in the environment or otherwise pertaining to the protection of the
environment, will have a material effect upon the capital expenditures, earnings
and competitive position of the Company and its subsidiaries.

(d)  FINANCIAL INFORMATION ABOUT GEOGRAPHIC AREAS

     The information called for under this Item is set forth in Note 15 to
Consolidated Financial Statements, on page 40 of this Annual Report on Form
10-K.

ITEM 2.  PROPERTIES

     The Company's corporate headquarters is located at 20 Florence Avenue,
Batavia, New York, consisting of a 45,000 square foot building. The Company's
manufacturing facilities are also located in Batavia, consisting of
approximately thirty-three acres and containing about 204,000 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, the Company leases a U.S. sales office in Houston.

     Assets of the Company, with a book value of $25,343, have been pledged to
secure certain borrowings.

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

                                        3
<PAGE>

ITEM 3.  LEGAL PROCEEDINGS

     This information is set forth in Note 16 to the Consolidated Financial
Statements on page 41 of the Annual Report on Form 10-K.

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

     No matters were submitted to the Company's security holders for a vote
during the fourth quarter of the fiscal year covered by this report.

                                    PART II

ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
         ISSUER PURCHASES OF EQUITY SECURITIES.

     (a) The Company sold no equity securities that were not registered during
the period covered by this Annual Report on Form 10-K.

                                        4
<PAGE>

ITEM 6.  SELECTED FINANCIAL DATA

<Table>
<Caption>
                                                  GRAHAM CORPORATION -- TEN YEAR REVIEW
                                   --------------------------------------------------------------------
                                     2005(1)      2004(1)(2)    2003(1)(2)    2002(1)(2)    2001(1)(2)
                                   ------------   -----------   -----------   -----------   -----------
                                                   IN THOUSANDS (EXCEPT PER SHARE DATA)
<S>                                <C>            <C>           <C>           <C>           <C>
OPERATIONS:
Net Sales........................  $     41,333   $    37,508   $    44,511   $    47,396   $    44,433
Gross Profit.....................         7,540         5,890         7,297        10,077         9,796
Gross Profit Percentage..........            18%           16%           16%           21%           22%
Income (Loss) From Continuing
  Operations.....................           296          (832)          148         2,305           195
Dividends........................           334           327           254
COMMON STOCK:
Basic (Loss) Earnings From
  Continuing Operations Per
  Share..........................           .17          (.51)          .09          1.40           .12
Diluted (Loss) Earnings From
  Continuing Operations Per
  Share..........................           .17          (.51)          .09          1.38           .12
Quarterly Dividend Per Share.....           .05           .05           .05
Market Price Range of Common
  Stock..........................   17.80-10.70    11.70-7.06    11.00-6.84    14.80-7.25    12.94-7.06
FINANCIAL DATA:
Working Capital..................        11,204        11,652        12,822        13,812        11,162
Capital Expenditures.............           224           249           799           688         1,124
Depreciation.....................           768           793           797           955           926
Total Assets.....................        33,529        35,740        38,323        43,704        36,608
Long-Term Debt...................            44            93           127           150           682
Shareholders' Equity.............        16,578        18,102        18,836        19,636        17,137
</Table>

- ---------------

(1) The financial data presented for 2005-1998 is for the respective twelve
    months ended March 31. The financial data presented for 1997 is for the
    three-month transition period ended March 31, 1997. The financial data
    presented for 1996-1995 is for the respective twelve months ended December
    31.

(2) The financial data presented for 2004-2003 has been restated to reflect the
    results of Graham Vacuum and Heat Transfer Limited as discontinued
    operations and the change in accounting for revenue recognition, as
    discussed in Notes 2 and 1, respectively, to the Consolidated Financial
    Statements. The financial data presented for 2002-1995 has not been restated
    for these items.

<Table>
<S>                                            <C>
NET SALES $ in Thousands
05                                                                                     41333
04                                                                                     37508
03                                                                                     44511
02                                                                                     47396
01                                                                                     44433
00                                                                                     38728
99                                                                                     52978
98                                                                                     56206
96                                                                                     51487
95                                                                                     50501
</Table>

           WORKING CAPITAL $ in Thousands

<Table>
<S>                                                           <C>
05                                                                               11204
04                                                                               11652
03                                                                               12822
02                                                                               13812
01                                                                               11162
00                                                                               12397
99                                                                               11989
98                                                                               12459
96                                                                                8239
95                                                                                7093
</Table>

                                        5
<PAGE>

<Table>
<Caption>
                                                         GRAHAM CORPORATION -- TEN YEAR REVIEW
                                    -------------------------------------------------------------------------------
                                    2000(1)(2)   1999(1)(2)    1998(1)(2)    1997(1)(2)     1996(2)     1995(2)(3)
                                    ----------   -----------   -----------   ----------   -----------   -----------
                                                  IN THOUSANDS (EXCEPT PER SHARE DATA)
<S>                                 <C>          <C>           <C>           <C>          <C>           <C>
OPERATIONS:
Net Sales........................   $   38,728   $    52,978   $    56,206   $   14,257   $    51,487   $    50,501
Gross Profit.....................        9,964        14,872        18,083        4,080        15,463        13,257
Gross Profit Percentage..........           26%           28%           32%          29%           30%           26%
Income (Loss) From Continuing
  Operations.....................         (833)        2,369         3,766          621         3,102         1,361
Dividends........................

COMMON STOCK:
Basic (Loss) Earnings From
  Continuing Operations Per
  Share..........................         (.55)         1.48          2.27          .39          1.96           .86
Diluted (Loss) Earnings From
  Continuing Operations Per
  Share..........................         (.55)         1.46          2.21          .38          1.93           .86
Quarterly Dividend Per Share.....
Market Price Range of Common
  Stock..........................    9.44-6.00    18.25-6.50   22.88-13.00   15.63-9.13    12.58-9.00    10.67-6.00

FINANCIAL DATA:
Working Capital..................       12,397        11,989        12,459       10,300         8,239         7,093
Capital Expenditures.............          711         1,189         1,400          237         1,291           204
Depreciation.....................          998           983           905          249           892           927
Total Assets.....................       34,596        34,136        37,030       31,224        30,494        29,499
Long-Term Debt...................        1,948           505           859        2,764         1,442         3,303
Shareholders' Equity.............       17,092        16,712        17,775       12,538        11,915         8,426
</Table>

- ---------------

(3) Per share data has been adjusted to reflect a three-for-two stock split on
    July 25, 1996.

<Table>
<S>                                                 <C>
LONG-TERM DEBT $ in Thousands
05                                                                                                  44
04                                                                                                  93
03                                                                                                 127
02                                                                                                 150
01                                                                                                 682
00                                                                                                1948
99                                                                                                 505
98                                                                                                 859
96                                                                                                1442
95                                                                                                3303
</Table>

   SHAREHOLDERS' EQUITY $ in Thousands

<Table>
<S>                                                           <C>
05                                                                               16578
04                                                                               18102
03                                                                               18836
02                                                                               19636
01                                                                               17137
00                                                                               17092
99                                                                               16712
98                                                                               17775
96                                                                               11915
95                                                                                8426
</Table>

                                        6
<PAGE>

ITEM 7.  GRAHAM CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
         CONDITION AND RESULTS OF OPERATIONS

                                 March 31, 2005
              (Dollar amounts in thousands except per share data).

OVERVIEW

     Graham Corporation ("Graham", "the Corporation" or "the Company") consists
of one engineering and manufacturing operating segment, which is located in
Batavia, New York. Formerly, the Company had an operating segment located in the
United Kingdom that manufactured vacuum equipment. In March 2005, Graham
Corporation's Board of Directors approved a plan to dispose of the U.K.
operating segment, which resulted in the liquidation of the operation in May
2005. As a result of the disposition, this segment is presented as a
discontinued operation in the Consolidated Financial Statements.

     Graham's fiscal financial reporting year commences April 1 and ends March
31.

     Graham Corporation designs, manufactures and supplies vacuum and heat
transfer equipment for the process industries throughout the world. The major
markets for Graham's equipment are chemical, petrochemical, petroleum refining
and electric power generating industries, including cogeneration and geothermal
plants. Other markets served include metal refining, pulp and paper processing,
shipbuilding, water heating, refrigeration, desalination, food processing, drug
manufacturing, heating, ventilating and air conditioning.

     Ejectors, vacuum pumps, condensers, heat exchangers and other products sold
are used to produce synthetic fibers, chemicals, petroleum products (including
gasoline), electric power, processed food (including canned, frozen and dairy
products), pharmaceutical products, paper, steel, fertilizers and numerous other
products used everyday by people throughout the world.

     Global growth and expansion in oil refineries, petrochemical plants and
power generation are driving current demand for Graham products. In order to
capitalize on this global trend, the Company has expanded its sales operations
by establishing a sales company in the U.K. in order to better serve Europe and
the Middle East. In fiscal year 2005, the Company established a sales office in
China to build its sales representative network to better serve the Asian
markets.

     Because Graham's products are capital goods, industrial downturns can have
a major impact on sales. Graham believes it is coming off of one of the longest
industrial recessions since the late 1990's. The level of inquiries for products
received in fiscal 2005 has given the Company reason to believe that Graham is
entering an up cycle for capital spending, which should continue to positively
impact its business for the immediate future.

                                        7
<PAGE>

     In the quarter ended September 30, 2004, the Corporation changed its method
of recognizing revenue for certain contracts from the completed contract to the
percentage-of-completion method. Financial results for fiscal years 2004 and
2003 have been restated to reflect this change. The impact of the change on net
sales, cost of products sold, (benefit) provision for income taxes, income
(loss) from continuing operations, net income (loss), income (loss) from
continuing operations per share and net income (loss) per share for the prior
fiscal years ended March 31, 2004 and 2003 is as follows:

<Table>
<Caption>
                                              2004                                     2003
                                     AMOUNTS REPORTED USING                   AMOUNTS REPORTED USING
                             --------------------------------------   --------------------------------------
                             PERCENTAGE OF   COMPLETED                PERCENTAGE OF   COMPLETED
                              COMPLETION     CONTRACT                  COMPLETION     CONTRACT
                                METHOD        METHOD     DIFFERENCE      METHOD        METHOD     DIFFERENCE
                             -------------   ---------   ----------   -------------   ---------   ----------
<S>                          <C>             <C>         <C>          <C>             <C>         <C>
Net sales..................     $37,508       $37,893      $(385)        $44,511       $43,960        551
Cost of products sold......     $31,618       $31,915      $(297)        $37,214       $36,720        494
(Benefit) provision for
  income taxes.............     $  (607)      $  (610)     $   3         $    68       $    54         14
Income (loss) from
  continuing operations....     $  (832)      $  (741)     $ (91)        $   148       $   105         43
Net income (loss)..........     $(1,161)      $(1,070)     $ (91)        $   176       $   133         43
Income (loss) from
  continuing operations per
  share
  Basic....................     $  (.51)      $  (.45)     $(.06)        $   .09       $   .06      $ .03
  Diluted..................     $  (.51)      $  (.45)     $(.06)        $   .09       $   .06      $ .03
Net income (loss) per share
  Basic....................     $  (.71)      $  (.65)     $(.06)        $   .11       $   .08      $ .03
  Diluted..................     $  (.71)      $  (.65)     $(.06)        $   .11       $   .08      $ .03
</Table>

     The effect of the change on retained earnings is as follows:

<Table>
<Caption>
                                                               2004      2003
                                                              -------   -------
<S>                                                           <C>       <C>
Balance at beginning of year as previously reported.........  $18,767   $18,888
Add adjustment for the cumulative effect on prior periods of
  applying retroactively the change in accounting method....       43         0
                                                              -------   -------
Balance at beginning of year, as adjusted...................   18,810    18,888
Net (loss) income...........................................   (1,161)      176
Dividends...................................................     (327)     (254)
                                                              -------   -------
Balance at end of year......................................  $17,322   $18,810
                                                              =======   =======
</Table>

     On March 15, 2005, Graham Corporation's Board of Directors approved a plan
to discontinue its U.K. operations by making available for sale the Company's
wholly-owned subsidiary, Graham Vacuum and Heat Transfer Limited and all of its
subsidiaries, including Graham Precision Pumps Limited. Two significant events
guided the Company to its decision to offer the U.K. operations for sale. The
Company commenced negotiations in October 2004 with a land developer to complete
a sales leaseback agreement of the land and buildings owned and occupied by
Graham Precision Pumps Limited. It was the Company's intent to use the proceeds
of the sale to retire its bank borrowings and enter into a new banking
agreement. The feasibility of this plan significantly diminished, when in March
2005, the Company evaluated the near term prospects for Graham Precision Pumps
Limited's orders. On March 24, 2005, the principal creditor of Graham's U.K.
companies, National Westminster Bank, exercised its right to appoint a receiver
for Graham Vacuum and Heat Transfer Limited and Graham Precision Pumps Limited.
In May 2005, the assets of Graham Precision Pumps Limited were sold by the
receiver. The Corporation did not receive any of the proceeds from the sale. The
divestiture of Graham Vacuum and Heat Transfer Limited and its subsidiaries has
been accounted for as a discontinued operation in the accompanying financial
statements. For additional information, see Note 2 in the Notes to Consolidated
Financial Statements.

                                        8
<PAGE>

FORWARD-LOOKING STATEMENTS

     Certain statements contained in this document, including in this
Management's Discussion and Analysis of Financial Condition and Results of
Operations, that are not historical facts, constitute "Forward-Looking
Statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. Forward-looking statements, in general, predict, forecast, indicate or
imply future results, performance or achievements and generally use words so
indicative. The Company wishes to caution the reader that numerous important
factors which involve risks and uncertainties, including but not limited to its
strategy to build its global sales representative channel, the effectiveness of
automation in its operations, the ability to improve its cost competitiveness,
customer preferences and changes in market conditions in the industries in which
the Company operates, and other factors discussed in the Company's filings with
the Securities and Exchange Commission, in the future, could affect the
Company's actual results and could cause its actual consolidated results to
differ materially from those expressed in any forward-looking statement made by,
or on behalf of, the Company.

CRITICAL ACCOUNTING POLICIES, ESTIMATES AND JUDGMENTS

     The discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America.

     Critical accounting policies are defined as those that are reflective of
significant judgments and uncertainties, and could potentially result in
materially different results under different assumptions and conditions.
Management has discussed each of these critical accounting policies and
estimates with the Audit Committee of the Board of Directors.

     Revenue Recognition -- The Corporation recognizes revenue on all contracts
with a planned manufacturing process in excess of four weeks (which approximates
575 direct labor hours) using the percentage-of-completion method. The
percentage-of-completion method is determined by relating actual labor incurred
to-date to management's estimate of total labor to be incurred on each contract.
Contracts in progress are reviewed monthly, and sales and earnings are adjusted
in current accounting periods based on revisions in the contract value and
estimated costs at completion. Losses on contracts are recognized immediately
when known.

     Revenue on other contracts (less than four weeks in duration, which
approximates less than 575 direct labor hours) not accounted for using the
percentage-of-completion method is recognized utilizing the completed contract
method. The majority of the Company's contracts have a planned manufacturing
process of less than four weeks and the results reported under this method do
not vary materially from the use of the percentage-of-completion method. The
Company recognizes revenue and all related costs on the completed contract
method upon substantial completion or shipment to the customer. Substantial
completion is consistently defined as at least 95% complete with regard to
direct labor hours. Customer acceptance is generally required throughout the
construction process and the Company has no further material obligations under
the contract after the revenue is recognized.

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

     To the extent that actual results differ from our assumptions, the
differences are reflected as unrecognized gains and losses and are amortized to
earnings over the estimated future service period of the plan participants to

                                        9
<PAGE>

the extent such total net recognized gains and losses exceed 10% of the greater
of the plan's projected benefit obligation or the market-related value of
assets. Significant differences in actual experience or significant changes in
future assumptions would affect the Company's pension and postretirement benefit
costs and obligations.

     Use of Estimates -- The preparation of these financial statements requires
us to make estimates and judgments that affect the reported amounts of assets
and liabilities, revenues and expenses and related disclosure of contingent
assets and liabilities at the date of our financial statements. Actual results
may differ from these estimates under different assumptions or conditions. Use
of estimates include the recording of revenue, pension obligations, and the
underlying assumptions, stock-based compensation and valuation reserves and/or
allowances for uncollectible accounts, inventory obsolescence, deferred taxes,
warranty, and liquidated damages.

RESULTS OF OPERATIONS

     For an understanding of the significant factors that influenced the
Company's performance, the following discussion should be read in conjunction
with the consolidated financial statements and the notes to consolidated
financial statements.

<Table>
<Caption>
                                                          FY 2005   FY 2004   FY 2003
                                                          -------   -------   -------
<S>                                                       <C>       <C>       <C>
Net sales...............................................  $41,333   $37,508   $44,511
Income (loss) from continuing operations................  $   296   $  (832)  $   148
Diluted income (loss) per share from continuing
  operations............................................  $  0.17   $ (0.51)  $  0.09
Identifiable assets.....................................  $33,529   $35,740   $38,323
</Table>

     Sales for the current year were $41,333, as compared to $37,508 for the
year ended March 31, 2004. This represents a 10% increase in sales. The increase
in sales for the twelve months ended March 31, 2005 was due to greater sales in
Graham's condensers, Heliflows and plate exchanger products, and one
petrochemical vacuum system shipment approximating 7% of annual sales.

     Sales for the last six months of fiscal year 2005 were up 29% over the same
period ended March 31,2004. Sales for the six months ended March 31, 2005 were
up 38% from the first half of the current fiscal year. The increase in sales in
the last half of the current fiscal year was due to improved demand for ejector
and condenser products. This demand is coming from the refinery and
petrochemical markets. Graham anticipates this trend to be sustained for at
least the near future. For further information, see Orders and Backlog, page 14
of the Management Discussion and Analysis of Financial Condition and Results of
Operations.

     The gross profit percentage for the year ended March 31, 2005 was 18%, as
compared to 16% for the year ended March 31, 2004. Gross profit percentage for
the last six months of fiscal year 2005 was 24%, as compared to 15% for the six
months ended March 31, 2004 and 10% for the six months ended September 30, 2004.
The improvement in gross profit percentage was due to greater sales volume,
selling price increases and the absence of one low profit margin sale for a
petrochemical vacuum system primarily recognized in revenue in the first half of
fiscal year 2005. The improvement in gross profit percentage, as compared to the
first half of fiscal year 2005, is expected to continue for at least the
immediate future.

     Selling, General and Administrative expenses were 19% of sales for the
current year, as compared to 21% for the year ended March 31, 2004. Selling,
General and Administrative expenses were down due to cost saving actions taken
to temporarily lower sales commissions and reduce spending in advertising and
travel expenses.

     Interest expense was $33 for the year ended March 31, 2005 and $46 for the
year ended March 31, 2004. Interest expense decreased due to less bank
borrowings.

     Other income for the twelve months ended March 31, 2005 was $1,592, as
compared to $522 for the twelve months ended March 31, 2004. Other income of
$1,592 resulted from a settlement of a contract dispute over cancellation
charges. The settlement of this matter ended a complaint filed in April 2004 in
the United States District Court for the Northern District of California
alleging breach of contract by a customer and a counterclaim filed by the
customer seeking specific performance of the contract or monetary damages. Other
income of $522,

                                        10
<PAGE>

recognized for the year ended March 31, 2004, represents a non-recurring
curtailment gain resulting from the discontinuation of postretirement medical
benefits.

     Other expenses recognized for the year ended March 31, 2005 of $1,049 were
substantially incurred in conjunction with transitioning two senior executives.
In accordance with an Agreement and General Release with Graham's former
President and CEO reached in November 2004, the Company will retain the former
officer as an independent consultant. The consulting contract does not require
performance for payment and, therefore, was expensed. His consulting services
currently include managing the South American sales territory. This Agreement
provides for a monthly retainer and certain medical and insurance benefits over
the period January 1, 2005 to November 8, 2008 for an estimated cost of $562. A
second senior executive was replaced in January 2005. The terms of his Agreement
included salary continuation for twelve months and certain medical benefits for
thirty-six months for an estimated cost of $157. Costs incurred through March
31, 2005 to recruit and relocate executive replacements resulted in an expense
recognition of $251. Other expense for the year ended March 31, 2004 was zero.

     The effective income tax rate for continuing operations for the year ended
March 31, 2005 was 18%, as compared to a benefit of 42% for the year ended March
31, 2004. The effective tax rate for fiscal year 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 the year ended March 2004 was enhanced due to
terminating split-dollar life insurance policies and distributing the proceeds
to the respective employees in October 2003.

     Income from continuing operations for the current year was $296 or $0.17
per diluted share. This compares to a loss of $832 or $0.51 per diluted share
for the year ended March 31, 2004.

     The Company incurred a net loss for the fiscal year, after recognition of
the loss from discontinued operations for its U.K. subsidiaries of $3,202, of
$2,906 or $1.69 per diluted share. This compares to a net loss of $1,161 for the
year ended March 31, 2004, after recognition of the loss from U.K. discontinued
operations (as restated for comparative purposes) of $329. The loss from
discontinued operations in fiscal 2005 of $3,202 includes the loss on disposal
of $2,637.

2004 COMPARED TO 2003

     Sales were $37,508 for fiscal year 2004 and $44,511 for fiscal year 2003.
This represents a 16% decrease in sales. This sales decline was due to fewer
surface condenser sales. Surface condenser sales to the domestic power industry
and worldwide chemical industry were down due to a capacity-to-demand imbalance
in these industries.

     The gross profit percentages for fiscal years 2004 and 2003 remained
unchanged at 16%. This was due to managing overhead costs in proportion to lower
sales. Cost actions initiated in prior years helped to reduce production costs
in fiscal year 2004. For example, in February 2003, postretirement medical
benefits for employees employed as of April 2003 were terminated. Additionally,
real estate taxes were reduced as a result of a legal proceeding settlement
entered into in September 2003 and workers' compensation costs were reduced by
back-to-work programs. The Company was also able to reduce its warranty reserve
because certain claims of significant value were settled.

     Selling, General and Administrative expenses for fiscal year 2004 were 21%
of sales, as compared to 18% for the fiscal year 2003. Total costs in fiscal
year 2004 actually decreased due to lower employment costs resulting from staff
downsizing.

     Interest expense was $46 in both fiscal years 2004 and 2003.

     Other income for fiscal year 2004 was $522, as compared to $1,801 for
fiscal year 2003. Fiscal year 2004 other income represented a curtailment gain
resulting from the discontinuing of postretirement medical benefits. Other
income of $1,801, recognized in fiscal year 2003, was a result of a contract
cancellation fee on an order from a customer in the electric power generating
industry.

     Other expense for fiscal year 2004 was zero, as compared to $658 for
severance costs in fiscal year 2003.

                                        11
<PAGE>

     The benefit for income taxes was 42% of the loss before income tax benefit
amount for fiscal year 2004, as compared to a provision for income taxes equal
to 31% of the income before income taxes amount in fiscal year 2003. The fiscal
year 2004 benefit was enhanced by an income tax benefit gained in terminating
split-dollar life insurance policies and distributing the proceeds to the
respective employees in October 2003. The 2003 effective tax rate was less than
the statutory rate of about 34% due to the impact of the extraterritorial income
exclusion benefit from foreign shipments.

     The loss from continuing operations for fiscal year 2004 was $832 or $.51
per fully diluted share. The Company recognized, from continuing operations,
income of $148 or $.09 per fully diluted share for fiscal year 2003.

     For comparative purposes, U.K. operating results have been reclassified to
discontinued operations for fiscal years 2004 and 2003. The net loss for fiscal
year 2004 was $1,161 or $.71 per diluted share, as compared to net income of
$176 or $.11 per diluted share in fiscal year 2003 after reclasses for U.K.
operations.

                              SHAREHOLDERS' EQUITY

<Table>
<Caption>
     SHAREHOLDERS' EQUITY
- ------------------------------
FYE 2005   FYE 2004   FYE 2003
- --------   --------   --------
<S>        <C>        <C>
$16,578    $18,102    $18,836
</Table>

2005 COMPARED TO 2004

     Shareholders' Equity decreased $1,524 or 8.4% for the year primarily due to
the disposal of Graham's U.K. operations (loss from discontinued operations of
$3,202 less gain in foreign currency translation of $1,452, net $1,750). In
addition, an increase to the minimum pension liability adjustment and the
corporate dividend further contributed to the decrease in equity. This decrease
in equity was offset by net income from continuing operations and the issuance
of common stock.

2004 COMPARED TO 2003

     Shareholders' Equity decreased $734 or 4% from March 31, 2003. Decreases
were caused by the net loss, an increase to the minimum pension liability
adjustment and the corporate dividend. These charges were partially offset by a
favorable foreign currency translation adjustment, issuance of common stock
resulting from the exercise of stock options and Director and Officer repayments
of notes due for the purchase of Graham's common stock under the Long-Term Stock
Ownership Plan.

                        LIQUIDITY AND CAPITAL RESOURCES

<Table>
<Caption>
                                                                  MARCH 31,
                                                              -----------------
                                                               2005      2004
                                                              -------   -------
<S>                                                           <C>       <C>
Working Capital.............................................  $11,204   $11,652
Cash Flow (Deficit) from Operations.........................  $(4,394)  $(1,265)
Cash and Investments........................................  $ 2,717   $ 5,763
Capital Expenditures........................................  $   224   $   249
Current Ratio...............................................      2.0       1.9
Debt/Capitalization.........................................     11.3%     10.6%
</Table>

     Working Capital equals Current Assets minus Current Liabilities. Current
Ratio equals Current Assets divided by Current Liabilities. Debt/Capitalization
equals total bank borrowings divided by equity.

                                        12
<PAGE>

                     CONTRACTUAL AND COMMERCIAL OBLIGATIONS

<Table>
<Caption>
                                                    LESS THAN    1-3     3-5
                                           TOTAL     1 YEAR     YEARS   YEARS   THEREAFTER
                                           ------   ---------   -----   -----   ----------
<S>                                        <C>      <C>         <C>     <C>     <C>
Short-term Debt..........................  $1,872    $1,872        --     --         --
Capital Lease Obligations(1).............      92        55        37     --         --
Operating Leases(1)......................      56        36        20     --         --
Pension and Postretirement Benefits(2)...     632       632               --         --
Other Long-Term Liabilities Reflected on
  the Balance Sheet Under GAAP...........     364         0       364     --         --
                                           ------    ------     -----   ----       ----
Total....................................  $3,016    $2,595     $(421)    --         --
                                           ======    ======     =====   ====       ====
</Table>

- ---------------

(1) For additional information, see Notes 6 and 7 to the consolidated Financial
    Statements.

(2) Amounts represent anticipated contributions to the defined benefit pension
    plan and postretirement medical benefit plan for FYE 2006. The Company
    expects to be required to make cash contributions beyond one year.

2005 COMPARED TO 2004

     Net cash consumed by operating activities of continuing operations for
fiscal year 2005 was $4,394 and $1,265 for fiscal year 2004. Cash consumption
increased primarily as a result of an increase in accounts receivable (an
increase of $3,249) and an increase in unbilled revenue (an increase of $3,620).
The increase in accounts receivable on March 31, 2005, as compared to March 31,
2004 was due to an increase in fiscal 2005 fourth quarter sales of $3,553 over
fiscal 2004 fourth quarter sales. Fifty-three percent of the fourth quarter
sales in fiscal 2005 were shipped in the month of March further increasing
accounts receivable. Unbilled revenues (sales recognized under the
percentage-of-completion method not yet billed to customers) increased over
fiscal 2004 because the stage of project completions was between billing
milestones, and there were also fewer progress payments negotiated on the
projects in process as of March 31, 2005 due to the competitive nature and size
of the contracts. The cash deficit from continuing operations was further
enlarged due to non-cash income recorded in the current year relating to the
settlement of a cancellation charge. Non-cash income recorded of $1,592 was
substantially collected in a prior fiscal year through progress billings, which
were included in customer deposits as of March 31, 2004. Non-cash income was
partially offset with non-cash expenses of $745 pertaining largely to senior
executive replacements. Cash was positively impacted due to an increase in
accounts payable on March 31, 2005 of $1,266, due to greater manufacturing
activity in the fourth quarter.

     Cash provided from investing activities of continuing operations in fiscal
year 2005 was $3,163, as compared to $1,299 in 2004. The increase in cash
provided of $1,864 was due to a reduction in the purchase of marketable
securities. Cash consumed in operations was largely financed using proceeds from
the redemption of marketable securities. Graham's investments in marketable
securities consist of U.S. government instruments. Between maturity dates of
government marketable securities, short-term bank borrowings were used to
finance operations. (See Note 7 of the Notes to Financial Statements for further
details on lines of credit).

     Other sources of cash generation for fiscal 2005 included issuance of
common stock to cover stock options exercised, which raised $390, as compared to
$311 in 2004, and repayments of notes outstanding for purchases of Graham stock
granted under the Company's Long-Term Stock Ownership Plan. In fiscal 2005, $46
was collected for note repayments, as compared to $348 for fiscal 2004.

     Other uses of cash for fiscal 2005 included capital expenditures by
continuing operations of $224, as compared to $249 for fiscal 2004, and
dividends paid on common stock of $333. Dividends paid in fiscal year 2004 were
$327.

     Total cash used by discontinued operations in fiscal year 2005 was $396
compared to cash generated of $301 in fiscal year 2004. This decrease was due
primarily to pay downs on short-term debt.

     Future anticipated cash requirements include a fiscal 2006 capital
expenditure program of about $2,000. This budget includes a substantial amount
for information technology and software expenditures that will be directed

                                        13
<PAGE>

toward enhancing engineering and design productivity. The Company intends to pay
regular quarterly dividends. The decision to pay dividends, however, remains
within the discretion of Graham's Board of Directors and may be affected by
various factors, including earnings, financial condition, capital requirements,
level of indebtedness and other considerations.

     The Company intends to generate cash to reinvest in the business in fiscal
2006 through earnings from operations and possibly the sale of ninety-nine
thousand shares of stock held as treasury stock. Graham believes its cash
sources for fiscal 2006 will be adequate to meet cash needs to carry out its
strategic plans and operations. For additional information on the Company's debt
capacity, see Note 7 to the Consolidated Financial Statements.

2004 COMPARED TO 2003

     Consolidated cash flow from continuing operations was negative $1,265 for
fiscal year 2004, as compared to a positive cash flow of $2,056 for fiscal year
2003. The fiscal year 2004 results were due to the net loss and $5,602 fewer
customer deposits.

     Fewer customer deposits were due to fewer sales of ejectors and condensers.
These products are typically negotiated with progress payments. The cash deficit
from continuing operations was further increased by the recognition of non-cash
income of $522, which related to a curtailment gain resulting from the
elimination of postretirement medical benefits. This change affected only active
employees.

     Other working capital accounts increasing cash used (e.g., increase of
$1,405 in accounts receivable and decreases in accounts payable of $1,557, and
other accrued expense of $1,048) were largely offset with a decrease in
inventory of $3,164.

     The cash deficit was financed through redeeming investments. Redemption of
investments were $1,199 in excess of maturities reinvested.

     Total cash provided by discontinued operations was $301 in fiscal year 2004
compared to $11 in fiscal year 2003.

ORDERS AND BACKLOG

     Orders for the current year were $49,857, as compared to $33,826 for the
year ended March 31, 2004, representing a 47% increase. Orders represent
communications received from customers requesting the supply of goods and/or
services from the Company.

     Orders for surface condensers increased in excess of $11,500 over the year
ended March 31, 2004 due to increased demand in major project work in the
petrochemical and refinery industry sectors. Improved business conditions are
global. As compared to the twelve months ended March 31, 2004, export orders are
up 46% and domestic orders are up 49%. Profit margins on orders in backlog have
improved due to price increases and an improved product mix.

     The activity in the refining sector is being driven from the need to
upgrade vacuum distillation, hydrotreater, hydrocracker and hydrodesulfurization
processes. These processes are used to reduce the content of sulfur in heavy
crude oil. Heavier crude, as a raw material for these refineries, is less
expensive than sweet crude oil. Petrochemical capital spending is being driven
from capacity expansion in methanol, gas-to-liquids, ethylene, ammonia, ethylene
glycol/ethylene oxide, styrene, polystyrene, cumene and phenol plants. This
capital spending is driven by end user demand for the by-products of oil.
Graham's products needed for these major projects include surface condensers,
ejectors and vacuum pump systems. Market risks that could slow or stop capital
spending in this sector include manufacturing capacity and demand getting out of
balance, the price of oil dropping, capital market financial concerns regarding
high debt, higher natural gas prices, and availability and costs for materials.

     Backlog of continuing operations was $22,376 at March 31, 2005, as compared
to $13,482 at March 31, 2004, representing a 66% increase. The prior year
backlog amounts have been restated to reflect contract cancellations and the
restatement of sales due to the change in the revenue recognition accounting
method. Backlog represents the total dollar value of orders received for which
revenue has not yet been recognized. All

                                        14
<PAGE>

orders in backlog represent orders from traditional markets in the Company's
established product lines. Approximately 44% of the backlog can be attributed to
equipment for refinery project work and 22% to petrochemical projects.

MARKET RISK (QUANTITATIVE AND QUALITATIVE DISCLOSURES)

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

     - foreign currency exchange rates

     - equity price risk (related to its Long-Term Incentive Plan for Directors)

     - material availability and price risk

     The assumptions applied in preparing quantitative disclosures regarding
foreign currency exchange rate and equity price risk are based upon volatility
ranges experienced in relevant historical periods, management's current
knowledge of the business and market place, and management's judgment of the
probability of future volatility based upon the historical trends and economic
conditions of the business.

     Graham's international consolidated sales for the past three years
approximates 40% of total sales. Operating in world markets involves exposure to
movements in currency exchange rates. Currency movements can affect sales in
several ways, the foremost being the ability to compete for orders against
competition having a relatively weaker currency. Business lost due to
competition for orders against competitors having a relatively weaker currency
cannot be quantified. Secondly, cash can be adversely impacted by the conversion
of sales in foreign currency to U.S. dollars. The substantial portion of
Graham's sales is collected in U.S. dollars. For both years ended March 31, 2005
and 2004, there were no sales in foreign currencies from continuing operations.
At certain times, the Company may enter into forward foreign currency exchange
agreements to hedge its exposure against unfavorable changes in foreign currency
values on significant sales contracts negotiated in foreign currencies.

     Graham has limited exposure to foreign currency purchases. For the years
ended March 31, 2005 and 2004, purchases in foreign currencies by continuing
operations were 4% and 8% of cost of products sold, respectively. In fiscal
years 2005 and 2004, the Company's operations in the United States recorded an
unusually large dollar volume of orders utilizing its former U.K. subsidiary
products. At certain times, forward foreign currency exchange contracts may be
utilized to limit currency exposure.

     The Company has a Long-Term Incentive Plan, which provides for awards of
share equivalent units (SEUs) for outside directors based upon the Company's
stock performance. SEUs are valued at fair market value thereby exposing the
Company to equity price risk. Upward adjustment to market value is limited to
(a) $16 per unit if at the valuation date the fair market value was less than or
equal to $16 per unit or (b) the fair market value at the valuation date if the
fair market value on that date was greater than $16 per unit. Gains and losses
recognized due to market price changes are included in the Company's results of
operations. Based upon the plan provisions and SEUs outstanding at March 31,
2005 and 2004 and a $16 per share price, a 50-75% change in the year end market
price of the Company's common stock would positively or (negatively) impact the
Company's income before income taxes as follows:

<Table>
<Caption>
                                                               MARCH 31,
                                                              ------------
                                                              2005   2004
                                                              ----   -----
<S>                                                           <C>    <C>
50% increase................................................  $ (5)  $(134)
50% decrease................................................  $106   $ 134
75% increase................................................  $ (5)  $(201)
75% decrease................................................  $159   $ 201
</Table>

                                        15
<PAGE>

     Assuming required net income targets are met, certain awards would be
provided, and based upon a market price of the Company's stock of $16 per share,
a 50-75% change in the stock price would positively (negatively) impact the
Company's income before income taxes in future years as follows:

<Table>
<Caption>
                                                    2006   2007   2008   2009   2010
                                                    ----   ----   ----   ----   ----
<S>                                                 <C>    <C>    <C>    <C>    <C>
50% increase......................................  $ (5)  $ (5)  $ (5)  $ (5)  $ (5)
50% decrease......................................  $143   $159   $176   $189   $201
75% increase......................................  $ (5)  $ (5)  $ (5)  $ (5)  $ (5)
75% decrease......................................  $214   $239   $264   $283   $301
</Table>

     The risks associated with materials include availability and price
increases. Although material shortages can affect the Company's ability to meet
delivery requirements for certain orders from time to time, historically, the
Company's shipment schedules have not been materially impacted. The Company has
identified alternative vendors in such cases and seeks to negotiate escalation
provisions in its sales contracts in the event that costs of materials increase.
Profit margins on sales would be reduced to the extent rising material costs
could not be passed on to Graham's customers.

CONTINGENCIES

     The Company is a co-defendant with numerous other defendants in matters of
litigation alleging personal injury from exposure to asbestos contained in some
of the Company's products previously manufactured. To date, it has been the
Company's experience that upon investigation the cases have been dismissed or
settled for minimal amounts. However, the magnitude of potential damages on
unsettled current claims is not determinable.

     From time to time, the Company is subject to legal proceedings and
potential claims arising from contractual agreements in the ordinary course of
business. The Company believes there are no such matters pending against it that
could have, individually or in the aggregate, a material adverse effect on its
financial statements.

NEW ACCOUNTING PRONOUNCEMENTS

     In November 2004, the Financial Accounting Standard Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 151, Inventory Costs.
This Statement amends the guidance in ARB No. 43, Chapter 4, "Inventory
Pricing", to clarify the accounting for abnormal amounts of idle facility
expense, freight, handling costs and wasted materials. This Statement requires
that those items be recognized as current-period charges regardless of whether
they meet the criterion of "abnormal." In addition, this Statement 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 be effective
for inventory costs incurred on a prospective basis during fiscal years
beginning after June 15, 2005. The pronouncement will have the effect of
accelerating the recognition of indirect manufacturing costs in times of below
normal manufacturing capacity utilization. Management has not determined the
impact on its Consolidated Financial Statements of adopting this Statement.

     In December 2004, the FASB issued SFAS Nos. 152, Accounting for Real Estate
Time-Sharing Transactions and 153, Exchanges of Non-monetary Assets as Amendment
of ARB Opinion No. 29. Both statements are effective for fiscal years beginning
after June 15, 2005. It is anticipated that neither pronouncement will have a
significant impact on Graham's financial reporting, if any.

     The FASB also issued in December 2004, SFAS No. 123R, "Share-Based
Payment". This Statement requires all share-based payments to employees,
including grants of employee stock options, to 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. Under SFAS No. 123(R), the Company must determine the
appropriate fair value model to be used for valuing share-based payments, the
amortization method for compensation cost and the transition method to be used
at the date of adoption. The transition alternatives include the modified
prospective or the modified retrospective adoption methods. Under the

                                        16
<PAGE>

modified retrospective method, prior periods may be restated either as of the
beginning of the year of adoption or for all periods presented. 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), while the modified retrospective methods would
record compensation expense for all unvested stock options and share awards
beginning with the first period restated. The Company is evaluating the
requirements of SFAS No. 123(R), but cannot yet estimate the effect of adopting
SFAS No. 123(R) as it has not yet selected the method of adoption or an
option-pricing model and has not yet finalized estimates of its expected
forfeitures. For additional information, see Note 1 to the Consolidated
Financial Statements.

CONTROLS AND PROCEDURES

     The Company's President and Chief Executive Officer and its Vice
President-Finance and Chief Financial Officer each have independently evaluated
the Company's disclosure controls and procedures as defined in Exchange Act
Rules 13a-15(e) and 15d-14(c) as of the end of the period covered by this annual
report on Form 10-K and each regards such controls as effective.

     There have been no significant changes to any such controls or in other
factors that could significantly affect such controls, subsequent to the date of
their evaluation by each of the CEO and the CFO.

OFF BALANCE SHEET ARRANGEMENTS

     The Company does not have any off balance sheet arrangements.

                                        17
<PAGE>

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     (Financial Statements, Notes to Financial Statements, Quarterly Financial
Data)

     (Dollar amounts in thousands except per share data. References to years
herein represent fiscal years ended March 31, 2005, 2004 and 2003).

                     CONSOLIDATED STATEMENTS OF OPERATIONS

<Table>
<Caption>
                                                                 YEAR ENDED MARCH 31,
                                                              ---------------------------
                                                               2005      2004      2003
                                                              -------   -------   -------
<S>                                                           <C>       <C>       <C>
Net sales...................................................  $41,333   $37,508   $44,511
                                                              -------   -------   -------
Costs, expenses and other income:
  Cost of products sold.....................................   33,793    31,618    37,214
  Selling, general and administrative.......................    7,691     7,805     8,178
  Interest expense..........................................       33        46        46
  Other expense.............................................    1,049                 658
  Other income..............................................   (1,592)     (522)   (1,801)
                                                              -------   -------   -------
  Total costs, expenses and other income....................   40,974    38,947    44,295
                                                              -------   -------   -------
Income (loss) from continuing operations before income
  taxes.....................................................      359    (1,439)      216
Provision (benefit) for income taxes........................       63      (607)       68
                                                              -------   -------   -------
Income (loss) from continuing operations....................      296      (832)      148
(Loss) income from discontinued operations (net of income
  taxes (benefit) of $(1,420), $(167) and $5 in 2005, 2004
  and 2003, respectively)...................................   (3,202)     (329)       28
                                                              -------   -------   -------
Net (loss) income...........................................  $(2,906)  $(1,161)  $   176
                                                              =======   =======   =======
Per Share Data
  Basic:
     Income (loss) from continuing operations...............  $   .17   $  (.51)  $   .09
     (Loss) income from discontinued operations.............  $ (1.90)  $  (.20)      .02
                                                              -------   -------   -------
     Net (loss) income......................................  $ (1.73)  $  (.71)  $   .11
                                                              =======   =======   =======
  Diluted:
     Income (loss) from continuing operations...............  $   .17   $  (.51)  $   .09
     (Loss) income from discontinued operations.............    (1.86)     (.20)      .02
                                                              -------   -------   -------
     Net (loss) income......................................  $ (1.69)  $  (.71)  $   .11
                                                              =======   =======   =======
</Table>

                See Notes to Consolidated Financial Statements.

                                        18
<PAGE>

                          CONSOLIDATED BALANCE SHEETS

<Table>
<Caption>
                                                                  MARCH 31,
                                                              -----------------
                                                               2005      2004
                                                              -------   -------
<S>                                                           <C>       <C>
ASSETS
Current assets:
  Cash and cash equivalents.................................  $   724   $   467
  Investments...............................................    1,993     5,296
  Trade accounts receivable, net of allowances ($28 and $75
     in 2005 and 2004, respectively)........................   10,026     8,950
  Unbilled revenue..........................................    3,620
  Inventories...............................................    4,823     6,984
  Domestic and foreign income taxes receivable..............       45       972
  Deferred income tax asset.................................      719     1,521
  Prepaid expenses and other current assets.................      139       217
                                                              -------   -------
       Total current assets.................................   22,089    24,407
Property, plant and equipment, net..........................    7,649     9,227
Deferred income tax asset...................................    3,747     2,048
Other assets................................................       44        58
                                                              -------   -------
       Total assets.........................................  $33,529   $35,740
                                                              =======   =======

LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
  Short-term debt...........................................  $ 1,872   $ 1,925
  Current portion of long-term debt.........................       48        44
  Accounts payable..........................................    3,374     3,230
  Accrued compensation......................................    2,802     3,866
  Accrued expenses and other liabilities....................    1,494     1,562
  Customer deposits.........................................    1,295     2,128
                                                              -------   -------
       Total current liabilities............................   10,885    12,755
Long-term debt..............................................       44        93
Accrued compensation........................................      213       239
Deferred income tax liability...............................                 77
Other long-term liabilities.................................      364        61
Accrued pension liability...................................    3,141     1,873
Accrued postretirement benefits.............................    2,304     2,540
                                                              -------   -------
       Total liabilities....................................   16,951    17,638
                                                              -------   -------
Shareholders' equity:
  Preferred stock, $1 par value --
     Authorized, 500,000 shares
  Common stock, $.10 par value --
     Authorized, 6,000,000 shares
     Issued, 1,796,740 and 1,757,450 shares in 2005 and
      2004, respectively....................................      180       176
  Capital in excess of par value............................    5,553     5,097
  Retained earnings.........................................   14,082    17,322
  Accumulated other comprehensive loss......................
     Minimum pension liability adjustment...................   (1,698)   (1,456)
     Cumulative foreign currency translation adjustment.....             (1,452)
                                                              -------   -------
                                                               18,117    19,687
Less:
  Treasury stock (99,123 shares in 2005 and 2004)...........   (1,385)   (1,385)
  Notes receivable from officers and directors..............     (154)     (200)
                                                              -------   -------
Total shareholders' equity..................................   16,578    18,102
                                                              -------   -------
       Total liabilities and shareholders' equity...........  $33,529   $35,740
                                                              =======   =======
</Table>

                See Notes to Consolidated Financial Statements.

                                        19
<PAGE>

                     CONSOLIDATED STATEMENTS OF CASH FLOWS

<Table>
<Caption>
                                                                  YEAR ENDED MARCH 31,
                                                              -----------------------------
                                                               2005       2004       2003
                                                              -------   --------   --------
<S>                                                           <C>       <C>        <C>
Operating activities:
  Income (Loss) from continuing operations..................  $   296   $   (832)  $    148
                                                              -------   --------   --------
  Adjustments to reconcile income (loss) from continuing
    operations to net cash (used) provided by operating
    activities of continuing operations:
    Non cash other (income) expense.........................     (846)      (522)        91
    Depreciation and amortization...........................      780        793        819
    Discount accretion on investments.......................      (38)       (49)      (115)
    Loss on disposal or sale of property, plant and
       equipment............................................        4                    16
    (Increase) decrease in operating assets:
       Accounts receivable..................................   (3,249)    (1,405)     9,954
       Unbilled revenue.....................................   (3,620)
       Inventories..........................................     (193)     3,252       (846)
       Domestic income taxes receivable/payable.............      888       (610)    (1,139)
       Prepaid expenses and other current and non-current
         assets.............................................      (57)        47         22
    Increase (decrease) in operating liabilities:
       Accounts Payable.....................................    1,266     (1,557)       117
       Accrued compensation, accrued expenses and other
         current and non-current liabilities................     (242)    (1,048)      (970)
       Customer deposits....................................      728         (4)    (4,554)
       Long-term portion of accrued compensation, accrued
         pension liability and accrued postretirement
         benefits...........................................     (169)       393     (1,500)
       Deferred income taxes................................       58        277         13
                                                              -------   --------   --------
         Total adjustments..................................   (4,690)      (433)     1,908
                                                              -------   --------   --------
  Net cash (used) provided by continuing operations.........   (4,394)    (1,265)     2,056
  Net cash (used) provided by discontinued operations.......      (85)       221       (159)
                                                              -------   --------   --------
  Net cash (used) provided by operating activities..........   (4,479)    (1,044)     1,897
                                                              -------   --------   --------
Investing activities:
  Purchase of property, plant and equipment.................     (224)      (249)      (799)
  Proceeds from sale of property, plant and equipment.......                   1         24
  Purchase of investments...................................   (8,462)   (13,209)   (23,636)
  Redemption of investments at maturity.....................   11,803     14,408     19,800
  Collection of notes receivable from officers and
    directors...............................................       46        348         90
                                                              -------   --------   --------
  Net cash provided (used) by investing activities of
    continuing operations...................................    3,163      1,299     (4,521)
  Net cash used by investing activities of discontinued
    operations..............................................      (75)       (34)      (143)
                                                              -------   --------   --------
  Net cash provided (used) by investing activities..........    3,088      1,265     (4,664)
                                                              -------   --------   --------
Financing activities:
  Increase (decrease) in short-term debt, net...............  $ 1,872
  Proceeds from issuance of long-term debt..................               9,280      4,795
  Principal repayments on long-term debt....................      (45)    (9,335)    (4,861)
  Issuance of common stock..................................      390        311
  Dividends paid............................................     (333)      (327)      (172)
  Acquisition of treasury stock.............................                 (20)
                                                              -------   --------   --------
  Net cash provided (used) by financing activities of
    continuing operations...................................    1,884        (91)      (238)
  Net cash (used) provided by financing activities of
    discontinued operations.................................     (233)       114        313
                                                              -------   --------   --------
  Net cash provided by financing activities.................    1,651         23         75
                                                              -------   --------   --------
  Effect of exchange rate on cash...........................        3          6          8
                                                              -------   --------   --------
  Net increase (decrease) in cash and equivalents...........      257        250     (2,684)
  Cash and cash equivalents at beginning of year............      467        217      2,901
                                                              -------   --------   --------
  Cash and cash equivalents at end of year..................  $   724   $    467   $    217
                                                              =======   ========   ========
</Table>

                See Notes to Consolidated Financial Statements.

                                        20
<PAGE>

           CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
<Table>
<Caption>
                                                                                   ACCUMULATED                    NOTES
                                     COMMON STOCK        CAPITAL IN                   OTHER                     RECEIVABLE
                                 ---------------------   EXCESS OF    RETAINED    COMPREHENSIVE   TREASURY    FROM OFFICERS
                                  SHARES     PAR VALUE   PAR VALUE    EARNINGS        LOSS          STOCK     AND DIRECTORS
                                 ---------   ---------   ----------   ---------   -------------   ---------   --------------
<S>                              <C>         <C>         <C>          <C>         <C>             <C>         <C>
Balance at March 31, 2002......  1,716,572   $     172   $   4,757    $  18,888     $  (2,178)    $  (1,161)    $    (842)
                                 ---------   ---------   ---------    ---------     ---------     ---------     ---------
Net income.....................                                             176
Foreign currency translation
  adjustment...................                                                           278
Minimum pension liability
  adjustment, net of income tax
  of $587......................                                                        (1,090)
    Total comprehensive loss...
Dividends......................                                            (254)
Collection of notes receivable
  from officers and
  directors....................                                                                                        90
                                 ---------   ---------   ---------    ---------     ---------     ---------     ---------
Balance at March 31, 2003......  1,716,572         172       4,757       18,810        (2,990)       (1,161)         (752)
                                 ---------   ---------   ---------    ---------     ---------     ---------     ---------
Net loss.......................                                          (1,161)
Foreign currency translation
  adjustment...................                                                           448
Minimum pension liability
  adjustment, net of income tax
  of $197......................                                                          (366)
    Total comprehensive loss...
Issuance of shares.............     40,878           4         307
Stock option tax benefit.......                                 33
Dividends......................                                            (327)
Acquisition of treasury stock                                                                          (224)          204
Collection of notes receivable
  from officers and
  directors....................                                                                                       348
                                 ---------   ---------   ---------    ---------     ---------     ---------     ---------
Balance at March 31, 2004......  1,757,450         176       5,097       17,322        (2,908)       (1,385)         (200)
Net loss.......................                                          (2,906)
Foreign currency translation
  adjustment...................                                                            92
Reclassification adjustment for
  losses included in net
  income.......................                                                         1,360
Minimum pension liability
  adjustment, net of income tax
  of $130......................                                                          (242)
    Total comprehensive loss...
Issuance of shares.............     39,290           4         386
Stock option tax benefit.......                                 70
Dividends......................                                            (334)
Collection of notes receivable
  from officers and
  directors....................                                                                                        46
                                 ---------   ---------   ---------    ---------     ---------     ---------     ---------
Balance at March 31, 2005......  1,796,740   $     180   $   5,553    $  14,082     $  (1,698)    $  (1,385)    $    (154)
                                 =========   =========   =========    =========     =========     =========     =========

<Caption>

                                 SHAREHOLDERS'
                                    EQUITY
                                 -------------
<S>                              <C>
Balance at March 31, 2002......    $  19,636
                                   ---------
Net income.....................          176
Foreign currency translation
  adjustment...................          278
Minimum pension liability
  adjustment, net of income tax
  of $587......................       (1,090)
                                   ---------
    Total comprehensive loss...         (636)
Dividends......................         (254)
Collection of notes receivable
  from officers and
  directors....................           90
                                   ---------
Balance at March 31, 2003......       18,836
                                   ---------
Net loss.......................       (1,161)
Foreign currency translation
  adjustment...................          448
Minimum pension liability
  adjustment, net of income tax
  of $197......................         (366)
                                   ---------
    Total comprehensive loss...       (1,079)
Issuance of shares.............          311
Stock option tax benefit.......           33
Dividends......................         (327)
Acquisition of treasury stock            (20)
Collection of notes receivable
  from officers and
  directors....................          348
                                   ---------
Balance at March 31, 2004......       18,102
Net loss.......................       (2,906)
Foreign currency translation
  adjustment...................           92
Reclassification adjustment for
  losses included in net
  income.......................        1,360
Minimum pension liability
  adjustment, net of income tax
  of $130......................         (242)
                                   ---------
    Total comprehensive loss...       (1,696)
Issuance of shares.............          390
Stock option tax benefit.......           70
Dividends......................         (334)
Collection of notes receivable
  from officers and
  directors....................           46
                                   ---------
Balance at March 31, 2005......    $  16,578
                                   =========
</Table>

                See Notes to Consolidated Financial Statements.
                                        21
<PAGE>

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 -- THE COMPANY AND ITS ACCOUNTING POLICIES:

     Graham Corporation 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 follow.

  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 shareholders' equity.
Translation adjustments are not adjusted for income taxes since they relate to
an investment which is permanent in nature.

  Revenue recognition

     During fiscal year 2005, the Company changed its method of recognizing
revenue for certain contracts from the completed contract to the
percentage-of-completion method. Formerly, only contracts with a planned
manufacturing process in excess of three months and with revenue of at least
$1,000 and 500 pounds sterling, in the USA and UK operating segments,
respectively, were accounted for under the percentage-of-completion method. Now
all contracts with a planned manufacturing process of four weeks or more (which
approximates 575 direct labor hours) and without a dollar threshold are
accounted for using the percentage-of-completion method. The Company believes
this is a preferable accounting method for these contracts because it measures
revenue, costs of products sold and related income on construction type
contracts based on progress on the contracts, thus providing a better measure of
the earnings process on a more timely basis. The Company extended its scope of
contracts accounted for using the percentage-of-completion method at this time
because management believes that the effects on the financial statements of
applying the completed contract method on these contracts could begin to vary
materially from the effects of applying the percentage-of-completion method. The
majority of the Company's contracts have a planned manufacturing process of less
than four weeks, and are accounted for using the completed contract method. The
financial results for prior years have been restated to reflect this change. The
impact of the change on net sales, cost of products sold, (benefit) provision
for income taxes, income (loss) from

                                        22
<PAGE>

continuing operations, net income (loss), income (loss) from continuing
operations per share and net income (loss) per share for the prior years
presented is as follows:

<Table>
<Caption>
                                  2004 AMOUNTS REPORTED USING              2003 AMOUNTS REPORTED USING
                             --------------------------------------   --------------------------------------
                             PERCENTAGE OF   COMPLETED                PERCENTAGE OF   COMPLETED
                              COMPLETION     CONTRACT                  COMPLETION     CONTRACT
                                METHOD        METHOD     DIFFERENCE      METHOD        METHOD     DIFFERENCE
                             -------------   ---------   ----------   -------------   ---------   ----------
<S>                          <C>             <C>         <C>          <C>             <C>         <C>
Net sales..................     $37,508       $37,893      $(385)        $44,511       $43,960        551
Cost of products sold......     $31,618       $31,915      $(297)        $37,214       $36,720        494
(Benefit) provision for
  income taxes.............     $  (607)      $  (610)     $   3         $    68       $    54         14
Income (loss) from
  continuing operations....     $  (832)      $  (741)     $ (91)        $   148       $   105         43
Net income (loss)..........     $(1,161)      $(1,070)     $ (91)        $   176       $   133         43
Income (loss) from
  continuing operations per
  share
  Basic....................     $  (.51)      $  (.45)     $(.06)        $   .09       $   .06      $ .03
  Diluted..................     $  (.51)      $  (.45)     $(.06)        $   .09       $   .06      $ .03
Net income (loss) per share
  Basic....................     $  (.71)      $  (.65)     $(.06)        $   .11       $   .08      $ .03
  Diluted..................     $  (.71)      $  (.65)     $(.06)        $   .11       $   .08      $ .03
</Table>

     The effect of the change on retained earnings is as follows:

<Table>
<Caption>
                                                               2004      2003
                                                              -------   -------
<S>                                                           <C>       <C>
Balance at beginning of year as previously reported.........  $18,767   $18,888
Add adjustment for the cumulative effect on prior periods of
  applying retroactively the change in accounting method....       43         0
                                                              -------   -------
Balance at beginning of year, as adjusted...................   18,810    18,888
Net (loss) income...........................................   (1,161)      176
Dividends...................................................     (327)     (254)
                                                              -------   -------
Balance at end of year......................................  $17,322   $18,810
                                                              =======   =======
</Table>

     Percentage of Completion

     The Company has established the systems and procedures essential to
developing the estimates required to account for a contract using the
percentage-of-completion method. The percentage-of-completion is determined by
relating actual labor incurred to-date to management's estimate of total labor
to be incurred on each contract. Contracts in progress are reviewed monthly, and
sales and earnings are adjusted in current accounting periods based on revisions
in 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 Sheet
to the extent that the revenue recognized exceeds the amounts billed to
customers. (Also see "Inventories" policy below).

     Completed Contract

     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 a
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.

                                        23
<PAGE>

  Shipping and handling fees and costs

     Shipping and handling fees billed to the customer are classified as revenue
and the related costs incurred for shipping and handling are included in cost of
products sold.

  Investments

     Investments consist primarily of fixed-income debt securities 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 positive 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. 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 is as follows at March 31:

<Table>
<Caption>
                                                               2005      2004
                                                              -------   -------
<S>                                                           <C>       <C>
Costs incurred since inception on contracts in progress.....  $ 8,641   $ 1,052
Estimated earnings since inception on contracts in
  progress..................................................    1,938       638
                                                              -------   -------
                                                               10,579     1,690
Less billings to date.......................................    8,516     5,436
                                                              -------   -------
Total.......................................................  $ 2,063   $(3,746)
                                                              =======   =======
</Table>

     The above activity is included in the accompanying Consolidated Balance
Sheets under the following captions at March 31:

<Table>
<Caption>
                                                               2005      2004
                                                              -------   -------
<S>                                                           <C>       <C>
Unbilled revenue............................................  $ 3,620
Progress payments reducing inventory (Note 3)...............     (262)  $(1,618)
Customer deposits...........................................   (1,295)   (2,128)
                                                              -------   -------
                                                              $ 2,063   $(3,746)
                                                              =======   =======
</Table>

  Property, plant and depreciation

     Property, plant and equipment are stated at cost net of accumulated
depreciation and amortization. Major additions and improvements are capitalized,
while maintenance and repairs are charged to expense as incurred. Depreciation
and amortization are provided based upon the estimated useful lives under the
straight line method. Estimated useful lives range from approximately five to
twenty-five years for office and manufacturing equipment and forty years for
buildings and improvements. Upon sale or retirement of assets, the cost and
related accumulated depreciation are removed from the accounts and any resulting
gain or loss is included in the results of operations. The Company assesses all
of its long-lived assets for impairment when impairment indicators are
identified. When the carrying value of an asset exceeds its undiscounted cash
flows, the Company recognizes an impairment loss if the asset's fair value is
less than its carrying value. The impairment is then calculated as the
difference between the carrying value and the fair value of the asset. No such
impairment losses were recorded in fiscal years 2005, 2004 or 2003.

                                        24
<PAGE>

  Product warranties

     The Company estimates the costs that may be incurred under its product
warranties and records a liability in the amount of such costs at the time
revenue is recognized. The reserve for product warranties is based upon past
claims experience and ongoing evaluations of any specific probable claims from
customers. A reconciliation of the changes in the product warranty liability is
presented in Note 5 of the Notes to Consolidated Financial Statements.

  Income taxes

     The Company recognizes deferred income tax assets and liabilities for the
expected future tax consequences of events that have been recognized in the
Company's financial statements or tax returns. Deferred income tax assets and
liabilities are determined based on the difference between the financial
statement and tax bases of assets and liabilities using currently enacted tax
rates. The Company evaluates the available evidence about future taxable income
and other possible sources of realization of deferred income tax assets and
records a valuation allowance to reduce deferred income tax assets to an amount
that represents the Company's best estimate of the amount of such deferred
income tax assets that more likely than not will be realized. No valuation
allowance was required at March 31, 2005.

  Stock-based compensation

     The Company accounts for stock-based compensation in accordance with
Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for
Stock-Based Compensation". As permitted by SFAS No. 123, the Company continues
to measure compensation for such plans using the intrinsic value based method of
accounting, prescribed by Accounting Principles Board (APB), Opinion No. 25,
"Accounting for Stock Issued to Employees". Accordingly, compensation cost for
stock options is measured as the excess, if any, of the quoted market price of
the Company's stock at the date of grant over the amount an employee must pay to
acquire the stock. Compensation cost for share equivalent units is recorded
based on the higher of the quoted market price of the Company's stock at the end
of the period up to $16 per unit or the stock price at the date of grant in
accordance with the terms of the Long-Term Incentive Plan.

     Under the intrinsic value method, no compensation expense has been
recognized for the Company's stock option plans. Had compensation cost for the
Company's two stock option plans been determined based on the fair value at the
grant date for awards under those plans in accordance with the fair value
methodology prescribed under SFAS No. 123, the Company's net income and net
income per share would have been the pro forma amounts indicated below:

<Table>
<Caption>
                                                                2005      2004     2003
                                                               -------   -------   -----
<S>                                              <C>           <C>       <C>       <C>
Net (loss) income..............................  As reported   $(2,906)  $(1,161)  $ 176
Stock-based employee compensation cost net of
  related tax benefits.........................                    118        75      69
                                                               -------   -------   -----
Pro forma net (loss) income....................                $(3,024)  $(1,236)  $ 107
                                                               =======   =======   =====
Basic (loss) income per share..................  As reported   $ (1.73)  $  (.71)  $ .11
                                                 Pro forma     $ (1.80)  $  (.75)  $ .06
Diluted (loss) income per share................  As reported   $ (1.69)  $  (.71)  $ .11
                                                 Pro forma     $ (1.76)  $  (.75)  $ .06
</Table>

                                        25
<PAGE>

     The weighted average fair value of the options granted during 2005, 2004,
and 2003 is estimated as $4.67, $3.27, and $2.88, respectively, using the Black
Scholes option pricing model with the following weighted average assumptions:

<Table>
<Caption>
                                                               2005         2004         2003
                                                            ----------   ----------   ----------
<S>                                                         <C>          <C>          <C>
Expected life.............................................     5 years      5 years      5 years
Volatility................................................       42.84%       47.13%       50.00%
Risk-free interest rate...................................        3.53         3.01%        2.81%
Dividend yield............................................        1.65%        2.25%        2.35%
</Table>

  Per share data

     Basic (loss) income per share is computed by dividing net (loss) 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 (loss) income per share is calculated by dividing net
(loss) income by the weighted average number of common and, when applicable,
potential common shares outstanding during the period. A reconciliation of the
numerators and denominators of basic and diluted (loss) income per share is
presented below:

<Table>
<Caption>
                                                      2005         2004         2003
                                                   ----------   ----------   ----------
<S>                                                <C>          <C>          <C>
Basic income (loss) per share:
  Numerator:
     Income (loss) from continuing operations....  $      296   $     (832)  $      148
                                                   ----------   ----------   ----------
  Denominator:
     Weighted common shares outstanding..........   1,666,937    1,630,546    1,648,249
     Share equivalent units (SEU) outstanding....      15,053       16,155       14,800
                                                   ----------   ----------   ----------
     Weighted average shares and SEUs
       outstanding...............................   1,681,990    1,646,701    1,663,049
                                                   ----------   ----------   ----------
Basic income (loss) per share from continuing
  operations.....................................  $      .17   $     (.51)  $      .09
                                                   ==========   ==========   ==========
Diluted income (loss) per share:
  Numerator:
     Income (loss) from continuing operations....  $      296   $     (832)  $      148
                                                   ----------   ----------   ----------
  Denominator:
     Weighted average shares and SEUs
       outstanding...............................   1,681,990    1,646,701    1,663,049
     Stock options outstanding...................      34,583                     9,037
     Contingently issuable SEUs..................         125
                                                   ----------   ----------   ----------
     Weighted average common and potential common
       shares outstanding........................   1,716,698    1,646,701    1,672,086
                                                   ----------   ----------   ----------
Diluted income (loss) per share from continuing
  operations.....................................  $      .17   $     (.51)  $      .09
                                                   ==========   ==========   ==========
</Table>

     Certain options to purchase shares of common stock, which totaled 36,600,
211,695 and 136,000 in 2005, 2004 and 2003, respectively, were not included in
the computation of diluted (loss) income per share as the effect would be
anti-dilutive.

  Cash flow statement

     The Company considers all highly liquid investments with an original
maturity of three months or less to be cash equivalents.

                                        26
<PAGE>

     Interest paid from continuing operations was $26 in 2005, $48 in 2004, and
$44 in 2003. In addition, income taxes (refunded) paid from continuing
operations were $(884) in 2005, $(274) in 2004, and $1,194 in 2003.

     Non cash activities during 2005, 2004, and 2003 included the recognition of
minimum pension liability adjustments, net of income tax benefits, of $242,
$448, and $1,090, respectively. In addition, the U.S. investment in the
Company's U.K. operations and the intercompany receivable totaling $3,994 were
written off as a result of the liquidation of the subsidiary. Dividends of $84,
$83 and $82 were recorded but not paid in 2005, 2004 and 2003, respectively.

     In 2004 and 2003, capital expenditures totaling $11 and $76, respectively,
were financed through the issuance of capital leases.

  Accumulated other comprehensive (loss) income

     Comprehensive (loss) income is comprised of net (loss) income and other
comprehensive income or loss items, which are accumulated as a separate
component of shareholders' equity. For the Company, other comprehensive income
or loss items include a foreign currency translation adjustment and a minimum
pension liability adjustment.

  Accounting and Reporting Changes

     In November 2004, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 151, "Inventory Costs." This Statement 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. This Statement requires that those items be recognized as current
period charges regardless of whether they meet the criterion of "abnormal". In
addition, this Statement requires that allocation of fixed production overheads
to the costs of conversion be based on the normal capacity of the production
facilities. This Statement is effective for inventory costs incurred during the
Company's fiscal year 2007. The Company believes the adoption of this Statement
will result in the acceleration of recognizing indirect manufacturing expenses
during times of below normal utilization of plant capacity. Management has not
determined the impact on the Consolidated Financial Statements of adopting this
Statement.

     In December 2004, the FASB issued SFAS No. 152, "Accounting for Real Estate
Time-Sharing Transactions" and SFAS No. 153, "Exchanges of Nonmonetary Assets".
Both Statements are effective for fiscal years beginning after June 15, 2005.
The Company does not believe either of these Statements will have a material
effect on the Company's consolidated financial position, results of operations
or cash flows.

     The FASB also issued in December 2004, SFAS No. 123R, "Share-Based
Payment". This Statement requires all share-based payments to employees,
including grants of employee stock options, to 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. Under SFAS No. 123(R), the Company must determine the
appropriate fair value model to be used for valuing share-based payments, the
amortization method for compensation cost and the transition method to be used
at the date of adoption. The transition alternatives include the modified
prospective or the modified retrospective adoption methods. Under the modified
retrospective method, prior periods may be restated either as of the beginning
of the year of adoption or for all periods presented. 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), while the modified retrospective methods would record
compensation expense for all unvested stock options and share awards beginning
with the first period restated. The Company is evaluating the requirements of
SFAS No. 123(R), but cannot yet estimate the effect of adopting SFAS No. 123(R)
as it has not yet selected the method of adoption or an option-pricing model and
has not yet finalized estimates of its expected forfeitures. For additional
information, see "Stock-Based Compensation" included in Note 1 of the Notes to
Consolidated Financial Statements.

                                        27
<PAGE>

  Reclassifications

     Certain reclassifications have been made to prior year financial
information to conform to the current year presentation.

NOTE 2 -- DISCONTINUED OPERATIONS:

     On March 15, 2005, Graham Corporation's Board of Directors approved a plan
to dispose of its U.K. operations by making available for sale the Company's
wholly-owned subsidiary, Graham Vacuum and Heat transfer Limited ("GVHT") and
all its subsidiaries, including GVHT's operating subsidiary Graham Precision
Pumps Limited ("GPPL") in Congleton, Cheshire, U.K. and to offer them for sale.
On March 24, 2005, the principal creditor of the U.K. companies, National
Westminster Bank, exercised its right to appoint a receiver for GVHT and GPPL to
sell the U.K. companies. The appointment of a receiver has resulted in a
liquidation of the assets of the U.K. companies, which was completed in May
2005. GPPL manufactured liquid ring vacuum pumps and complete vacuum pump
systems used in the chemical, petrochemical, petroleum refining and power
industries. The disposal of the U.K. companies has been presented in the
Consolidated Statement of Operations as a discontinued operation and,
accordingly, the results of operations for the prior years have been restated to
reflect the U.K. operations separately from continuing operations.

     Net sales for GPPL were $6,096 for the operating period in 2005 and $5,428
and $5,418 in the years ended March 31, 2004 and 2003, respectively. Pretax
(loss) income for GPPL was $(470) for the operating period in 2005 and $(496)
and $33 in the years ended March 31, 2004 and 2003, respectively.

     The 2005 loss from discontinued operations includes a loss from disposal of
$2,637, which is net of related income tax benefits of $1,515. This loss
reflects that the Company will not receive any proceeds from the disposal of the
U.K. operation.

NOTE 3 -- INVENTORIES:

     Major classifications of inventories are as follows:

<Table>
<Caption>
                                                               2005      2004
                                                              -------   -------
<S>                                                           <C>       <C>
Raw materials and supplies..................................  $ 2,098   $ 1,745
Work in process.............................................    1,421     4,478
Finished products...........................................    1,566     2,500
                                                              -------   -------
                                                                5,085     8,723
Less -- progress payments...................................      262     1,618
        inventory reserve...................................                121
                                                              -------   -------
                                                              $ 4,823   $ 6,984
                                                              =======   =======
</Table>

NOTE 4 -- PROPERTY, PLANT AND EQUIPMENT:

     Major classifications of property, plant and equipment are as follows:

<Table>
<Caption>
                                                               2005      2004
                                                              -------   -------
<S>                                                           <C>       <C>
Land........................................................  $   210   $   302
Buildings and improvements..................................   10,297    10,987
Machinery and equipment.....................................   14,349    18,081
Construction in progress....................................                  5
                                                              -------   -------
                                                               24,856    29,375
Less -- accumulated depreciation and amortization...........   17,207    20,148
                                                              -------   -------
                                                              $ 7,649   $ 9,227
                                                              =======   =======
</Table>

                                        28
<PAGE>

     Depreciation expense from continuing operations in 2005, 2004, and 2003 was
$768, $793, and $797, respectively.

NOTE 5 -- PRODUCT WARRANTY LIABILITY:

     The reconciliation of the changes in the product warranty liability is as
follows:

<Table>
<Caption>
                                                               2005      2004
                                                              -------   -------
<S>                                                           <C>       <C>
Balance at beginning of year................................  $   242   $   592
Expense for product warranties..............................      124        89
Product warranty claims paid................................     (111)     (439)
                                                              -------   -------
Balance at end of year......................................  $   255   $   242
                                                              =======   =======
</Table>

NOTE 6 -- LEASES:

     The Company leases equipment and office space under various operating
leases. Rent expense for continuing operations applicable to operating leases
was $53, $69 and $75 in 2005, 2004, and 2003, respectively.

     Property, plant and equipment include the following amounts for leases
which have been capitalized.

<Table>
<Caption>
                                                               2005      2004
                                                              -------   -------
<S>                                                           <C>       <C>
Machinery and equipment.....................................  $   222   $   224
Less accumulated amortization...............................      137        96
                                                              -------   -------
                                                              $    85   $   128
                                                              =======   =======
</Table>

     Amortization of machinery and equipment under capital lease for continuing
operations amounted to $43, $43 and $52 in 2005, 2004, and 2003, respectively,
and is included in depreciation expense.

     As of March 31, 2005, future minimum payments required under non-cancelable
leases are:

<Table>
<Caption>
                                                              OPERATING   CAPITAL
                                                               LEASES     LEASES
                                                              ---------   -------
<S>                                                           <C>         <C>
2006........................................................     $36       $ 55
2007........................................................      19         37
2008........................................................       1         11
                                                                 ---       ----
Total minimum lease payments................................     $56        103
                                                                 ===
Less -- amount representing interest........................                 11
                                                                           ----
Present value of net minimum lease payments.................               $ 92
                                                                           ====
</Table>

NOTE 7 -- DEBT:

  Short-Term Debt Due Banks

     The Company and its subsidiaries had short-term borrowings outstanding as
follows:

<Table>
<Caption>
                                                               2005     2004
                                                              ------   ------
<S>                                                           <C>      <C>
United States revolving credit facility.....................  $1,872
Borrowings of United Kingdom subsidiary under line of credit
  at bank's rate plus 1 1/2%................................           $1,925
                                                              ------   ------
                                                              $1,872   $1,925
                                                              ======   ======
</Table>

     The United States revolving credit facility agreement provides a line of
credit of up to $8,000 including letters of credit (Note 8) through October 31,
2005. Under the terms of the agreement, the Company was able to borrow at a rate
of prime at March 31, 2005 and 2004. The bank's prime rate was 5.75% and 4% at
March 31,
                                        29
<PAGE>

2005 and 2004, respectively. The United States operations had available unused
lines of credit of $3,588 at March 31, 2005.

     The United Kingdom subsidiary had a revolving credit facility agreement,
which provided a line of credit of 1,220 pounds sterling ($2,245 at the March
31, 2004 exchange rate) including letters of credit. The interest rate was the
bank's base rate plus 1 1/2%. The bank's base rate was 4% at March 31, 2004. The
United Kingdom short-term bank borrowings were collateralized by assets of the
United Kingdom subsidiary, which had a book value of $786 at March 31, 2004. The
United States operation did not provide a corporate guarantee or any security
for the United Kingdom revolving credit facility. Short-term debt was retired by
the receiver upon the liquidation and sale of assets of the United Kingdom
subsidiary (Note 2).

     The weighted average interest rate on short-term borrowings in 2005 and
2004 was 4.3% and 4.6%, respectively.

  Long-Term Debt

     The Company and its subsidiaries had long-term borrowings outstanding as
follows:

<Table>
<Caption>
                                                              2005   2004
                                                              ----   ----
<S>                                                           <C>    <C>
Capital lease obligations (Note 6)..........................  $92    $137
Less: current amounts.......................................   48      44
                                                              ---    ----
                                                              $44    $ 93
                                                              ===    ====
</Table>

     With the exception of capital leases, there are no long-term debt payment
requirements over the next five years.

     The Company is required to pay commitment fees of 1/2% on the unused
portion of the domestic revolving credit facility. No other financing
arrangements require compensating balances or commitment fees.

     The loan agreements contain provisions pertaining to the maintenance of
minimum working capital balances, tangible net worth and financial ratios as
well as restrictions on the payment of cash dividends to shareholders and
incurrence of additional long-term debt.

NOTE 8 -- FINANCIAL INSTRUMENTS AND DERIVATIVE FINANCIAL INSTRUMENTS

  Concentrations of Credit Risk:

     Financial instruments that potentially subject the Company to
concentrations of credit risk consist principally of cash, cash equivalents,
investments, and trade accounts receivable. The Company places its cash, cash
equivalents, and investments with high credit quality financial institutions,
and actively evaluates the credit worthiness of these financial institutions.
Concentrations of credit risk with respect to trade accounts receivable are
limited due to the large number of customers comprising the Company's customer
base and their geographic dispersion. At March 31, 2005 and 2004, the Company
had no significant concentrations of credit risk.

  Letters of Credit:

     The Company has entered into standby letter of credit agreements with
financial institutions relating to the guarantee of future performance on
certain contracts. At March 31, 2005 and 2004, the Company was contingently
liable on outstanding standby letters of credit aggregating $2,540 and $1,511,
respectively.

  Foreign Exchange Risk Management:

     The Company, as a result of its global operating and financial activities,
is exposed to market risks from changes in foreign exchange rates. In seeking to
minimize the risks and/or costs associated with such activities, the Company may
utilize foreign exchange forward contracts with fixed dates of maturity and
exchange rates. The Company does not hold or issue financial instruments for
trading or other speculative purposes and only contracts with high quality
financial institutions. If the counter-parties to the exchange contracts do not
fulfill

                                        30
<PAGE>

their obligations to deliver the contracted foreign currencies, the Company
could be at risk for fluctuations, if any, required to settle the obligation. At
March 31, 2005 and 2004, there were no foreign exchange forward contracts held
by the Company.

  Fair Value of Financial Instruments:

     The estimates of the fair value of financial instruments are summarized as
follows:

          INVESTMENTS -- The fair value of investments at March 31, 2005 and
     2004 approximated the carrying value.

          SHORT-TERM DEBT -- The carrying value of short-term debt approximates
     fair value due to the short-term maturity of this instrument and the
     variable interest rate.

NOTE 9 -- INCOME TAXES:

     The provision (benefit) for income taxes related to income from continuing
operations consists of:

<Table>
<Caption>
                                                              2005   2004    2003
                                                              ----   -----   ----
<S>                                                           <C>    <C>     <C>
Current:
  Federal...................................................  $  0   $(892)  $ 14
  State.....................................................     5       8     41
                                                              ----   -----   ----
                                                                 5    (884)    55
                                                              ----   -----   ----
Deferred:
  Federal...................................................    36     266     40
  State.....................................................    22      11    (27)
                                                              ----   -----   ----
                                                                58     277     13
                                                              ----   -----   ----
Total provision (benefit) for income taxes..................  $ 63   $(607)  $ 68
                                                              ====   =====   ====
</Table>

     The reconciliation of the provision (benefit) from continuing operations
calculated using the United States federal tax rate with the provision (benefit)
for income taxes from continuing operations presented in the financial
statements is as follows:

<Table>
<Caption>
                                                              2005   2004    2003
                                                              ----   -----   ----
<S>                                                           <C>    <C>     <C>
Provision (benefit) for income taxes at federal rate........  $122   $(489)  $ 73
State taxes.................................................    25      16
Charges not deductible for income tax purposes..............    43      54     81
Recognition of tax benefit generated by extraterritorial
  income exclusion..........................................   (94)    (98)   (79)
Cash surrender value of officer life insurance policies
  redeemed..................................................          (130)
Tax credits.................................................   (20)            (3)
Other.......................................................   (13)     40     (4)
                                                              ----   -----   ----
Provision (benefit) for income taxes........................  $ 63   $(607)  $ 68
                                                              ====   =====   ====
</Table>

                                        31
<PAGE>

     The deferred income tax asset (liability) recorded in the Consolidated
Balance Sheets results from differences between financial statement and tax
reporting of income and deductions. A summary of the composition of the net
deferred income tax asset follows:

<Table>
<Caption>
                                                               2005     2004
                                                              ------   ------
<S>                                                           <C>      <C>
Depreciation................................................  $ (865)  $ (857)
Accrued compensation........................................     400      229
Accrued pension liability...................................   1,219      985
Accrued postretirement benefits.............................     961    1,053
Compensated absences........................................     500      521
Inventories.................................................    (304)     (86)
Warranty liability..........................................     100       94
Restructuring reserve.......................................      55       60
Liquidated damages liability................................      19       30
Federal and state loss carryforwards........................   2,070      479
Federal tax credits.........................................     121      104
New York State investment tax credit........................     130      137
Other.......................................................      60      129
                                                              ------   ------
                                                               4,466    2,878
Less: Valuation allowance
Deferred income tax asset of continuing operations..........   4,466    2,878
Deferred income tax asset of discontinued operations........              614
                                                              ------   ------
                                                              $4,466   $3,492
                                                              ======   ======
</Table>

     The net deferred income tax asset is presented in the Consolidated Balance
Sheets as follows:

<Table>
<Caption>
                                                               2005     2004
                                                              ------   ------
<S>                                                           <C>      <C>
Current deferred income tax asset...........................  $  719   $1,521
Long-term deferred income tax asset.........................   3,747    2,048
Long-term deferred income tax liability.....................              (77)
                                                              ------   ------
                                                              $4,466   $3,492
                                                              ======   ======
</Table>

     Deferred income taxes include the impact of the federal AMT credit, which
may be carried forward indefinitely, federal and state operating loss
carryforwards of $9,692, which expire in 2025, and investment tax credits, which
expire from 2009 to 2020.

NOTE 10 -- EMPLOYEE BENEFIT PLANS:

  Retirement Plans

     The Company has a qualified defined benefit plan covering employees in the
United States hired prior to January 1, 2003, which is non-contributory.
Benefits are based on the employee's years of service and average earnings for
the five highest consecutive calendar years of compensation in the ten year
period preceding retirement. The Company's funding policy for the plan is to
contribute the amount required by the Employee Retirement Income Security Act of
1974. The measurement date for the plan is December 31.

                                        32
<PAGE>

     The components of pension cost are:

<Table>
<Caption>
                                                              2005    2004    2003
                                                              -----   -----   -----
<S>                                                           <C>     <C>     <C>
Service cost-benefits earned during the period..............  $ 472   $ 474   $ 398
Interest cost on projected benefit obligation...............    975     959     892
Expected return on assets...................................   (905)   (783)   (759)
Amortization of:
  Transition asset..........................................    (15)    (44)    (44)
  Unrecognized prior service cost...........................      4       4       4
  Actuarial loss............................................    304     287      81
                                                              -----   -----   -----
Net pension cost............................................  $ 835   $ 897   $ 572
                                                              =====   =====   =====
</Table>

     The weighted average actuarial assumptions used to determine net pension
cost are:

<Table>
<S>                                                           <C>   <C>   <C>
Discount rate...............................................    6%  6 3/4% 7 1/4%
Rate of increase in compensation levels.....................    3%    3%    3%
Long-term rate of return on plan assets.....................    9%    9%    9%
</Table>

     The expected long-term rate of return is based on the plan's asset
allocation using forward-looking assumptions in the context of historical
returns, correlations and market volatilities. The contribution to the plan for
the plan year ended December 31, 2005 is estimated to be $431.

     Changes in the Company's benefit obligation, plan assets and funded status
for the pension plan are presented below:

<Table>
<Caption>
                                                               2005      2004
                                                              -------   -------
<S>                                                           <C>       <C>
Change in the benefit obligation
  Projected benefit obligation at beginning of year.........  $17,333   $14,462
  Service cost..............................................      419       421
  Interest cost.............................................      975       959
  Actuarial (gain) loss.....................................     (641)    2,009
  Benefit payments..........................................     (479)     (518)
                                                              -------   -------
  Projected benefit obligation at end of year...............  $17,607   $17,333
                                                              =======   =======
  Accumulated benefit obligation at end of year.............  $14,048   $13,069
                                                              =======   =======
</Table>

                                        33
<PAGE>

     The weighted average actuarial assumptions used to determine the benefit
obligation are:

<Table>
<S>                                                           <C>       <C>
Discount rate...............................................     5.93%        6%
Rate of increase in compensation levels.....................        3%        3%

Change in fair value of plan assets
  Fair value of plan assets at beginning of year............  $ 9,988   $ 8,898
  Actual return on plan assets..............................      254     1,258
  Employer contribution.....................................      772       350
  Benefit and administrative expense payments...............     (479)     (518)
                                                              -------   -------
  Fair value of plan assets at end of year..................  $10,535   $ 9,988
                                                              =======   =======
Funded status
  Funded status at end of year..............................  $(7,072)  $(7,345)
  Unrecognized transition obligation........................                (16)
  Unrecognized prior service cost...........................       42        47
  Unrecognized actuarial loss...............................    6,173     6,520
                                                              -------   -------
  Net liability recognized..................................  $  (857)  $  (794)
                                                              =======   =======
</Table>

     The following benefit payments, which reflect future service, are expected
to be paid:

<Table>
<S>                                                           <C>
2006........................................................  $  480
2007........................................................     536
2008........................................................     614
2009........................................................     614
2010........................................................     692
2011-2015...................................................   4,279
                                                              ------
                                                              $7,215
                                                              ======
</Table>

     The Company recognized an additional minimum pension liability for the
underfunded defined benefit plan in 2005 and 2004. The additional minimum
pension liability is equal to the excess of the accumulated benefit obligation
over plan assets and the accrued liability. Amounts recognized in the
Consolidated Balance Sheets consist of the following:

<Table>
<Caption>
                                                               2005      2004
                                                              -------   -------
<S>                                                           <C>       <C>
Accrued benefit liability...................................  $(3,512)  $(3,081)
Intangible asset............................................       42        47
Deferred income tax asset...................................      915       784
Accumulated other comprehensive income......................    1,698     1,456
                                                              -------   -------
                                                              $  (857)  $  (794)
                                                              =======   =======
</Table>

     The current portion of the accrued pension liability as of March 31, 2005
and 2004 of $574 and $1,382, respectively, is included in the caption "Accrued
Compensation" and the long-term portion is separately presented in the
Consolidated Balance Sheets. The current portion of the accrued pension
liability decreased at March 31, 2005 due to the reduction in the expected
contributions to the plan as a result of changes in actuarial funding
assumptions.

                                        34
<PAGE>

     The weighted average asset allocation of the plan assets by asset category
is as follows:

<Table>
<Caption>
                                                                           DECEMBER 31,
                                                                TARGET     -------------
                                                              ALLOCATION   2004     2003
                                                              ----------   ----     ----
<S>                                                           <C>          <C>      <C>
Asset Category
  Equity securities.........................................    50-70%      64%      60%
  Debt securities...........................................    20-50%      33%      33%
  Other, including cash.....................................     0-10%       3%       7%
                                                                           ---      ---
                                                                           100%     100%
                                                                           ===      ===
</Table>

     The investment strategy of the plan is to generate a consistent total
investment return sufficient to pay present and future plan benefits to
retirees, while minimizing the long-term cost to the Company. Target allocations
for asset categories are used to earn a reasonable rate of return, provide
required liquidity and minimize the risk of large losses. Targets are adjusted
when considered necessary to reflect trends and developments within the overall
investment environment.

     On February 4, 2003, the Company closed the defined benefit plan to all new
employees hired on or after January 1, 2003. In place of the defined benefit
plan, these employees participate in the Company's defined contribution plan.
The Company contributes a fixed percentage of employee compensation to this plan
on an annual basis for these employees. The Company contribution to the defined
contribution plan for these employees in 2005 and 2004 was $7 and $1,
respectively.

     The Company has a Supplemental Executive Retirement Plan (SERP) which
provides retirement benefits associated with wages in excess of the legislated
qualified plan maximums. Pension expense recorded in 2005, 2004, and 2003
related to this plan was $29, $28 and $27, respectively. At March 31, 2005 and
2004, the related liability was $202 and $173, respectively, and is included in
the caption "Accrued Pension Liability" in the Consolidated Balance Sheets.

     The Company has a domestic defined contribution plan covering substantially
all employees. Company contributions to the plan are determined by a formula
based on profitability and are made at the discretion of the Compensation
Committee of the Board of Directors. Contributions were $0 in each of the years
2005, 2004, and 2003.

     The Company has a deferred compensation plan that allows certain key
employees to defer a portion of their compensation. The principal and interest
earned on the deferred balances are payable upon retirement. The accrued
compensation liability under this plan was $2 and $125 at March 31, 2005 and
2004, respectively.

     Other Postretirement Benefits

     In addition to providing pension benefits, the Company has a plan in the
United States which provides health care benefits for eligible retirees and
eligible survivors of retirees. The measurement date for the plan is December
31.

     On February 4, 2003, the Company irrevocably terminated postretirement
health care benefits for current U.S. employees. Benefits payable to retirees of
record on April 1, 2003 remained unchanged. As a result of the plan change, a
curtailment gain of $522 was recognized. This gain is included in the caption
"Other Income" in the 2004 Consolidated Statement of Operations. Of the $2,464
accrued postretirement benefit liability included in the Consolidated Balance
Sheet at March 31, 2005, $1,641 does not represent a cash obligation, but rather
an unrecognized prior service benefit from a plan amendment, and will be
amortized into income over the next 11 years. The amount of the credit
recognized in 2005 and 2004 was $166 and $124, respectively.

                                        35
<PAGE>

     The components of postretirement benefit cost are:

<Table>
<Caption>
                                                              2005    2004    2003
                                                              -----   -----   ----
<S>                                                           <C>     <C>     <C>
Service cost -- benefits earned during the period...........  $   0   $  13   $ 50
Interest cost on accumulated benefit obligation.............     72     100    182
Amortization of prior service benefit.......................   (166)   (124)
Amortization of actuarial loss..............................     13      10    (87)
                                                              -----   -----   ----
Net postretirement benefit (benefit) cost...................  $ (81)  $  (1)  $145
                                                              =====   =====   ====
</Table>

     The weighted average discount rate used to develop the net postretirement
benefit cost were 6%, 6 3/4% and 7 1/2% in 2005, 2004 and 2003, respectively.

     Changes in the Company's benefit obligation, plan assets and funded status
for the plan are as follows:

<Table>
<Caption>
                                                               2005     2004
                                                              ------   -------
<S>                                                           <C>      <C>
Change in the benefit obligation
  Projected benefit obligation at beginning of year.........  $1,160   $ 2,826
  Service cost..............................................                13
  Interest cost.............................................      72       100
  Plan amendments...........................................            (1,930)
  Participant contributions.................................      25        18
  Actuarial loss............................................     125       312
  Benefit payments..........................................    (179)     (179)
                                                              ------   -------
  Projected benefit obligation at end of year...............  $1,203   $ 1,160
                                                              ======   =======
</Table>

     The weighted average actuarial assumptions used to develop the accrued
postretirement benefit obligation were:

<Table>
<Caption>
                                                              2005     2004
                                                              ----     ----
<S>                                                           <C>      <C>
Discount rate...............................................  5.93%      6%
Medical care cost trend rate................................     7%    7 1/2%
</Table>

     The medical care cost trend rate used in the actuarial computation
ultimately reduces to 4 1/2% in 2010 and subsequent years. This was accomplished
using 1/2% decrements for the years 2006 through 2010.

<Table>
<Caption>
                                                               2005      2004
                                                              -------   -------
<S>                                                           <C>       <C>
Change in fair value of plan assets
  Fair value of plan assets at beginning of year............  $     0   $     0
  Employer contribution.....................................      154       161
  Participants' contributions...............................       25        18
  Benefit payments..........................................     (179)     (179)
                                                              -------   -------
  Fair value of plan assets at end of year..................  $     0   $     0
                                                              =======   =======
Funded status
  Funded status at end of year..............................  $(1,203)  $(1,160)
  Unrecognized prior service benefit........................   (1,641)   (1,807)
  Unrecognized actuarial gain...............................      380       267
                                                              -------   -------
  Net liability recognized..................................  $(2,464)  $(2,700)
                                                              =======   =======
</Table>

                                        36
<PAGE>

     The following benefit payments are expected to be paid:

<Table>
<S>                                                           <C>
2006........................................................  $  153
2007........................................................     151
2008........................................................     147
2009........................................................     140
2010........................................................     134
2011-2015...................................................     557
                                                              ------
                                                              $1,282
                                                              ======
</Table>

     The current portion of the accrued postretirement benefit obligation of
$160, at both March 31, 2005 and 2004, is included in the caption "Accrued
Compensation" and the long-term portion is separately presented in the
Consolidated Balance Sheets.

     Assumed medical care cost trend rates could have a significant effect on
the amounts reported for the postretirement benefit plan. However, due to the
caps imposed on the Company's share of the premium costs, a one percentage point
change in assumed medical care cost trend rates would not have a significant
effect on the total service and interest cost components or the postretirement
benefit obligation.

NOTE 11 -- STOCK COMPENSATION PLANS:

     The 2000 Graham Corporation Incentive Plan to Increase Shareholder Value
provides for the issuance of up to 150,000 shares of common stock in connection
with grants of incentive stock options and non-qualified stock options to
officers, key employees and outside directors. The 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.

     The 1995 Graham Corporation Incentive Plan to Increase Shareholder Value
provides for the issuance of up to 192,000 shares of common stock in connection
with grants of incentive stock options and non-qualified stock options to
officers, key employees and outside directors. The 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.

     The Company has a Long-Term Incentive Plan which provides for awards of
share equivalent units for outside directors based upon the Company's
performance. Each unit is equivalent to one share of the Company's common stock.
Share equivalent units are credited to each outside director's account for each
of the first five full fiscal years of the director's 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. The
cost of performance units earned and charged to pre-tax income under this Plan
was $0 in each of the years 2005, 2004, and 2003.

                                        37
<PAGE>

     Information on options under the Company's plans is as follows:

<Table>
<Caption>
                                                                               WEIGHTED
                                                         OPTION      SHARES    AVERAGE
                                                         PRICE        UNDER    EXERCISE
                                                         RANGE       OPTION     PRICE
                                                      ------------   -------   --------
<S>                                                   <C>            <C>       <C>
Outstanding at March 31, 2002.......................  $ 7.50-21.44   198,173    $12.78
Granted.............................................     $7.50        32,000    $ 7.50
Cancelled...........................................     $21.44       (4,200)   $21.44
                                                                     -------
Outstanding at March 31, 2003.......................  $ 7.50-21.44   225,973    $11.87
Granted.............................................  $  8.80-9.14    32,500    $ 8.85
Exercised...........................................  $  7.50-8.00   (40,878)   $ 7.62
Cancelled...........................................  $ 7.67-21.44    (5,900)   $13.57
                                                                     -------
Outstanding at March 31, 2004.......................  $ 7.50-21.44   211,695    $12.18
Granted.............................................  $12.50-13.00    39,000    $12.73
Exercised...........................................  $ 7.50-21.44   (39,290)   $ 9.93
Cancelled...........................................  $11.00-21.44   (20,400)   $15.50
                                                                     -------
Outstanding at March 31, 2005.......................  $ 7.50-21.44   191,005    $12.40
                                                                     =======
</Table>

<Table>
<Caption>
                                                                               WEIGHTED AVERAGE
                                      OPTIONS OUTSTANDING   WEIGHTED AVERAGE      REMAINING
EXERCISE PRICE                         AT MARCH 31, 2005     EXERCISE PRICE    CONTRACTUAL LIFE
- --------------                        -------------------   ----------------   ----------------
<S>                                   <C>                   <C>                <C>
$ 7.50- 9.14........................         53,655              $ 8.23              6.46years
 11.00-13.00........................        100,750               11.91              6.72
 16.13-21.44........................         36,600               19.86              2.74
                                            -------
$ 7.50-21.44........................        191,005              $12.40              5.88
                                            =======
</Table>

     There were 191,005 options exercisable at March 31, 2005, which had a
weighted average exercise price of $12.40 and 211,695 options exercisable at
March 31, 2004 which had a weighted average exercise price of $12.18. The
outstanding options expire October 2005 to December 2014. Options available for
future grants were 80,050 at March 31, 2005 and 98,650 at March 31, 2004.

NOTE 12 -- SHAREHOLDER RIGHTS PLAN:

     On July 27, 2000 the Company adopted a Shareholder Rights Plan. Under the
Plan, as of September 11, 2000, one share Purchase Right ("Right") is attached
to each outstanding share of Common Stock. When and if the Rights become
exercisable, each Right would entitle the holder of a share of Common Stock to
purchase from the Company one one-hundredth (1/100) interest in a share of
Series A Junior Participating preferred stock, at a price of $45.00 per one
one-hundredth (1/100) interest in a share of preferred stock, subject to
adjustment. The Rights become exercisable upon certain events: (i) if a person
or group of affiliated persons acquires 15% or more of the Company's outstanding
Common Stock; or (ii) if a person or group commences a tender offer for 15% or
more of the Company's outstanding Common Stock.

     The Company may redeem the Rights for $.01 per Right at any time prior to
the acquisition by a person or group of affiliated persons of beneficial
ownership of 15% or more of the Company's outstanding common stock ("Acquiring
Person").

     In the event that any person or group of affiliated persons becomes an
Acquiring Person, each holder of a Right other than Rights beneficially owned by
the Acquiring Person will have the right to receive upon exercise a number of
shares of common stock having a market value of twice the purchase price of the
Right. In the event that the Corporation is acquired in a merger or other
business combination transaction or fifty percent (50%) or more of its
consolidated assets or earning power is sold, each holder of a Right will have
the right to receive,

                                        38
<PAGE>

upon exercise, a number of shares of common stock of the acquiring corporation
that at the time of such transaction will have a market value of two times the
purchase price of the Right.

NOTE 13 -- OTHER INCOME AND EXPENSE:

     In November 2004, the Company entered into an Agreement and General Release
in connection with the retirement of its former President and CEO. In accordance
with the agreement, the Company will retain the former officer as an independent
consultant for the period January 1, 2005 to November 8, 2008 and provide
certain medical, dental and insurance benefits during the consulting period. The
agreement also contains a non-compete provision. The agreement, which does not
require performance for payment, was accounted for as an individual deferred
compensation arrangement, and, therefore, an expense of $648 was recognized.
This expense is included in the caption "Other Expense" in the 2005 Consolidated
Statement of Operations. The current and long-term portions of the related
liability at March 31, 2005 were $198 and $322, respectively, and are included
in the captions "Accrued Expenses and Other Liabilities" and "Other Long-Term
Liabilities" in the 2005 Consolidated Balance Sheet.

     In September 2004, the Company settled a contract dispute with a customer
regarding cancellation charges. As a result of the settlement, other income of
$1,592 was recorded and is presented in the caption "Other Income" in the 2005
Consolidated Statement of Operations.

     During 2005, the workforce in the United States was restructured by
transitioning certain senior management employees and eliminating positions at
the staff level. As a result, a restructuring charge of $401 was recognized,
which included severance and related employee benefit costs. This charge is
included in the caption "Other Expense" in the 2005 Consolidated Statement of
Operations.

     On February 4, 2003, the Company irrevocably terminated postretirement
healthcare benefits for current U.S. employees. Benefits payable to retirees of
record on April 1, 2003 remained unchanged. As a result of the plan change, a
curtailment gain of $522 was recognized. This gain is included in the caption
"Other Income" in the 2004 Consolidated Statement of Operations.

     During fiscal year 2003, an order from a customer in the electric power
generating industry that was previously suspended was cancelled. The contract
for the cancelled order entitled the Company to a cancellation charge of $2,155,
which was paid to the Company in March 2003. This income, net of costs incurred
on the contract of $354, is presented in the caption "Other Income" in the 2003
Consolidated Statement of Operations.

     In January 2003, the workforce in the United States was restructured by
eliminating positions at the staff and senior management levels in an effort to
reduce costs. As a result, a restructuring charge of $658 was recognized, which
included severance and related employee benefit costs. This charge is included
in the caption "Other Expense" in the 2003 Consolidated Statement of Operations.

     A reconciliation of the changes in the restructuring reserve, which is
included in the caption "Accrued Expenses and Other Liabilities" in the
Consolidated Balance Sheets is as follows:

<Table>
<Caption>
                                                              2005    2004
                                                              -----   -----
<S>                                                           <C>     <C>
Balance at beginning of year................................  $ 153   $ 390
Expense for restructuring...................................    401      10
Amounts paid for restructuring..............................   (412)   (247)
                                                              -----   -----
Balance at end of year......................................  $ 142   $ 153
                                                              =====   =====
</Table>

     The liability at March 31, 2005 will be paid in fiscal years 2006-2007.

NOTE 14 -- RELATED PARTY TRANSACTIONS:

     In April 2000, the Board of Directors adopted a Long-Term Stock Ownership
Plan to encourage officers and directors to broaden their equity ownership in
the Company. The Board authorized the sale under the Plan of up to 160,000
shares of the Company's common stock that was held as treasury stock. Of the
amount authorized,

                                        39
<PAGE>

eligible participants purchased 117,800 shares at fair market value. The
eligible participants paid cash equal to the par value of the shares and a note
receivable was recorded by the Company for the remaining balance due on the
purchase of the shares. The notes receivable are fixed rate interest bearing
notes with a term of ten years. The notes are repayable in equal quarterly
installments through March 31, 2010. The notes, which are full recourse notes,
contain certain provisions which grant a security interest to the Company in the
shares and any proceeds from the sale of the shares and are presented as a
component of Shareholders' Equity in the Consolidated Balance Sheets.

     On April 1, 2003, the Company acquired 30,800 shares of common stock
previously issued under the Long-Term Stock Ownership Plan from two former
officers. This transaction was accounted for as a purchase. The shares were
redeemed at the original issue price of $7.25, as compared to a market price at
the time of the closing of $7.55. This transaction resulted in a $224 increase
to treasury stock, a $204 reduction in notes receivable from officers and
directors, and cash payments to former officers. The cash payments approximate
amounts previously paid on the notes.

NOTE 15 -- SEGMENT INFORMATION:

     In March 2005, the Company made available for sale the United Kingdom
operation, which resulted in the appointment of a receiver by its bank, and,
subsequently, the liquidation of the operation. (See Note 2 to the Consolidated
Financial Statements for additional disclosure). As a result of the disposition
of this operating segment, which has been presented as a discontinued operation
in the Consolidated Financial Statements with prior year results being restated,
the Company has only one operating segment. Prior year segment information has
been restated to reflect the change in the structure of the Company. The United
States operation designs and manufactures heat transfer and vacuum equipment.
Heat transfer equipment includes surface condensers, Heliflows, water heaters
and various types of heat exchangers. Vacuum equipment includes steam jet
ejector vacuum systems and liquid ring vacuum pumps. These products are sold
individually or combined into package systems for use in several industrial
markets. The Company also services and sells spare parts for its equipment.

     Net sales by product line from continuing operations for the following
fiscal years are:

<Table>
<Caption>
                                                           2005      2004      2003
                                                          -------   -------   -------
<S>                                                       <C>       <C>       <C>
Heat transfer equipment.................................  $17,240   $13,437   $26,655
Vacuum equipment........................................   22,314    21,328    16,480
All other...............................................    1,779     2,743     1,376
                                                          -------   -------   -------
Net sales...............................................  $41,333   $37,508   $44,511
                                                          =======   =======   =======
</Table>

     The breakdown of net sales from continuing operations by geographic area
for the following fiscal years is:

<Table>
<Caption>
                                                           2005      2004      2003
                                                          -------   -------   -------
<S>                                                       <C>       <C>       <C>
Net Sales:
  Africa................................................  $   403   $    23   $    71
  Asia..................................................    6,154     8,341     2,040
  Australia & New Zealand...............................      731     2,222        18
  Canada................................................    3,756     6,068     4,573
  Mexico................................................    1,007        69       136
  Middle East...........................................    1,783     1,064     4,821
  South America.........................................    1,874     1,879     1,326
  United States.........................................   24,995    17,440    31,223
  Western Europe........................................      594       253       233
  Other.................................................       36       149        70
                                                          -------   -------   -------
     Net sales..........................................  $41,333   $37,508   $44,511
                                                          =======   =======   =======
</Table>

                                        40
<PAGE>

NOTE 16 -- CONTINGENCIES:

     The Company has been named as a defendant in certain lawsuits wherein the
respective plaintiffs allege personal injury from exposure to asbestos contained
in products made by the Company. The Company is a co-defendant with numerous
other defendants in these suits. The Company has retained litigation counsel to
defend these claims. The claims are similar to previous asbestos suits naming
the Company as defendant, which either were dismissed when it was shown that the
Company had not supplied products to the plaintiffs' places of work or were
settled for minimal amounts below the expected defense costs. The potential for
liability is not determinable.

     At March 31, 2005, management was unaware of any additional litigation
matters. However, from time to time, the Company is subject to legal proceedings
and potential claims arising from contractual agreements in the ordinary course
of business. The Company believes there are no such matters pending against it
that could have, individually or in the aggregate, a material adverse effect on
its financial statements.

                                        41
<PAGE>

QUARTERLY FINANCIAL DATA (UNAUDITED):

     A capsule summary of the Company's unaudited quarterly results for 2005 and
2004 is presented below:

<Table>
<Caption>
                                      FIRST          SECOND         THIRD          FOURTH         TOTAL
                                     QUARTER        QUARTER        QUARTER        QUARTER          YEAR
                                   ------------   ------------   ------------   ------------   ------------
<S>                                <C>            <C>            <C>            <C>            <C>
2005(1)(2)
Net sales........................  $      8,281   $      9,071   $     10,783   $     13,198   $     41,333
Gross profit.....................           781            953          2,572          3,234          7,540
Income (loss) from continuing
  operations.....................          (749)           392            (90)           743            296
Loss (income) from discontinued
  operations.....................          (228)            (9)            69         (3,034)        (3,202)
Net (loss) income................          (977)           383            (21)        (2,291)        (2,906)
Per share:
  Basic
  Income (loss) from continuing
    operations...................          (.45)           .23           (.05)           .44            .17
  (Loss) income from discontinued
    operations...................          (.14)           .01            .04          (1.79)         (1.90)
  Net (loss) income..............          (.58)           .23           (.01)         (1.35)         (1.73)
  Diluted
  Income (loss) from continuing
    operations...................          (.45)           .23           (.05)           .42            .17
  Income (loss) from discontinued
    operations...................          (.14)           .01            .04          (1.73)         (1.86)
  Net (loss) income..............          (.58)           .23           (.01)         (1.31)         (1.69)
Market price range of common
  stock..........................   11.95-10.70    12.00-10.95    14.79-11.40    17.80-12.77    17.80-10.70
2004(1)(2)
Net sales........................  $      7,746   $     11,226   $      8,891   $      9,645   $     37,508
Gross profit.....................           609          2,502            980          1,799          5,890
(Loss) income from continuing
  operations.....................          (579)           326           (719)           140           (832)
Loss from discontinued
  operations.....................          (126)          (117)           (30)           (56)          (329)
Net (loss) income................          (705)           209           (749)            84         (1,161)
Per share:
  Basic
  (Loss) income from continuing
    operations...................          (.35)           .20           (.44)           .08           (.51)
  Loss from discontinued
    operations...................          (.08)          (.07)          (.02)          (.03)          (.20)
  Net (loss) income..............          (.43)           .13           (.46)           .05           (.71)
  Diluted
  (Loss) income from continuing
    operations...................          (.35)           .20           (.44)           .08           (.51)
  Loss from discontinued
    operations...................          (.08)          (.07)          (.02)          (.03)          (.20)
  Net (loss) income..............          (.43)           .13           (.46)           .05           (.71)
Market price range of common
  stock..........................     9.20-7.06      9.65-8.35     10.58-8.65    11.70-10.00     11.70-7.06
</Table>

- ---------------

(1) The financial data presented for the first quarter of 2005 and all four
    quarters of 2004 has been restated to reflect the change in accounting for
    revenue recognition. (See Note 1 to the Consolidated Financial Statements).

(2) The financial data presented for the first three quarters of 2005 and all
    four quarters of 2004 has been restated to reflect the results of Graham
    Vacuum and Heat Transfer as discontinued operations. (See Note 2 to the
    Consolidated Financial Statements).

                                        42
<PAGE>

            REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Shareholders
Graham Corporation
Batavia, New York

     We have audited the accompanying consolidated balance sheets of Graham
Corporation and subsidiaries (the "Company") as of March 31, 2005 and 2004, and
the related consolidated statements of operations, changes in shareholders'
equity, and cash flows for each of the three years in the period ended March 31,
2005. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.

     We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. The Company is not
required to have, nor were we engaged to perform, an audit of its internal
control over financial reporting. Our audit included consideration of internal
control over financial reporting as a basis for designing audit procedures that
are appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.

     In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of Graham Corporation and
subsidiaries as of March 31, 2005 and 2004, and the results of their operations
and their cash flows for each of the three years in the period ended March 31,
2005, in conformity with accounting principles generally accepted in the United
States of America.

     As discussed in Note 1 to the consolidated financial statements, during the
year ended March 31, 2005, the Company changed its method of accounting for
construction-type contracts and, retroactively, restated the 2004 and 2003
financial statements for the change.

/s/ Deloitte & Touche LLP

Deloitte & Touche LLP
Rochester, New York
June 15, 2005

                                        43
<PAGE>

ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
         FINANCIAL DISCLOSURE

     None.

ITEM 9A.  CONTROLS AND PROCEDURES

     The Company's President and Chief Executive Officer and its Vice
President-Finance and Chief Financial Officer each have independently evaluated
the Company's disclosure controls and procedures as defined in Exchange Act
Rules 13a-15(e) and 15d-15(e) and each regards such controls as effective as of
the end of the period covered by this Annual Report on Form 10-K.

     There have been no significant changes to the internal control over
financial reporting during the last fiscal quarter that have materially
affected, or that are reasonably likely to materially affect, the Company's
internal control over financial reporting.

     There have been no significant changes to any such controls or in other
factors that could significantly affect such controls, subsequent to the date of
their evaluation by each of the CEO and the CFO.

ITEM 9B.  OTHER INFORMATION

     (Not applicable).

                                    PART III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS

     Except as otherwise stated specifically in this response to Item 10, the
information called for under this Item is set forth in statements under
"Election of Directors" and "Executive Officers" of the Company's Proxy
Statement for its 2005 Annual Meeting of Stockholders, which statements are
hereby incorporated herein by reference.

     Code of Ethics.  The Company has adopted a Code of Ethics applicable to its
principal executive officer, principal financial officer, controller and others
performing similar functions. The Code of Ethics is available on the Company's
website at www.graham-mfg.com.

ITEM 11.  EXECUTIVE COMPENSATION

     The information called for under this Item is set forth in statements under
"Compensation of Directors" of the Company's Proxy Statement for its 2005 Annual
Meeting of Stockholders and also under "Executive Compensation" of such proxy
statement, which statements are hereby incorporated herein by reference.

                                        44
<PAGE>

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
          RELATED STOCKHOLDER MATTERS

(a) SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS

     Except as set forth below, the information called for under this Item is
set forth in statements under "Security Ownership of Certain Beneficial Owners
and Management" of the Company's Proxy Statement for its 2005 Annual Meeting of
Stockholders, which statements are hereby incorporated herein by reference.

<Table>
<Caption>
                                                       EQUITY COMPENSATION PLAN INFORMATION
                                     ------------------------------------------------------------------------
                                               (A)                     (B)                      (C)
                                                                                       NUMBER OF SECURITIES
                                                                                      REMAINING AVAILABLE FOR
                                     NUMBER OF SECURITIES TO                           FUTURE ISSUANCE UNDER
                                         BE ISSUED UPON          WEIGHTED AVERAGE       EQUITY COMPENSATION
                                     EXERCISE OF OUTSTANDING    EXERCISE PRICE OF        PLANS (EXCLUDING
                                        OPTIONS, WARRANTS      OUTSTANDING OPTIONS,   SECURITIES REFLECTED IN
PLAN CATEGORY                              AND RIGHTS          WARRANTS AND RIGHTS          COLUMN (A))
- -------------                        -----------------------   --------------------   -----------------------
<S>                                  <C>                       <C>                    <C>
Equity compensation plans approved
  by security holders..............          191,005                  $12.40                  80,050
Equity compensation plans not
  approved by security holders.....                0                       0                       0
                                             -------                  ------                  ------
Total..............................          191,005                  $12.40                  80,050
                                             =======                  ======                  ======
</Table>

(B) SECURITY OWNERSHIP OF MANAGEMENT

     The information called for under this Item is set forth in statements under
"Security Ownership of Certain Beneficial Owners and Management", "Election of
Directors" and "Executive Compensation" of the Company's Proxy Statement for its
2005 Annual Meeting of Stockholders, which statements are hereby incorporated
herein by reference.

(C) CHANGES IN CONTROL

     (Not applicable).

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     The information called for under this Item is set forth in statements under
"Certain Relationships and Related Transactions" of the Company's Proxy
Statement for its 2005 Annual Meeting of Stockholders, which statements are
hereby incorporated herein by reference.

ITEM 14.  PRINCIPAL ACCOUNTANT FEES AND SERVICES

     The information called for under this Item is set forth in statements under
"Principal Accountant Fees and Services" in the Company's Proxy Statement for
its 2005 Annual Meeting of Stockholders, which statements are hereby
incorporated herein by reference.

ITEM 15.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

     (a) (1) The following are Financial Statements and related information
filed as part of this Annual Report on Form 10-K.

                                        45
<PAGE>

<Table>
<Caption>
                                                                     SEQUENTIAL
                                                                     PAGE NUMBER
                                                                     -----------
<S>  <C>                                                             <C>
(A)  Consolidated Statements of Operations for the Fiscal Years
     ended March 31, 2005, 2004 and 2003.........................          18
(B)  Consolidated Balance Sheets as of March 31, 2005 and 2004...          19
(C)  Consolidated Statements of Cash Flows for the Fiscal Years
     ended March 31, 2005, 2004 and 2003.........................          20
(D)  Consolidated Statements of Changes in Shareholders' Equity
     for the Fiscal Years ended March 31, 2005, 2004 and 2003....          21
(E)  Notes to Consolidated Financial Statements..................          22
(F)  Quarterly Financial Data....................................          42
(G)  Report of Independent Registered Public Accounting Firm.....          43
</Table>

     (a) (2) In addition to the above, the following Financial Statement
Schedules and related information are required to be filed as part of this
Annual Report on Form 10-K:

<Table>
<Caption>
                                                                     SEQUENTIAL
                                                                     PAGE NUMBER
                                                                     -----------
<S>  <C>                                                             <C>
(A)  Report of Independent Registered Public Accounting Firm on          47
     Financial Statement Schedules...............................
     Financial Statement Schedules for the Fiscal Years ended
     March 31, 2005, 2004 and 2003 as follows:
     (ii) Valuation and Qualifying Accounts (Schedule II)........        48
</Table>

     Other financial statement schedules have been omitted because the required
information is not present or is not present in amounts sufficient to require
submission of the schedule or because the required information is shown in the
consolidated financial statements or notes thereto.

                                        46
<PAGE>

            REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Shareholders
Graham Corporation
Batavia, New York

     We have audited the consolidated financial statements of Graham Corporation
and subsidiaries (the "Company") as of March 31, 2005 and 2004, and for each of
the three years in the period ended March 31, 2005, and have issued our report
thereon dated June 15, 2005 (which report expresses an unqualified opinion and
includes an explanatory paragraph concerning a change in accounting method for
construction-type contracts in 2005); such consolidated financial statements and
report are included elsewhere in this Form 10-K. Our audits also included the
consolidated financial statement schedule of the Company listed in Item 15. This
consolidated financial statement schedule is the responsibility of the Company's
management. Our responsibility is to express an opinion based on our audits. In
our opinion, such consolidated financial statement schedule, when considered in
relation to the basic consolidated financial statements taken as a whole,
presents fairly, in all material respects, the information set forth therein.

/s/ Deloitte & Touche LLP

Deloitte & Touche LLP
Rochester, New York
June 15, 2005

                                        47
<PAGE>

                      GRAHAM CORPORATION AND SUBSIDIARIES

                SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
                                 (IN THOUSANDS)

<Table>
<Caption>
                                          BALANCE AT   CHARGED TO   CHARGED TO                BALANCE AT
                                          BEGINNING    COSTS AND      OTHER                     END OF
DESCRIPTION                               OF PERIOD     EXPENSES     ACCOUNTS    DEDUCTIONS     PERIOD
- -----------                               ----------   ----------   ----------   ----------   ----------
<S>                                       <C>          <C>          <C>          <C>          <C>
Year ended March 31, 2005
  Reserves deducted from the asset to
     which they apply:
     Reserve for doubtful accounts
       receivable.......................     $ 75         $ 16         $(32)(c)    $ (31)        $ 28
  Reserves included in the balance sheet
     caption
     Accrued expenses
       Restructuring reserve............      153          401                      (412)         142
                                             ----         ----         ----        -----         ----
                                             $228         $417         $(32)       $(443)        $170
                                             ====         ====         ====        =====         ====
Year ended March 31, 2004
  Reserves deducted from the asset to
     which they apply:
     Reserve for doubtful accounts
       receivable.......................     $ 35         $ 35         $  6(a)     $  (1)        $ 75
  Reserves included in the balance sheet
     caption
     Accrued expenses
       Restructuring reserve............      390           10                      (247)         153
                                             ----         ----         ----        -----         ----
                                             $425         $ 45         $  6        $(248)        $228
                                             ====         ====         ====        =====         ====
  Reserves deducted from the asset to
     which they apply:
     Reserve for doubtful accounts
       receivable.......................     $ 76         $ (4)(b)     $  5(a)     $ (42)        $ 35
  Reserves included in the balance sheet
     caption
     Accrued expenses
       Restructuring reserve............        0          658                      (268)         390
                                             ----         ----         ----        -----         ----
                                             $ 76         $654         $  5        $(310)        $425
                                             ====         ====         ====        =====         ====
</Table>

- ---------------
Notes:

(a)  Represents a bad debt recovery and a foreign currency translation
     adjustment.

(b)  Represents a reversal of the reserve.

(c)  Represents a bad debt recovery and a reduction due to the liquidation of
     Graham Vacuum and Heat Transfer Limited.

                                        48
<PAGE>

     (a) (3) The following exhibits are required to be filed by Item 15(c) of
         Form 10-K:

<Table>
<Caption>
EXHIBIT NO.
- -----------
<C>           <S>
     *3.1     Certificate of Incorporation of Graham Corporation
     +3.2     By-laws of Graham Corporation, as amended
     *4.1     Certificate of Incorporation of Graham Corporation
    **4.2     Stockholder Rights Plan of Graham Corporation
  ***10.1     1989 Stock Option and Appreciation Rights Plan of Graham
                Corporation
 ****10.2     1995 Graham Corporation Incentive Plan to Increase
                Shareholder Value
 ++++10.3     Graham Corporation Outside Directors' Long-Term Incentive
                Plan
    #10.4     Employment Contracts between Graham Corporation and Named
                Executive Officers
    +10.5     Senior Executive Severance Agreements with Named Executive
                Officers
   ++10.6     2000 Graham Corporation Incentive Plan to Increase
                Shareholder Value
  +++10.7     Long-Term Stock Ownership Plan of Graham Corporation
   ##10.8     Directors' Indemnification Agreements
     10.9     Amended and Restated Credit Facility Agreement and First,
                Second and Third Amendments dated 2002, 2004 and 2005,
                respectively
  ###10.10    Fourth Amendment to Credit Facility Agreement
     11       Statement regarding computation of per share earnings
                Computation of per share earnings is included in Note 1 of
                the Notes to Consolidated Financial Statements
 ####14       Code of Ethics
     23.1     Consent of Deloitte & Touche LLP
     31.1     Rule 13a-14(a)/15d-14(a) Certification of Chief Executive
                Officer
     31.2     Rule 13a-14(a)/15d-14(a) Certification of Chief Financial
                Officer
     32       Section 1350 Certifications
</Table>

- ---------------
   + Incorporated herein by reference from the Quarterly Report of Registrant on
     Form 10-Q for the quarterly period ended June 30, 2004.

  ++ Incorporated herein by reference from the Registrant's Proxy Statement for
     its 2001 Annual Meeting of Shareholders.

 +++ Incorporated herein by reference from the Registrant's Proxy Statement for
     its 2000 Annual Meeting of Shareholders.

++++ Incorporated herein by reference from the Current Report on Form 8-K of
     Registrant filed on March 9, 2005.

   * Incorporated herein by reference from the Annual Report of Registrant on
     Form 10-K for the year ended December 31, 1989.

  ** Incorporated herein by reference from the Registrant's Current Report on
     Form 8-K dated August 23, 2000 and Registrant's Form 8-A dated September
     15, 2000.

 *** Incorporated herein by reference from the Registrant's Proxy Statement for
     its 1990 Annual Meeting of Shareholders.

**** Incorporated herein by reference from the Registrant's Proxy Statement for
     its 1996 Annual Meeting of Shareholders.

   # Incorporated herein by reference from the Annual Report of Registrant on
     Form 10-K for fiscal year ended March 31, 1998 and Current Report on Form
     8-K of Registrant filed on December 2, 2004.

  ## Incorporated herein by reference from the Quarterly Report of Registrant on
     Form 10-Q for the quarterly period ended December 31, 2004.

 ### Incorporated herein by reference from the Current Report on Form 8-K of
     Registrant filed on June 15, 2005.

#### Incorporated herein by reference from the Annual Report of Registrant on
     Form 10-K for the fiscal year ended March 31, 2004.

                                        49
<PAGE>

     Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this annual report to be
signed on its behalf by the undersigned, thereunto duly authorized.

                                          GRAHAM CORPORATION

DATE:  June 15, 2005
                                          By /s/      J. RONALD HANSEN

                                            ------------------------------------
                                                      J. Ronald Hansen
                                               Vice President -- Finance &
                                                      Administration
                                               and Chief Financial Officer
                                              (Principal Accounting Officer)

     Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.

<Table>
<Caption>
                                      SIGNATURE
                                      ---------
<C>                                                    <S>                                <C>



              /s/ WILLIAM C. JOHNSON                   President and Chief Executive      June 15, 2005
- ---------------------------------------------------      Officer; Director
                William C. Johnson

               /s/ J. RONALD HANSEN                    Vice President -- Finance &        June 15, 2005
- ---------------------------------------------------      Administration
                 J. Ronald Hansen                        and Chief Financial Officer
                                                         (Principal Accounting
                                                         Officer)

             /s/ CORNELIUS S. VAN REES                 Director                           June 15, 2005
- ---------------------------------------------------
               Cornelius S. Van Rees

               /s/ JERALD D. BIDLACK                   Director; Chairman of the Board    June 15, 2005
- ---------------------------------------------------
                 Jerald D. Bidlack

               /s/ HELEN H. BERKELEY                   Director                           June 15, 2005
- ---------------------------------------------------
                 Helen H. Berkeley

               /s/ H. RUSSEL LEMCKE                    Director                           June 15, 2005
- ---------------------------------------------------
                 H. Russel Lemcke

             /s/ WILLIAM C. DENNINGER                  Director                           June 15, 2005
- ---------------------------------------------------
               William C. Denninger

               /s/ JAMES J. MALVASO                    Director                           June 15, 2005
- ---------------------------------------------------
                 James J. Malvaso
</Table>

                                        50
<PAGE>

================================================================================

                       SECURITIES AND EXCHANGE COMMISSION

                             WASHINGTON, D.C. 20549


                              --------------------


                                    EXHIBITS

                                   filed with

                                    FORM 10-K

                  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

                                       of

                       THE SECURITIES EXCHANGE ACT OF 1934

                    FOR THE FISCAL YEAR ENDED March 31, 2005


                              --------------------


                               GRAHAM CORPORATION


================================================================================

</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-10.9
<SEQUENCE>2
<FILENAME>l13696aexv10w9.txt
<DESCRIPTION>EXHIBIT 10.9
<TEXT>
<PAGE>
                                                                    EXHIBIT 10.9


                 AMENDED AND RESTATED CREDIT FACILITY AGREEMENT

            THIS AMENDED AND RESTATED CREDIT FACILITY AGREEMENT is made as of
the 3rd day of November, 1999 by and between GRAHAM CORPORATION, a corporation
formed under the laws of the State of Delaware with offices at 20 Florence
Avenue, Batavia, New York and FLEET NATIONAL BANK, a national banking
association formed under the laws of the United States of America with offices
at One East Avenue, Rochester, New York 14638.

            This Agreement amends, restates, clarifies and supersedes in its
entirety the Restated Credit Facility Agreement between Graham Corporation (as
successor by merger to Graham Manufacturing Co., Inc.) and Fleet National Bank
(as successor to Fleet Bank) dated as of October 31, 1996, as amended by the
First Amendment to the Credit Agreement dated September 28, 1998.

            The parties hereby agree as follows:

ARTICLE 1. - DEFINITIONS

            1.1 The following terms shall have the following meanings unless
otherwise expressly stated herein:

            "Affiliate" shall mean any entity which directly or indirectly, or
      through one or more intermediaries, Controls or is Controlled By or is
      Under Common Control with the Borrower.

            "Bank" shall mean Fleet National Bank and its successors, legal
      representatives, and assigns.

            "Borrower" shall mean Graham Corporation and its successors, legal
      representatives, and assigns.

            "Break Costs" shall mean an amount equal to the amount (if any)
      required to compensate the Bank for any additional losses (including
      without limitation any loss, cost, or expense incurred by reason of the
      liquidation or reemployment of deposits or funds acquired by the Bank to
      fund or maintain the Obligations), costs, and expenses (including without
      limitation penalties) it may reasonably incur as a result of or in
      connection with a prepayment of an Obligation bearing interest at a
      LIBOR-based rate. If by reason of an Event of Default the Bank elects to
      declare the Obligations to be immediately due and payable, then any Break
      Costs with respect to the Obligations shall become due and payable in the
      same manner as though Borrower had exercised a right of prepayment.

            "Business Day" shall mean, in respect of any date that is specified
      in this Agreement to be subject to adjustment in accordance with
      applicable Business Day Convention, a day on which commercial banks settle
      payments in (i) London, if the payment obligation is calculated by
      reference to any LIBOR Rate, or (ii) New York, if the payment obligation
      is calculated by reference to any Prime Rate.

            "Cash Flow" shall mean net income plus depreciation and amortization
      less Unfunded Capital Expenditures less distributions, dividends, and
      stock repurchases.

<PAGE>

            "Controls" (including the terms "Controlled By" or "Under Common
      Control") shall mean but not be limited to the ownership of ten percent
      (10%) or more of the outstanding shares of capital stock of any
      corporation having voting power for the election of directors, whether or
      not at the same time stock of any other class or classes has or might have
      voting power by reason of the happening of any contingency, or ownership
      of ten percent (10%) or more of any interest in any partnership, or any
      other interest by reason of which a controlling influence over the affairs
      of the entity may be exercised.

            "Current Ratio" shall mean current assets compared to current
      liabilities, as determined by GAAP.

            "Debt Service Coverage Ratio" shall mean the ratio of (a) earnings
      before interest, taxes and depreciation to (b) interest expense and
      current maturities of long term debt.

            "Debt To Worth Ratio" shall mean Total Liabilities compared to
      Tangible Net Worth, as determined by GAAP.

            "Environment" means any water including but not limited to surface
      water and ground water or water vapor; any land including land surface or
      subsurface; stream sediments; air; fish; wildlife; plants; and all other
      natural resources or environmental media.

            "Environmental Laws" means all federal, state and local
      environmental, land use, zoning, health, chemical use, safety and
      sanitation laws, statutes, ordinances, regulations, codes and rules
      relating to the protection of the Environment and/or governing the use,
      storage, treatment, generation, transportation, processing, handling,
      production or disposal of Hazardous Substances and the regulations, rules,
      ordinances, bylaws, policies, guidelines, procedures, interpretations,
      decisions, orders and directives of federal, state and local governmental
      agencies and authorities with respect thereto.

            "Environmental Permits" means all licenses, permits, approvals,
      authorizations, consents or registrations required by any applicable
      Environmental Laws and all applicable judicial and administrative orders
      in connection with ownership, lease, purchase, transfer, closure, use
      and/or operation of the Improvements and/or as may be required for the
      storage, treatment, generation, transportation, processing, handling,
      production or disposal of Hazardous Substances.

            "Environmental Report" means written reports, if any, prepared for
      the Bank by an environmental consulting or environmental engineering firm.

            "ERISA" shall mean the Employee Retirement Income Security Act of
      1974, as amended.

            "Event of Default" shall mean the occurrence of any event described
      in Article 14 hereof.

            "GAAP" shall mean generally accepted accounting principles as in
      effect from time to time.

                                       2

<PAGE>

            "Hazardous Substances" means, without limitation, any explosives,
      radon, radioactive materials, asbestos, urea formaldehyde foam insulation,
      polychlorinated biphenyls, petroleum and petroleum products, methane, and
      any other material defined as a hazardous material, hazardous waste, toxic
      substance or hazardous substance in the Comprehensive Environmental
      Response, Compensation and Liability Act of 1980, as amended, 42 U.S.C.
      Sections 9601, et. seq.; the Hazardous Materials Transportation Act, as
      amended, 49 U.S.C. Sections 1801, et. seq.; the Resource Conservation and
      Recovery Act, as amended, 42 U.S.C. Sections 6901, et. seq.; Articles 17
      and 27 of the New York State Environmental Conservation Law or any other
      federal, state, or local law, regulation, rule, ordinance, bylaw, policy,
      guideline, procedure, interpretation, decision, order, or directive,
      whether existing as of the date hereof, previously enforced or
      subsequently enacted.

            "Improvements" shall mean any Property.

            "Increased Cost" means, in the event the Borrower elects the LIBOR
      Rate with respect to any of the Obligations, any additional amounts
      sufficient to compensate the Bank for any increased costs of funding or
      maintaining the Obligations as a result of any law or guideline adopted
      pursuant to or arising out of the July 1988 report of the Basle Committee
      on Banking Regulations and Supervisory Practices entitled "International
      Convergence of Capital Measurement and Capital Standards", or the adoption
      after the date of this Agreement of' any law or guideline regarding
      capital adequacy, or any change in any of the foregoing or in the
      interpretation or administration of any of the foregoing by any
      governmental authority, central bank or comparable agency charged with the
      interpretation or administration thereof, or compliance by the Bank or the
      Bank's holding company, if any, with any request or directive regarding
      capital adequacy (whether or not having the force of law) of any such
      authority, central bank or comparable agency, which has or would have the
      effect of reducing the rate of return on the Bank's capital or on the
      capital of the Bank's holding company, if any, as a consequence of the
      transactions contemplated by this Agreement and all related documents and
      agreements, the existence of the Bank's commitment, or the note(s) bearing
      interest at a rate based on the LIBOR Rate, to a level below that which
      the Bank or the Bank's holding company could have achieved but for such
      adoption, change or compliance (taking into consideration such Bank's
      policies on capital adequacy).

            "Letter of Credit" shall mean one or more Letters of Credit
      described in Article 3 of this Agreement.

            "LIBOR" shall mean, as applicable with respect to principal amounts
      on which a LIBOR Rate is in effect (a "LIBOR Advance"), the rate per annum
      (rounded upward, if necessary, to the nearest 1/32 of one percent) as
      determined on the basis of the offered rates for deposits in U.S. dollars,
      for a period of time comparable to such LIBOR Advance which appears on the
      Telerate page 3750 as of 11:00 a.m. London time on the day that is two
      London Business Days preceding the first day of such LIBOR Advance;
      provided, however, if the rate described above does not appear on the
      Telerate System on any applicable interest determination date, the LIBOR
      rate shall be the rate (rounded upwards as described above, if necessary)
      for deposits in dollars for a period substantially equal to the interest
      period on the Reuters Page "LIBO" (or such other page as may replace the
      LIBO Page on that service for

                                       3

<PAGE>

      the purpose of displaying such rates), as of 11:00 a.m. (London Time), on
      the day that is two (2) London Business Days prior to the beginning of
      such interest period.

            If both the Telerate and Reuters system are unavailable, then the
      rate for that date will be determined on the basis of the offered rates
      for deposits in U.S. dollars for a period of time comparable to such LIBOR
      Advance which are offered by four major banks in the London interbank
      market at approximately 11:00 a.m. London time, on the day that is two (2)
      London Business Days preceding the first day of such LIBOR Advance as
      selected by the Bank. The principal London office of each of the four
      major London banks will be requested to provide a quotation of its U.S.
      dollar deposit offered rate. If at least two such quotations are provided,
      the rate for that date will be the arithmetic mean of the quotations. If
      fewer than two quotations are provided as requested, the rate for that
      date will be determined on the basis of the rates for loans quoted in U.S.
      dollars to leading European banks for a period of time comparable to such
      LIBOR Advance offered by major banks in New York City at approximately
      11:00 a.m. New York City time, on the day that is two London Business Days
      preceding the first day of such LIBOR Advance. In the event that the Bank
      is unable to obtain any such quotation as provided above, it will be
      deemed that LIBOR pursuant to a LIBOR Advance cannot be determined. In the
      event that the Board of Governors of the Federal Reserve System shall
      impose a Reserve Percentage with respect to LIBOR deposits of the Bank,
      then for any period during which such Reserve Percentage shall apply,
      LIBOR shall be equal to the amount determined above divided by an amount
      equal to 1 minus the Reserve Percentage. "Reserve Percentage" shall mean
      the maximum aggregate reserve requirement (including all basic,
      supplemental, marginal and other reserves) which is imposed on member
      banks of the Federal Reserve System against "Euro-currency Liabilities" as
      defined in Regulation D.

            "LIBOR Interest Period" shall mean any particular one-, two- or
      three-month period during which an applicable LIBOR Rate shall be in
      effect.

            "LIBOR Rate" shall mean, with respect to any interest rate period,
      the rate per annum equal to LIBOR, further adjusted to reflect any
      Increased Cost.

            "Obligations" shall include all of the Borrower's obligations to the
      Bank of any kind or nature, arising in the past, now or in the future,
      including without limitation obligations related to this Agreement and
      under the Revolving Line Note, any Reimbursement Agreement, and the Term
      Loan Note.

            "Prime Rate" means the variable per annum rate of interest so
      designated from time to time by Fleet National Bank as its prime rate. The
      Prime Rate is a reference rate and does not necessarily represent the
      lowest or best rate being charged to any customer.

            "Property" shall mean any real property or improvements owned,
      occupied or operated by the Borrower.

            "Rate Change Date" shall mean the first day of the first month of
      each one-, two- or three-month period, depending on the rate(s) selected
      by the Borrower.

                                       4

<PAGE>

            "Reimbursement Agreement" shall mean a Reimbursement Agreement
      substantially in the form of the Bank's standard letter of credit
      reimbursement agreement, or otherwise acceptable to the Bank in its sole
      discretion.

            "Release" has the same meaning as given to that term in Section
      101(22) of the Comprehensive Environmental Response, Compensation and
      Liability Act of 1980, as amended, 42 U.S.C. Section 9601(22), and the
      regulations promulgated thereunder.

            "Revolving Line" shall mean the revolving line of credit established
      pursuant to Section 2.1 of this Agreement.

            "Revolving Line Note" shall mean the note evidencing Obligations
      related to the Revolving Line as described in Section 2.2 of this
      Agreement.

            "Revolving Line Termination Date" shall mean the date on which the
      Revolving Line terminates as described in Section 2.5 of this Agreement.

            "Tangible Net Worth" shall mean total tangible assets (excluding all
      intercompany assets and accounts from officers and Affiliates) less Total
      Liabilities as determined by GAAP.

            "Term Loan" shall mean a term loan made pursuant to Article 4 of
      this Agreement, or all such Term Loans, collectively, as the context may
      indicate.

            "Term Loan Note" shall mean the note(s) evidencing Obligations
      related to the Term Loan as described in Section 4.2 of this Agreement.

            "Total Liabilities" shall mean the sum of all liabilities shown on
      the Borrower's balance sheet as of the applicable date of determination,
      determined in accordance with GAAP.

            "Unfunded Capital Expenditures" shall mean capital expenditures,
      determined according to GAAP, not paid for with borrowing, lease
      financing, or other similar indebtedness.

ARTICLE 2. - REVOLVING LINE

            2.1 Revolving Line. Subject to the terms and conditions of this
Agreement, the Bank hereby establishes for the benefit of the Borrower a
revolving line of credit in the maximum principal amount of Thirteen Million
Dollars ($13,000,000) outstanding at any one time. The proceeds of the Revolving
Line shall be used to meet the Borrower's letter of credit, foreign exchange and
working capital requirements. A portion of the Revolving Line may be used by the
Borrower to fund, with the prior approval of the Bank's portfolio manager
responsible for the Borrower, a foreign exchange guidance line of credit not to
exceed (a) $500,000 for foreign exchange contracts maturing on any one day; and
(b) $3,333,333.00 for total foreign exchange contracts (with respect to forward
contracts, not to exceed one year from the date of contract) outstanding at any
one time. With respect to advances other than for foreign exchange under the
Revolving Line, the entire $500,000 foreign exchange sublimit will be reserved
for purposes of

                                       5

<PAGE>

determining availability under the Revolving Line, irrespective of the amounts
actually advanced under the foreign exchange guidance line. Subject to the terms
of this Agreement, the Borrower may borrow, repay, and reborrow under the
Revolving Line so long as the aggregate principal amount outstanding at any time
(plus (a) the aggregate face amount of letters of credit issued pursuant to
Article 4 hereof and (b) the outstanding principal amount of the Term Loan, if
applicable) does not exceed $13,000,000.

            2.2 Revolving Line Note. The Borrower shall execute, together with
this Agreement, a note evidencing Obligations related to the Revolving Line in
the form of Exhibit A attached hereto and made a part hereof.

            2.3 Interest Rate and Payments. Outstanding amounts under the
Revolving Line, except as specifically provided herein, shall bear interest
until paid in full at the Prime-based rate determined with reference to Table
2.3, below. Each of the two financial triggers applicable to a given rate in
Table 2.3 must be satisfied for that rate to apply. If the Debt Service Coverage
Ratio financial trigger in respect of a particular rate is satisfied but the
Debt To Worth Ratio financial trigger is not satisfied, the applicable rate
shall be twenty-five (25) basis points higher than the rate indicated based upon
the Debt Service Coverage Ratio financial trigger. The financial performance
triggers shall be measured quarterly and on a consolidated basis for the
Borrower (with a rolling twelve-month period for the Debt Service Coverage
Ratio) as of the end of each of the Borrower's fiscal quarters.

                                                                       TABLE 2.3

<TABLE>
<CAPTION>
    Debt to Worth Ratio             Debt Service Coverage Ratio        LIBOR - Based Rate        Prime-Based Rate
- ----------------------------       ------------------------------      ------------------       ------------------
<S>                                <C>                                 <C>                      <C>
< or = 1.75 (< or = 1.50 to        <1.5 to 1.0                         LIBOR + 275 bp           Prime Rate
1 at 3/31/00 and thereafter)

< or = 1.50 to 1                   > or = 1.5 to 1.0, < 2.00 to 1      LIBOR + 225 bp           Prime Rate - 0.50%

< or = 1.25 to 1                   > or = 2.00 to 1.0, < 2.5 to 1      LIBOR + 175 bp           Prime Rate - 1.00%

< or = 1.00 to 1.0                 > or = 2.5 to 1.0 < 3.0 to 1.0      LIBOR + 150 bp           Prime Rate - 1.25%

< or = 1.00 to 1.0                 > or = 3.00 to 1.0                  LIBOR + 125 bp           Prime Rate - 1.50%
</TABLE>

            The Borrower, however, may from time to time elect to have the one-,
two- or three-month LIBOR Rate determined in accordance with Table 2.3 apply to
some or all of the amounts outstanding under the Revolving Line by giving at
least two (2) business days' prior notice in writing or by telecopy to the Bank,
provided, that after the first such election, any subsequent election may only
be made at least two (2) business days' prior to, and to become effective on, a
Rate Change Date. The notice shall specify the outstanding principal amount to
bear interest at the LIBOR-based rate or rates (with any outstanding amounts
from time to time under the Revolving Line, in excess of such specified amount,
to bear interest at the applicable Prime-based rate). The rate(s) of interest so
elected shall be in effect (as adjusted on each applicable Rate Change Date or

                                       6

<PAGE>

with each change in the Prime Rate, as applicable), until the effective date of
any subsequent election notice received by the Bank. During any period in which
a LIBOR-based rate is in effect, if the principal amount outstanding under the
Revolving Line bearing interest at such rate is ever less than the principal
amount stated in the related election notice, the Borrower shall pay Break
Costs, if any. Interest shall be calculated based on actual days elapsed divided
by a year of 360 days. Changes in the rate of interest applicable to the
Revolving Line Note shall become effective automatically, immediately, and
without notice or demand of any kind at the time of changes in the Prime Rate,
as applicable.

            2.4 Payments. Payments of all accrued interest under the Revolving
Line Note shall be made on the first day of each month.

            All remaining outstanding principal and accrued interest shall be
due and payable in full upon the earlier of (a) at the option of the Bank, upon
written notice to Borrower, an Event of Default, or (b) the Revolving Line
Termination Date, provided that under certain circumstances, some or all of the
principal amounts outstanding under the Revolving Line may be converted to a
Term Loan in accordance with the terms of Article 4 hereof.

            The Revolving Line shall be freely prepayable in whole or in part at
the option of Borrower, provided, however, that prepayment due to a refinancing
of the Revolving Line in whole or in part by another financial institution (i)
one year or less after the date hereof must be accompanied by an additional
$100,000 premium payment, (ii) more than one year but less than two years after
the date hereof must be accompanied by an additional $50,000 premium payment,
and (iii) thereafter prior to the Revolving Line Termination Date must be
accompanied by an additional $10,000 premium payment.

            In addition, with respect to any LIBOR Advance, Borrower may prepay
only upon at least three (3) Business Days prior written notice to Bank (which
notice shall be irrevocable), and any such prepayment shall occur only on the
last day of the LIBOR Interest Period with respect to any LIBOR Advance.
Borrower shall pay to Bank, upon request of Bank, such amount or amounts as
shall be sufficient (in the reasonable opinion of the Bank) to compensate it for
any loss, cost, or expense incurred as a result of : (i) any payment of a LIBOR
Advance on a date other than the day of a LIBOR Interest Period for such Loan;
(ii) any failure by Borrower to borrower a LIBOR Advance on the date specified
by Borrower's written notice; (iii) any failure by Borrower to pay a LIBOR
Advance on the date for payment specified in Borrower's written notice. Without
limiting the foregoing, Borrower shall pay to Bank a "yield maintenance fee" in
an amount computed as follows: The current rate for United States Treasury
securities (bills on a discounted basis shall be converted to a bond equivalent)
with a maturity date closest to the term chosen pursuant to the Fixed Rate
Election as to which the prepayment is made, shall be subtracted from the LIBOR
in effect at the time of prepayment. If the result is zero or a negative number,
there shall be no yield maintenance fee. If the result is a positive number,
then the resulting percentage shall be multiplied by the amount of the principal
balance being prepaid. The resulting amount shall be divided by 360 and
multiplied by the number of days remaining in the term chosen pursuant to the
Fixed Rate Election as to which the prepayment is made. Said amount shall be
reduced to present value calculated by using the above referenced United States
Treasury securities rate and the number of days remaining in the term chosen
pursuant to the Fixed Rate Election as to which prepayment is made. The
resulting amount shall be the yield maintenance fee due to the Bank upon the
payment of a LIBOR Advance. Each

                                       7

<PAGE>

reference in this paragraph to "Fixed Rate Election" shall mean the election by
Borrower of the LIBOR Rate. If by reason of an Event of Default, Bank elects to
declare any principal amounts to be immediately due and payable, then any yield
maintenance fee with respect to a LIBOR Advance shall become due and payable in
the same manner as though the Borrower had exercised such right of prepayment.

            In the event that principal amounts outstanding under the Revolving
Line exceed the maximum available amount described herein at any time, Borrower,
after receiving written notice from the Bank, promptly shall make a principal
payment to the Bank without penalty sufficient to reduce outstanding principal
amounts to the maximum amount available hereunder.

            2.5 Revolving Line Termination. Unless extended in writing by the
Bank on terms and conditions then acceptable to the Bank, the Revolving Line
will terminate on the earlier of (i) October 31, 2002, or (ii) at the Bank's
option upon written notice to Borrower upon an Event of Default.

            2.6 Audits. Borrower agrees to allow the Bank complete access to all
books and records of the Borrower at reasonable intervals and at reasonable
times upon reasonable request and upon the Bank's execution of a confidentiality
agreement with the Borrower in form satisfactory to Borrower in its reasonable
judgment. Borrower agrees to submit information which the Bank may reasonably
request from time to time in connection with the Revolving Line.

            2.7 Unused Fee. The Borrower shall pay the Bank a quarterly fee of
one-quarter percent (0.25%) per annum times the average unused availability
under the Revolving Line during the preceding quarter. For purposes of
calculating such average unused availability, the face amounts of outstanding
Letters of Credit and foreign exchange transactions shall be aggregated with
amounts borrowed under the Revolving Line in determining what portion of the
Revolving Line has been used. At the end of each fiscal quarter, the Bank will
bill the Borrower for the unused fee.

            2.8 Facility Fee. The Borrower shall pay the Bank on or before the
date of the first advance hereunder a facility fee of one-half percent (0.50%)
of the maximum amount available under the Revolving Line (i.e., $65,000).

ARTICLE 3. - LETTERS OF CREDIT

            3.1 Letters of Credit. Subject to the terms and conditions of this
Agreement, the Bank will make letters of credit available for the account of the
Borrower in an aggregate stated face amount not exceeding the lesser of (a) Four
Million Dollars ($4,000,000), and (b) the remaining availability under the
Revolving Line. Letters of credit will be made promptly available for the
Borrower's work in process (to support customer progress payments) or as
otherwise reasonably requested by Borrower with respect to customer contracts,
for warranty work on completed products, and, subject to a sublimit of $500,000,
to fund the Borrower's workers compensation program. The stated amount
outstanding under all Letters of Credit at all times shall reduce, dollar for
dollar, the amount available for advances under the Revolving Line. The Letters
of Credit shall be in form satisfactory to the Bank. Subject to all of the
foregoing, the Bank will collectively issue up to a maximum of $2,000,000 in
letters of credit with maturities of up to three (3) years from the date of

                                       8

<PAGE>

issuance or, with the prior written consent of the Bank, for a longer period of
time on an as needed basis.

            3.2 Commissions; Fees. The Borrower will pay letter of credit
commissions to the Bank on the date of issuance of each Letter of Credit and on
each anniversary date thereafter if a Letter of Credit is renewed or has a
maturity in excess of one year from the date of issuance, equal to one and
one-quarter percent (1.25%) of the face amount thereof for standby letters of
credit, and one-quarter percent (0.25%) of the face amount thereof for
documentary letters of credit, provided, however, that commissions on letters of
credit having maturities of less than one year shall be charged ratably. In
addition, the Borrower will pay to the Bank a $150 administrative fee for each
letter of credit issued pursuant to this Agreement.

ARTICLE 4. - TERM LOAN

            4.1 Term Loan. Subject to the terms and conditions of this
Agreement, and provided that Borrower is in compliance with all Financial
Covenants set forth in Article 13, and no Event of Default has been declared
that has not been timely cured, (a) prior to or upon the Revolving Line
Termination Date, the Borrower shall have the right from time to time to convert
not less than Two Million Dollars ($2,000,000) at any one time and up to Nine
Million Dollars ($9,000,000) in the aggregate of then-outstanding principal
amounts under the Revolving Line (excluding the face amount of any outstanding
letters of credit), and (b) on the Revolving Line Termination Date, all
then-outstanding principal amounts under the Revolving Line (excluding the face
amount of any outstanding letters of credit) shall be converted, to a two-year
term loan (each, a "Term Loan"). The proceeds of each Term Loan shall be used to
satisfy such Revolving Line Obligations. The principal amount outstanding under
each Term Loan from time to time shall reduce, dollar for dollar, the amount
available for advances under the Revolving Line, if any.

            4.2 Term Loan Note. Each Term Loan shall be evidenced by a note in
favor of the Bank dated the respective Conversion Date (as defined in Section
4.4) in the form of Exhibit B attached hereto and made a part hereof.

            4.3 Interest Rate. At Borrower's election at the time each Term Loan
is advanced by the Bank, the outstanding principal amount of such Term Loan
shall bear interest until paid in full, except as otherwise specifically
provided herein, at a LIBOR-based rate or Prime-based rate determined on the
basis of the financial triggers and related rates set forth in Table 2.3.
Interest shall be calculated based on actual days elapsed divided by a year of
360 days.

            4.4 Payments. Payments of all accrued interest under each Term Loan
Note shall be made on the first day of each month, commencing on the first day
of the month following the date of conversion of some or all of the Revolving
Line to such Term Loan (the "Conversion Date"). Separate principal payments
equal to one twenty-fourth (1/24) of the original principal amount of the Term
Loan each shall be made on the first day of every month commencing on the first
day of the month following the Conversion Date. All remaining principal and
accrued interest shall be due and payable in full on the earlier of the
declaration and failure to cure an Event of Default or the second anniversary of
the Conversion Date.

                                       9

<PAGE>

            Each Term Loan shall be freely prepayable in whole or in part at the
option of the Borrower, but in the case of a Term Loan with interest at a LIBOR
Rate, only on a Rate Change Date and after five Business Days' prior written
notice, provided, however, that prepayment due to a refinancing of any Term Loan
in whole or in part with another financial institution (i) one year or less
after the date hereof must be accompanied by an additional $100,000 premium
payment, (ii) more than one year but less than two years after the date hereof
must be accompanied by an additional $50,000 premium payment, and (iii)
thereafter prior to the maturity date of the Term Loan must be accompanied by an
additional $10,000 premium payment.

            In addition, with respect to any LIBOR Advance, Borrower may prepay
only upon at least three (3) Business Days prior written notice to Bank (which
notice shall be irrevocable), and any such prepayment shall occur only on the
last day of the LIBOR Interest Period with respect to any LIBOR Advance.
Borrower shall pay to Bank, upon request of Bank, such amount or amounts as
shall be sufficient (in the reasonable opinion of the Bank) to compensate it for
any loss, cost, or expense incurred as a result of: (i) any payment of a LIBOR
Advance on a date other than the day of a LIBOR Interest Period for such Loan;
(ii) any failure by Borrower to borrower a LIBOR Advance on the date specified
by Borrower's written notice; (iii) any failure by Borrower to pay a LIBOR
Advance on the date for payment specified in Borrower's written notice. Without
limiting the foregoing, Borrower shall pay to Bank a "yield maintenance fee" in
an amount computed as follows: The current rate for United States Treasury
securities (bills on a discounted basis shall be converted to a bond equivalent)
with a maturity date closest to the term chosen pursuant to the Fixed Rate
Election as to which the prepayment is made, shall be subtracted from the LIBOR
in effect at the time of prepayment. If the result is zero or a negative number,
there shall be no yield maintenance fee. If the result is a positive number,
then the resulting percentage shall be multiplied by the amount of the principal
balance being prepaid. The resulting amount shall be divided by 360 and
multiplied by the number of days remaining in the term chosen pursuant to the
Fixed Rate Election as to which the prepayment is made. Said amount shall be
reduced to present value calculated by using the above referenced United States
Treasury securities rate and the number of days remaining in the term chosen
pursuant to the Fixed Rate Election as to which prepayment is made. The
resulting amount shall be the yield maintenance fee due to the Bank upon the
payment of a LIBOR Advance. Each reference in this paragraph to "Fixed Rate
Election" shall mean the election by Borrower of the LIBOR Rate. If by reason of
an Event of Default, Bank elects to declare any principal amounts to be
immediately due and payable, then any yield maintenance fee with respect to a
LIBOR Advance shall become due and payable in the same manner as though the
Borrower had exercised such right of prepayment.

ARTICLE 5. - EXPENSES/DEFAULT RATE INCREASES

            5.1 Administrative Expenses. The Borrower shall pay any reasonable
fees, expenses and disbursements, including reasonable legal fees, of the Bank
related to the negotiation, drafting and execution of this Agreement (which
shall be due at closing), and any reasonable fees, expenses and disbursements,
including reasonable legal fees, of the Bank related to this Agreement, the
Obligations, the perfection of any collateral security required hereunder, and
the transactions contemplated by this Agreement, limited as expressly provided
herein. Such payments shall be due from time to time upon the Bank giving the
Borrower notice of the amount of such expenses and reasonable documentation in
support of such amounts (it being understood that detailed descriptions of
attorneys' services will not be required in order to preserve applicable
privileges and

                                       10

<PAGE>

confidences). The Borrower shall pay all costs associated with periodic updates
of the condition of title to the Property requested by the Bank (for the purpose
of assuring the Borrower's compliance with Section 11.1 and 11.9 hereof),
provided, that, prior to an Event of Default, the Bank shall not make such
requests more than once in any calendar year.

            5.2 Collection Costs. At the request of the Bank, the Borrower shall
promptly pay any expenses, reasonable attorney's fees, costs, or disbursements
in connection with collection of any of the Obligations or enforcement of any of
the Bank's rights hereunder or under any note, security agreement, mortgage,
reimbursement agreement, guarantee, or other agreement related hereto. This
obligation shall survive the payment of any notes executed hereunder. The Bank
may apply any payments of any nature received by it first to the payment of
Obligations under this Section 5.2, notwithstanding any conflicting provision
contained in this Agreement or any other agreement with the Borrower.

            5.3 Default Interest Rate. Upon the failure of the Borrower to
comply with any covenant contained in Section 10.1 or Article 12 of this
Agreement, the rate of interest on each of the Obligations shall be increased to
a rate at all times equal to one and one-half percentage points (1.50%) above
the rate of interest which would be in effect absent such failure of compliance,
such increased rate to remain in effect through and including the end of the
quarter in which such failure of compliance is remedied. Upon the declaration of
and failure timely to cure an Event of Default, the provisions of this paragraph
shall be superseded by the provisions of the second paragraph of this Section
5.3 which relates to increases in the rate of interest in case of the
declaration of and failure timely to cure an Event of Default.

            Upon the declaration of and failure timely to cure an Event of
Default, the rate of interest on each of the Obligations shall be increased to a
rate at all times equal to one and one-half percentage points (1.50%) above the
rate of interest which would be in effect absent such failure of compliance,
such increased rate to remain in effect through the earlier of (a) the date on
which such Event of Default is cured and (b) payment in full of all of the
Obligations and cancellation of further commitments to lend under this
Agreement, or written waiver of such Event of Default by the Bank.

            5.4 Late Payment Fees. If the entire amount of any required
principal and/or interest is not paid in full within ten (10) days after the
same is due, Borrower shall pay to Bank a late fee equal to five percent (5%) of
the required payment.

ARTICLE 6. - COLLATERAL

            6.1 Security Interests. As collateral for all Obligations, the
Borrower shall provide to the Bank a security interest and lien in all personal
property assets of the Borrower, including without limitation machinery,
equipment, furniture, fixtures (subject to obtaining landlord waivers, where
necessary), vehicles, accounts, inventory, chattel paper, interests in leases
and property under lease, intellectual property and proprietary interests,
documents, instruments, and general intangibles. Such security interests shall
be first liens on such assets, which shall not be otherwise encumbered except as
specified on Schedule 6.1 attached hereto and made a part hereof.

ARTICLE 7. - REPRESENTATIONS OF BORROWER

            The Borrower represents and warrants to the Bank as follows:

                                       11

<PAGE>

            7.1 Organization and Power. The Borrower is duly organized, validly
existing and in good standing under the laws of the State of New York, and is
duly qualified to transact business and in good standing in all states in which
it is required to qualify and in which failure to qualify could have a material
adverse impact on its business. The Borrower has full power and authority to own
its properties, to carry on its business as now being conducted, to execute,
deliver and perform this Agreement and all related documents and instruments,
and to consummate the transactions contemplated hereby. The Borrower has no
subsidiaries or Affiliates except those listed on Schedule 7.1.

            7.2 Proceedings of Borrower. All necessary action on the part of the
Borrower, including shareholder approval to the extent required, relating to
authorization of the execution and delivery of this Agreement and all related
documents and instruments, and the performance of the Obligations of the
Borrower hereunder and thereunder has been taken. This Agreement and all related
documents and instruments constitute legal, valid and binding obligations of the
Borrower, enforceable in accordance with their respective terms. To the best of
Borrower's knowledge, after due inquiry, the Borrower has no defenses, offsets,
claims or counterclaims with respect to its obligations arising under this
Agreement and all related documents and instruments. The execution and delivery
by the Borrower of this Agreement and all related documents and agreements, and
the performance by the Borrower of its obligations under this Agreement and all
related documents and agreements, will not violate any provision of law or the
Borrower's Certificate of Incorporation or By-laws. The execution, delivery and
performance of this Agreement and all related documents and agreements, and the
consummation of the transactions contemplated hereby will not violate, be in
conflict with, result in a breach of, or constitute a default under any
agreement to which the Borrower is a party or by which any of its properties is
or may be bound, or any order, writ, injunction, or decree of any court or
governmental instrumentality, and will not result in the creation or imposition
of any lien, charge or encumbrance upon any of its properties.

            7.3 Capitalization. All of the outstanding shares and other equity
interests of the Borrower are duly authorized, validly issued, and fully paid.
There is no existing contract, debenture, security, right, option, warrant, call
or similar commitment of any character calling for or relating to the issuance
or purchase of shares or other equity interests of the Borrower.

            7.4 Litigation. Except as disclosed in the most recent Financial
Statements described in Section 7.5 hereof and in Schedule 13.1, there is no
action, suit or proceeding at law or in equity or by or before any governmental
instrumentality or other agency pending or, to the knowledge of the Borrower,
threatened against or affecting the Borrower that brings into question the
legality, validity or enforceability of this Agreement or the transactions
contemplated hereby or that, if adversely determined, would have a material
adverse effect on the financial condition or the business of the Borrower.

            7.5 Financial Statements. All financial statements furnished by the
Borrower to the Bank are complete and correct as they relate to the Borrower,
have been prepared in accordance with the applicable standard described in
Section 10.1 hereof throughout the periods indicated, and fairly present the
financial condition of the Borrower, as of the dates thereof and the results of
its operations for the periods covered thereby.

                                       12

<PAGE>

            7.6 Adverse Changes. Since the most recent financial statements
described in Section 7.5 hereof there has been no material adverse change in the
condition, financial or otherwise, of the Borrower.

            7.7 Taxes. The Borrower has filed or caused to be filed when due, or
has obtained extensions for, all federal tax returns and all state and local tax
returns that are required to be filed, and has paid or caused to be paid all
taxes as shown on said returns or any assessment received.

            7.8 Properties. The Borrower has good and marketable title to all of
its material properties and assets, including without limitation, the properties
and assets reflected in the most recent financial statements referred to in
Section 7.5 hereof. The Borrower has undisturbed peaceable possession under all
leases under which it is operating, none of which contain provisions that may
materially affect the operations of the Borrower, and all such leases are in
full force and effect.

            7.9 Indebtedness. Except as disclosed in the most recent financial
statements referred to in Section 7.5 hereof and in Schedule 11.1, the Borrower
has no outstanding indebtedness or contingent liabilities (including without
limitation "off-balance sheet" liabilities), other than trade payables not yet
due incurred in the ordinary course of business, and is not the account party
with respect to letters of credit.

            7.10 Franchises, Permits. The Borrower has all material franchises,
permits, licenses and other authority as are necessary to enable the Borrower to
conduct its business as now being conducted, and is not in default under any
such franchise, permit, license or authority.

            7.11 ERISA. No action, event, or transaction has occurred that could
give rise to a lien or encumbrance on the assets of the Borrower as a result of
the application of relevant provisions of ERISA, and the Borrower is in material
compliance with all requirements of ERISA.

            7.12 Margin Securities. No proceeds of the Obligations have been or
will be used for the purpose of purchasing or carrying Margin Securities as
defined in Regulation U of the Federal Reserve Board.

            7.13 Compliance With Law. The Borrower is not in violation of any
laws, ordinances, governmental rules, requirements, or regulations to which it
is subject which violation might materially adversely affect the condition
(financial or otherwise) of the Borrower. The Borrower has obtained and is in
compliance with all licenses, permits, franchises, and governmental
authorizations necessary for the ownership of its properties and the conduct of
its business, for which failure to comply could materially adversely affect the
condition (financial or otherwise) of Borrower.

            7.14 Patents, Trademarks, and Authorizations. The Borrower owns or
possesses all patents, trademarks, service marks, trade names, copyrights,
licenses, authorizations, and all rights with respect to the foregoing,
necessary to the conduct of its business as now conducted without any material
conflict with the rights of others.

            7.15 Contracts and Agreements. The Borrower is not a party to any
contract or agreement that materially adversely affects its business, property,
assets, or condition, financial or

                                       13

<PAGE>

otherwise, and the Borrower is in compliance in all material respects with all
contracts and agreements to which it is a party.

ARTICLE 8. - REPRESENTATIONS OF THE BANK

            The Bank hereby makes the following representations, warranties and
covenants on which the Borrower may rely in executing and delivering this
Agreement. Such representations and warranties are made as of the date of
execution of this Agreement.

            8.1 This Agreement has been duly authorized, executed and delivered
by the Bank and constitutes a legal, valid and binding obligation of the Bank
enforceable against the Bank in accordance with its terms.

            8.2 At the date of execution of this Agreement, the Bank does not
believe, nor does it have any reason or cause to believe, that it cannot perform
each and every one of its agreements contained in this Agreement.

ARTICLE 9. - CONDITIONS OF LENDING

            The following conditions must be satisfied before the Bank shall
have any obligation to make any advance under this Agreement:

            9.1 Representations and Warranties. The representations and
warranties of the Borrower contained herein shall be true and correct as of the
date of making of each such advance, with the same effect as if made on and as
of such date.

            9.2 No Defaults. There shall exist no condition or event that
constitutes (or that, with the giving of notice or the passage of time or both,
would constitute) an Event of Default under Article 14 hereof at the time each
advance is made.

            9.3 Performance. The Borrower shall have performed and complied with
all agreements and conditions required to be performed or complied with by it
prior to or at the time the advance is made.

            9.4 Opinion of Counsel. Upon the request of the Bank, the Borrower
shall have delivered an opinion of its counsel, dated the date of the first
advance, reasonably satisfactory to the Bank.

            9.5 Documents to be Delivered. The Borrower shall have delivered to
the Bank all security agreements, mortgages, reimbursement agreements,
assignments, guarantees, and any related documents necessary or desirable in
connection with the requirements of Article 6 hereof. All notes evidencing the
Obligations shall have been delivered to the Bank at the time of the making of
the respective loans.

            9.6 Certified Resolutions. The Borrower shall have delivered a
certificate of its corporate secretary certifying, as of the date of the first
advance, resolutions duly adopted by the Board of Directors of the Borrower
authorizing the execution, delivery and performance of this Agreement and all
related documents and agreements, and the consummation of the transactions

                                       14

<PAGE>

contemplated hereby, which resolutions shall remain in full force and effect so
long as any of the Obligations are outstanding or any commitment to lend exists
under this Agreement.

            9.7 Fees and Taxes. The Borrower shall have paid all filing fees,
taxes, and assessments related to the borrowings and the perfection of any
interests in collateral security required hereunder.

            9.8 Insurance. The Borrower shall have delivered evidence
satisfactory to the Bank of the existence of insurance required hereby.

            9.9 Real Estate Taxes. Borrower must provide proof of payment of
current real estate taxes and assessments, if any.

            9.10 Environmental Insurance. The Borrowers shall have provided to
the Bank an environmental inspection report in form and substance satisfactory
to the Bank prepared by engineers satisfactory to the Bank, or insurance
satisfactory to the Bank covering environmental liabilities.

            9.11 Organizational Documents. The Borrower shall have delivered to
the Bank copies of its then-effective Certificate of Incorporation, By-laws,
d/b/a certificates, and other organizational documents and instruments, or a
written certificate that such documents and instruments have not been changed or
amended since the last advance to Borrower pursuant to the terms of this
Agreement.

            9.12 Other Documents and Agreements. On or before the date of this
Agreement, the Borrower shall have delivered such other documents, instruments,
and agreements as the Bank and its legal counsel may reasonably require in
connection with the transactions contemplated hereby.

            9.13 Financial Statements. On or before the date of this Agreement,
the Borrower shall have delivered to the Bank a copy of the Borrower's most
recent consolidated financial statements.

            9.14 Certificates of Good Standing. On or before the date of this
Agreement the Borrower shall have delivered to the Bank certificates of good
standing from appropriate state officials to the effect that the Borrower is in
good standing in the state of its formation as well as in all other states in
which qualification is necessary for the Borrower to carry on its business in
such states.

ARTICLE 10. - AFFIRMATIVE COVENANTS OF BORROWER

            So long as any Obligations to the Bank shall be outstanding or this
Agreement remains in effect, unless the Bank otherwise consents in writing, the
Borrower shall:

            10.1 Financial Statements. Furnish to the Bank as soon as available,
but in no event later than July 31, 2000 and each July 31 of any year thereafter
in which this Agreement remains in effect, copies of annual consolidated
financial statements of the Borrower prepared in accordance with GAAP, audited
by and with an unqualified opinion from an independent certified public

                                       15

<PAGE>

accountant approved by the Bank, which approval will not be unreasonably
withheld. Said financial statements shall include at least a balance sheet and a
statement of profit and loss, and shall be accompanied by a schedule showing
computation of financial covenants by an officer of the Borrower and a copy of
any management letter prepared by such accountants. Such financial statements
shall be accompanied by a certificate of the Chief Financial Officer of the
Borrower to the effect that to the best of his knowledge after due inquiry, no
Event of Default has occurred and no condition exists which with the passage of
time or the giving of notice would constitute an Event of Default or, if an
Event of Default shall have occurred and be continuing specifying the steps
being taken to cure such Event of Default.

            The Borrower also shall furnish to the Bank not more than fifty (50)
days after the close of each quarter of its fiscal year copies of quarterly
consolidated unaudited financial statements of the Borrower prepared in
accordance with GAAP. Said statements shall include at least a balance sheet, a
statement of profit and loss, and a schedule showing computation of financial
covenants. Such financial statements shall be accompanied by a written
acknowledgment of the Chief Financial Officer of the Borrower to the effect that
to the best of his knowledge after due inquiry, no Event of Default has occurred
and no condition exists which with the passage of time or the giving of notice
would constitute an Event of Default.

            Not more than thirty (30) days after the close of each quarter, the
Borrower shall deliver to the Bank an aging of accounts receivable and an aging
of accounts payable. Said information shall be certified to be true and correct
to the best knowledge of the Chief Financial Officer of the Borrower.

            Not more than thirty (30) days after the close of each quarter,
Borrower shall deliver to the Bank a backlog report. Said information shall be
certified to be true and correct by an officer of Borrower.

            Not more than sixty (60) days after the close of each fiscal year,
Borrower shall deliver to the Bank a business plan and forecast for the next
succeeding fiscal year.

            The Borrower shall provide to the Bank interim financial statements,
if any, prepared by the Borrower's independent accountants.

            10.2 Other Reports and Inspections. Furnish to the Bank such
additional information, reports, or financial statements as the Bank may, from
time to time, reasonably request.

            Upon execution of a confidentiality agreement with the Borrower in
form satisfactory to Borrower in its reasonable judgment, the Borrower shall
permit any person designated by the Bank to inspect the property, assets, and
books of the Borrower at reasonable intervals and times and, prior to an Event
of Default, upon reasonable notice, and shall discuss its affairs, finances, and
accounts at reasonable intervals and times with the Bank from time to time as
often as may be reasonably requested.

            10.3 Taxes. Pay and discharge all taxes, assessments, levies, and
governmental charges upon the Borrower, its income and property, prior to the
date on which penalties are attached thereto; provided, however, that the
Borrower may in good faith contest any such taxes, assessments,

                                       16

<PAGE>

levies, or charges so long as such contest is diligently pursued and no lien or
execution exists or is levied against any of Borrower's assets related to the
contested items.

            10.4 Insurance. Maintain or cause to be maintained insurance, of
kinds and in amounts as described on Schedule 10.4 annexed hereto, with the
insurance companies specified in such Schedule 10.4, or with other responsible
insurance companies on all of its real and personal properties in such amounts
and against such risks as are prudent, including but not limited to, full-risk
extended coverage hazard insurance to the full insurable value of real property
(co-insurance not being permitted without the prior written consent of the
Bank), all-risk coverage for personal property, business interruption or loss of
rents coverage, worker's compensation insurance (unless the Borrower is
self-insuring on terms approved by the Bank in advance), and comprehensive
general liability insurance. The Borrower also shall maintain flood insurance
covering any of its real properties located in flood zones. The Borrower shall
provide to the Bank, annually, a detailed list and evidence satisfactory to the
Bank of its insurance carriers and coverage. Hazard insurance policies for real
property shall name the Bank as loss payee, and for personalty, loss payee, as
its interests may appear, and liability insurance policies shall name the Bank
as additional insured, and all policies shall provide for at least thirty (30)
day's prior notice of cancellation to the Bank.

            10.5 Existence. Cause to be done all things necessary to preserve
and to keep in full force and effect its existence, rights, and franchises
material to its financial condition and to comply in all material respects with
all valid laws and regulations now in effect or hereafter promulgated by any
properly constituted governmental authority having jurisdiction.

            10.6 Maintenance of Properties. At all times maintain, preserve,
protect, and keep its material property used or useful in conducting its
business, in good repair, working order, and condition and, from time to time,
make all needful and proper repairs, renewals, replacements, betterments, and
improvements thereto, so that the business carried on may be properly and
advantageously conducted at all times.

            10.7 Material Changes, Judgments. Notify the Bank immediately of any
Event of Default (or event that, with notice or passage of time or both, would
constitute an Event of Default), and any material adverse change in the
financial condition of the Borrower and of the filing of any suits, judgments,
or liens which, if adversely determined, could have a material adverse effect on
the business or financial condition of the Borrower. The Borrower also shall
notify the Bank immediately of any change in the name, identity, or
organizational structure of the Borrower, or any material change in any equity
or other ownership interest in the Borrower.

            10.8 ERISA Compliance. Comply in all material respects with the
provisions of ERISA and regulations and interpretations related thereto.

            10.9 Franchises/Permits/Laws. Preserve and keep in full force and
effect all material franchises, permits, licenses, and other authority as are
necessary to enable it to conduct its business as being conducted on the date of
this Agreement and comply in all material respects with all laws, regulations,
and requirements now in effect or hereafter promulgated by any properly
constituted governmental authority having jurisdiction over it.

                                       17

<PAGE>

            10.10 Payments. Make all payments as and when required by this
Agreement and the notes and other agreements related hereto or to the
Obligations.

            10.11 Amendments. Give the Bank written notice of an amendment or
modification to its Certificate of Incorporation or other governing documents or
agreements.

            10.12 Shareholder and Officer Loans. The Borrower shall provide to
the Bank subordination agreements in form satisfactory to the Bank covering any
shareholder or officer loans to the Borrower or other obligations of the
Borrower to its respective shareholders or officers in existence from time to
time.

ARTICLE 11. - NEGATIVE COVENANTS OF BORROWER

            So long as any Obligations shall be outstanding, or this Agreement
shall remain in effect, unless the Bank otherwise consents in writing, the
Borrower shall not, directly or indirectly:

            11.1 Indebtedness, Mortgages and Liens. Create, incur, assume, or
allow to exist, voluntarily or involuntarily, any obligation or obligations in
the aggregate exceeding $300,000 at any one time during the term of this
Agreement for borrowed money or its equivalent, lease, mortgage, pledge, lien or
other encumbrance of any kind upon, or any security interest in, any of its
property or assets, whether real or personal, whether now owned or hereafter
acquired, excluding only (i) Obligations to and interests held by the Bank, (ii)
obligations described in Schedule 11.1 attached hereto and made a part hereof,
(iii) encumbrances described in Schedule 6.1, (iv) obligations and interests to
which the Bank consents in writing, (v) the charge upon property purchased under
conditional sales or other title retention agreements (vi) trade indebtedness
incurred in the ordinary course of the Borrower's business, (vii) accrued
payroll or compensation obligations; and (viii) loans, advances or other
distributions permitted by Section 11.3(b).

            11.2 Contingent Liabilities. Assume, guarantee, endorse,
contingently agree to purchase, or otherwise become liable in any manner upon
any obligation or obligations in the aggregate exceeding $150,000 at any time
during the term of this Agreement, contingent or otherwise, whether funded or
current, or guarantee the dividends, of any person, firm, corporation, or other
entity except for endorsement of negotiable instruments for deposit, collection,
or similar transactions in the ordinary course of business.

            11.3 Loans and Investments. (a) Except as permitted by Section
11.3(b), make any loan or advance to, or any investment in, any person, firm,
joint venture, corporation or other entity whatsoever exceeding $150,000 in the
aggregate at any one time outstanding, except short-term investments in
certificates of deposit of financial institutions and similar investments made
in the ordinary course of business.

            (b) Borrower shall not make any loans, advances, or other
distributions of any kind exceeding $500,000 in the aggregate at any one time
outstanding to any Affiliates of the Borrower without the prior consent of the
Bank, which may be withheld in its absolute discretion.

            11.4 Mergers, Sales and Acquisitions/Change in Ownership Interests.
Enter into any merger or consolidation, or acquire all or substantially all the
stock or other ownership interests or assets of any person, firm, joint venture,
corporation, or other entity for an amount exceeding

                                       18

<PAGE>

$5,000,000, in the aggregate, or sell, lease, transfer, or otherwise dispose of
any material portion of its assets except in the ordinary course of business.

            11.5 Dividends and Distributions. Make any cash or property
dividends or distributions with respect to any of its shareholder or ownership
interests, or apply any of its property or assets to the purchase, redemption or
other retirement of, or set apart any sum for the payment of any cash dividends
on or distributions with respect to, or for the purchase, redemption or other
retirement of, or make any other distribution by reduction of capital or
otherwise in respect of, any shareholder or ownership interests in Borrower.

            11.6 Material Changes. Permit any material change to be made in the
character of the business of the Borrower, or in its Chairman & CEO or Chief
Financial Officer, other than for cause unless Borrower shall have provided for
a successor reasonably acceptable to the Bank, or in the nature of its
operations as carried on at the date hereof.

            11.7 Judgments. Allow to exist for more than sixty (60) days any
judgments against Borrower in excess of $250,000 in the aggregate which are not
fully covered by insurance or for which an appeal or other proceeding for the
review thereof shall not have been taken and for which a stay of execution
pending such appeal shall not have been obtained.

            11.8 Margin Securities. Allow any proceeds of the Obligations to be
used for the purpose of carrying any Margin Securities as defined in Regulation
U of the Board of Governors of the Federal Reserve.

            11.9 Negative Pledge. Enter into any agreement with anyone other
than the Bank in which Borrower agrees not to pledge or otherwise transfer or
encumber any asset of Borrower (including any and all Property) now or hereafter
owned, whether or not such asset has been pledged to the Bank.

ARTICLE 12. - FINANCIAL COVENANTS

            So long as any Obligations to the Bank shall be outstanding or this
Agreement remains in effect, unless the Bank otherwise consents in writing, the
Borrower shall:

            12.1 Minimum Tangible Net Worth. Maintain a minimum Tangible Net
Worth of (i) $8,500,000 from the date hereof until March 30, 2000, (ii)
$12,000,000 from March 31, 2000 through March 30, 2001, (iii) $13,000,000 from
March 31, 2001 through March 30, 2002, and (iv) $14,000,000 at all times after
March 30, 2002, as shown in each case on the quarterly and annual financial
statements for the Borrower provided to the Bank.

            12.2 Maximum Debt To Worth Ratio. Maintain a maximum Debt To Worth
Ratio for the Borrower of (i) 1.75 to 1.0 from the date hereof until March 30,
2001, and (ii) 1.50 to 1.0 at all times thereafter, as shown on each quarterly
and annual financial statement for the Borrower provided to the Bank.

            12.3 Minimum Debt Service Coverage Ratio. Maintain a minimum Debt
Service Coverage Ratio for the Borrower of 1.3 to 1.0, as shown on each year-end
financial statement for the Borrower provided to the Bank. For the fiscal year
ending March 31, 2000, any expenses incurred to

                                       19

<PAGE>

close the Borrower's United Kingdom Pension Plan will be excluded from the Debt
Service Coverage Ratio.

            12.4 Minimum Working Capital. Maintain minimum net working capital
of $8,000,000 at all times, as shown on the annual financial statement for the
Borrower provided to the Bank.

ARTICLE 13. - ENVIRONMENTAL MATTERS; INDEMNIFICATION

            13.1 Environmental Representations. The Borrower represents and
warrants that, to the best of Borrower's knowledge and except as described in
Schedule 13.1 annexed hereto:

      (a)   Neither the Improvements nor any property adjacent to the
            Improvements is being or has been used for the storage, treatment,
            generation, transportation, processing, handling, production or
            disposal of any Hazardous Substance or as a landfill or other waste
            disposal site or for the storage of petroleum or petroleum based
            products except in compliance with all Environmental Laws.

      (b)   Underground storage tanks are not and have not been located on the
            Improvements except in compliance with all Environmental Laws.

      (c)   The soil, subsoil, bedrock, surface water and groundwater of the
            Improvements are free of any Hazardous Substances.

      (d)   There has been no Release, nor is there the threat of a Release of
            any Hazardous Substance on, at or from the Improvements or any
            property adjacent to or within the immediate vicinity of the
            Improvements which through soil, subsoil, bedrock, surface water or
            groundwater migration could come to be located on the Improvements,
            and Borrower has not received any form of notice or inquiry from any
            federal, state or local governmental agency or authority, any
            operator, tenant, subtenant, licensee or occupant of the
            improvements or any property adjacent to or within the immediate
            vicinity of the Improvements or any other person with regard to a
            Release or the threat of a Release of any Hazardous Substance on, at
            or from the Improvements or any property adjacent to the
            Improvements.

      (e)   All Environmental Permits relating to the Borrower and the
            Improvements have been obtained and are in full force and effect.

      (f)   No event has occurred with respect to the Improvements which, with
            the passage of time or the giving of notice, or both, would
            constitute a violation of any applicable Environmental Law or
            non-compliance with any Environmental Permit.

      (g)   There are no agreements, consent orders, decrees, judgments, license
            or permit conditions or other orders or directives of any federal,
            state or local court, governmental agency or authority relating to
            the past, present or future ownership, use, operation, sale,
            transfer or conveyance of the Improvements which require any change
            in the present condition of the Improvements or any work, repairs,

                                       20

<PAGE>

            construction, containment, clean up, investigations, studies,
            removal or other remedial action or capital expenditures with
            respect to the Improvements.

      (h)   There are no actions, suits, claims or proceedings, pending or
            threatened, which could cause the incurrence of expenses or costs of
            any name or description or which seek money damages, injunctive
            relief, remedial action or any other remedy that arise out of,
            relate to or result from (i) a violation or alleged violation of any
            applicable Environmental Law or non-compliance or alleged
            non-compliance with any Environmental Permit, (ii) the presence of
            any Hazardous Substance or a Release or the threat of a Release of
            any Hazardous Substance on, at or from the Improvements or any
            property adjacent to or within the immediate vicinity of the
            Improvements or (iii) human exposure to any Hazardous Substance,
            noises, vibrations or nuisances of whatever kind to the extent the
            same arise from the condition of the Improvements or the ownership,
            use, operation, sale, transfer or conveyance thereof.

            13.2 Environmental Covenants. The Borrower covenants and agrees with
the Bank that, so long as this Agreement remains in effect, the Borrower shall:

      (a)   Comply with, and shall cause all operators, tenants, subtenants,
            licensees and occupants of the Improvements to comply with all
            applicable Environmental Laws and shall obtain and comply with, and
            shall cause all operators, tenants, subtenants, licensees and
            occupants of the Improvements to obtain and comply with, all
            Environmental Permits.

      (b)   Not cause or permit any change to be made in the present or intended
            use of the Improvements which would (i) violate any applicable
            Environmental Law, or (ii) constitute non-compliance with any
            Environmental Permit.

      (c)   Promptly provide the Bank with a copy of all notifications which it
            gives or receives with respect to any past or present Release or the
            threat of a Release of any Hazardous Substance on, at or from the
            Improvements or any property adjacent to the Improvements.

      (d)   Undertake and complete all investigations, studies, sampling and
            testing and all removal and other remedial actions required by law
            to contain, remove and clean up all Hazardous Substances that are
            determined to be present at the Improvements in accordance with all
            applicable Environmental Laws and all Environmental Permits.

      (e)   At all times allow the Bank and its officers, employees, agents,
            representatives, contractors and subcontractors reasonable access
            after reasonable prior notice to the Improvements for the purposes
            of ascertaining site conditions, including, but not limited to,
            subsurface conditions.

      (f)   Deliver promptly to the Bank: (i) copies of any material documents
            received from the United States Environmental Protection Agency, or
            any state, county or municipal environmental or health agency
            concerning the Borrower's operations or the Improvements; and (ii)
            copies of any material documents submitted by the Borrower to the
            United States Environmental Protection Agency or any state, county
            or

                                       21

<PAGE>

            municipal environmental or health agency concerning its operations
            or the Improvements, excluding normal manifesting documentation
            submitted in the ordinary course in connection with shipments of
            product or routine emission or discharge reports submitted in the
            ordinary course of operations.

      (g)   If at any time the Bank obtains any reasonable evidence or
            information which suggests that a material potential environmental
            problem may exist at the Improvements, the Bank may require that a
            full or supplemental environmental inspection and audit report with
            respect to the Improvements of a scope and level of detail
            satisfactory to the Bank be prepared by an environmental engineer or
            other qualified person acceptable to the Bank at Borrower's expense.
            Such audit may include a physical inspection of the Improvements, a
            visual inspection of any property adjacent to or within the
            immediate vicinity of the Improvements, personnel interviews and a
            review of all Environmental Permits. If the Bank requires, such
            inspection shall also include a records search and/or subsurface
            testing for the presence of Hazardous Substances in the soil,
            subsoil, bedrock, surface water and/or groundwater. If such audit
            report indicates the presence of any Hazardous Substance or a
            Release or the threat of a Release of any Hazardous Substance on, at
            or from the Improvements, Borrower shall promptly undertake and
            diligently pursue to completion all necessary, appropriate and
            legally required investigative, containment, removal, clean up and
            other remedial actions, using methods recommended by the engineer or
            other person who prepared said audit report and acceptable to the
            appropriate federal, state and local agencies or authorities.

            13.3 Indemnity. The Borrower agrees to indemnify, defend, and hold
harmless the Bank from and against any and all liabilities, claims, damages,
penalties, expenditures, losses, or charges, including, but not limited to, all
costs of investigation, monitoring, legal representation, remedial response,
removal, restoration or permit acquisition of any kind whatsoever, which may now
or in the future be undertaken, suffered, paid, awarded, assessed, or otherwise
incurred by the Bank (or any other person or entity affiliated with the Bank or
representing or acting for the Bank or at the Bank's behest, or with a claim on
the Bank or to whom the Bank has liability or responsibility of any sort related
to this Section 13.3) relating to, resulting from or arising out of (a) the use
of the Improvements for the storage, treatment, generation, transportation,
processing, handling, production or disposal of any Hazardous Substance or as a
landfill or other waste disposal site, (b) the presence of any Hazardous
Substance or a Release or the threat of a Release of any Hazardous Substance on,
at or from the Improvements, (c) the failure to promptly undertake and
diligently pursue to completion all necessary, appropriate and legally required
investigative, containment, removal, clean up and other remedial actions with
respect to a Release or the threat of a Release of any Hazardous Substance on,
at or from the improvements, (d) human exposure to any Hazardous Substance,
noises, vibrations or nuisances of whatever kind to the extent the same arise
from the condition of the Improvements or the ownership, use, operation, sale,
transfer or conveyance thereof, (e) a violation of any applicable Environmental
Law, (f) non-compliance with any Environmental Permit or (g) a material
misrepresentation or inaccuracy in any representation or warranty or a material
breach of or failure to perform any covenant made by Borrower in this Agreement.

            13.4 No Limitation. The liability of Borrower under this Article 13
shall in no way be limited, abridged, impaired or otherwise affected by (a) any
amendment or modification of this

                                       22

<PAGE>

Agreement or any other document relating to the Obligations by or for the
benefit of Borrower or any subsequent owner of the Improvements except for an
amendment or modification which expressly refers to this Article 13, (b) any
extensions of time for payment or performance required by this Agreement or any
other document relating to the Obligations, (c) the release of Borrower, any
guarantor, or any other person from the performance or observance of any of the
agreements, covenants, terms or conditions contained in this Agreement or any
other document relating to the Obligations by operation of law, the Bank's
voluntary act or otherwise, (d) the invalidity or unenforceability of any of the
terms or provisions of this Agreement or any other document relating to the
Obligations, (e) any exculpatory provision contained in this Agreement or any
other document relating to the Obligations limiting the Bank's recourse to
property encumbered by any mortgage or to any other security or limiting the
Bank's rights to a deficiency judgment against Borrower, (f) any applicable
statute of limitations, (g) any investigation or inquiry conducted by or on the
behalf of the Bank or any information which the Bank may have or obtain with
respect to the environmental or ecological condition of the Improvements, (h)
the sale, assignment or foreclosure of any interest in collateral for the
Obligations, (i) the sale, transfer or conveyance of all or part of the
Improvements, (j) the dissolution and liquidation of Borrower, (k) the death or
legal incapacity of any individual, (I) the release or discharge, in whole or in
part, of Borrower in any bankruptcy, insolvency, reorganization, arrangement,
readjustment, composition, liquidation or similar proceeding, or (m) any other
circumstances which might otherwise constitute a legal or equitable release or
discharge of Borrower, in whole or in part.

            13.5 Survival. Notwithstanding anything to the contrary contained
herein, the Borrower's liability under this Article 13 shall survive the
discharge, satisfaction or assignment of this Agreement by the Bank until all of
the following conditions are satisfied in full:

      (a)   all of the Obligations and any other costs and expenses incurred by
            the Bank in connection with therewith are paid in full;

      (b)   neither the Bank nor any affiliate of the Bank nor any person or
            entity representing or acting for the Bank or at the Bank's behest
            nor any person or entity with a claim against the Bank or to whom
            the Bank has liability or responsibility of any sort has at any time
            or in any manner participated in the management or control of, taken
            possession of or title to the Improvements or any portion thereof,
            whether by foreclosure, deed in lieu of foreclosure or otherwise, or
            had the capacity or ability to participate in the decisions or
            actions of the Borrower as the same relate to Hazardous Substances;

      (c)   between the date of this Agreement and the date on which the
            Obligations are paid in full, as provided in clause (a) above, there
            has been no change in any applicable Environmental Law which would
            make the Bank, or any affiliate of the Bank or any person or entity
            representing or acting for the Bank or at the Bank's behest or any
            person or entity with a claim against the Bank or to whom the Bank
            has liability or responsibility of any sort, liable in respect of
            any of the indemnified matters contained in this Article 14
            notwithstanding the fact that no event, circumstance or condition of
            the nature described in clause (b) above ever occurred; and

      (d)   there exist no indemnified matters which are then pending.

                                       23

<PAGE>

            13.6 Investigations. If the Borrower defaults on any of its
Obligations pursuant to this Agreement or any other loan document, the Bank or
its designees shall have the right, upon reasonable notice to the Borrower, to
enter upon the Improvements and conduct such tests, investigation and sampling,
including but not limited to installation of monitoring wells, as shall be
reasonably necessary for the Bank to determine whether any disposal of Hazardous
Substances has occurred on, at or near the Improvements. The costs of all such
tests, investigations and samplings shall be considered as additional
indebtedness secured by all collateral for the Obligations and shall become
immediately due and payable without notice and with interest thereon at highest
rate then borne by any of the Obligations.

            13.7 No Warranty Regarding Information. The Borrower agrees that the
Bank shall not be liable in any way for the completeness or accuracy of any
Environmental Report or the information contained therein. The Borrower further
agrees that the Bank has no duty to warn the Borrower or any other person or
entity about any actual or potential environmental contamination or other
problem that may have become apparent or will become apparent to the Bank.

ARTICLE 14. - DEFAULTS

            14.1 Defaults. The following events (hereinafter called "Events of
Default") shall constitute defaults under this Agreement. Such Events of Default
shall be without prejudice to the Bank's right to demand payment in full of
Obligations payable on demand, as specified in this Agreement or the notes
relating to such Obligations, at any time and shall be effective as to such
demand Obligations only in the event that a demand has not been made prior to
the occurrence of such an Event of Default.

            a. Nonpayment. Failure of the Borrower to make any payment of any
      type under the terms of this Agreement, any of the notes related hereto,
      or of any of the agreements contemplated hereunder, within ten (10) days
      after the same becomes due and payable.

            b. Performance. Failure of the Borrower to observe or perform any
      condition, covenant or term of this Agreement and all related agreements
      and documents; provided, however, that an Event of Default shall not occur
      unless such failure is not cured within thirty (30) days after the Bank
      gives the Borrower written notice of same.

            c. Other Obligations. Failure of the Borrower to observe or perform
      any other material condition, covenant, or term of any other agreement
      with the Bank after any applicable cure or grace period related thereto,
      or default by the Borrower under any agreement involving borrowed money or
      the like, or any other material agreement evidencing or securing
      indebtedness to any third person or entity.

            d. Representations. Failure of any material representation or
      warranty made by the Borrower in connection with the execution and
      performance of this Agreement, or any certificate of officers pursuant
      hereto, to be truthful, accurate or correct in all material respects.

            e. Financial Difficulties. Financial difficulties of the Borrower as
      evidenced by:

                                       24

<PAGE>

                  (i) any admission in writing of inability to pay debts as they
            become due; or

                  (ii) the filing of a voluntary or involuntary petition in
            bankruptcy, or under any chapters of the Bankruptcy Code, or under
            any federal or state statute providing for the relief of debtors; or

                  (iii) making general assignment for the benefit of creditors;
            or

                  (iv) consenting to the appointment of a trustee or receiver
            for all or a major part of any of its assets or property; or

                  (v) the entry of a court order appointing a receiver or a
            trustee for all a major part of any of its assets or property,
            provided that Borrower shall have sixty (60) days to obtain an order
            removing such receiver or trustee; or

                  (vi) the occurrence of any event, action, or transaction
            giving rise to a lien or encumbrance on the assets of the Borrower
            as a result of application of relevant provisions of ERISA.

            14.2 Remedies. If any one or more Events of Default occur and is
continuing, the Bank may, at its option, take either or both of the following
actions at the same or different times: (i) terminate any further commitments or
obligations of the Bank, and (ii) accelerate all Obligations of the Borrower to
the Bank such that the same become forthwith due and payable without
presentment, demand, protest, or other notice of any kind, all of which are
hereby expressly waived.

            In case any such Events of Default shall occur, the Bank shall be
entitled to maintain proceedings to recover judgment against the Borrower for
all Obligations of the Borrower to the Bank either before, or after, or during
the pendency of any proceedings for the enforcement, of any security interests,
mortgages, pledges, or guarantees and, in the event of realization of any funds
from any security or guarantee and application thereof to the payment of the
Obligations due, the Bank shall be entitled to enforce payment of and recover
judgment for all amounts remaining due and unpaid on such Obligations. The Bank
shall be entitled to exercise any other legal or equitable right which it may
have, and may proceed to protect and enforce its rights by any other appropriate
proceedings, including action for the specific performance of any covenant or
agreement contained in this Agreement and other agreements held by the Bank.

            14.3 Application of Proceeds. All payments received after an Event
of Default shall be applied by the Bank as follows:

            (a) First: to the payment of all reasonable fees, costs and expenses
incurred in connection with the collection, recovery and realization of amounts
due pursuant to the Obligations;

            (b) Second: to the payment in full of the Obligations with all such
payments being applied first to the payment of interest, with any balance to the
payment and reduction of principal, in the order of maturity, and other amounts
due; and

                                       25

<PAGE>

            (c) Third: the balance, if any, of such proceeds remaining after
payment in full of the foregoing items, to the Borrower or as a court of
competent jurisdiction may otherwise direct.

ARTICLE 15. - MISCELLANEOUS

            15.1 Waiver. No delay or failure of the Bank to exercise any right,
remedy, power or privilege hereunder shall impair the same or be construed to be
a waiver of the same or of any Event of Default or an acquiescence therein. No
single or partial exercise of any right, remedy, power or privilege shall
preclude other or further exercise thereof by the Bank. All rights, remedies,
powers, and privileges herein conferred upon the Bank shall be deemed cumulative
and not exclusive of any others available.

            15.2 Survival of Representations. All representations and warranties
contained herein shall survive the execution and delivery of this Agreement and
the execution and delivery of other agreements hereunder.

            15.3 Additional Security; Setoff. Borrower hereby grants to Bank, a
lien, security interest and right of setoff as security for all liabilities and
obligations to Bank, whether now existing or hereafter arising, upon and against
all deposits, credits, collateral and property, now or hereafter in the
possession, custody, safekeeping or control of Bank or any entity under the
control of Fleet Financial Group, Inc., or in transit to any of them. At any
time, without demand or notice, Bank may set off the same or any part thereof
and apply the same to any liability or obligation of Borrower even though
unmatured and regardless of the adequacy of any other collateral securing the
Loan. ANY AND ALL RIGHTS TO REQUIRE BANK TO EXERCISE ITS RIGHTS OR REMEDIES WITH
RESPECT TO ANY OTHER COLLATERAL WHICH SECURES THE LOAN, PRIOR TO EXERCISING ITS
RIGHT OF SETOFF WITH RESPECT TO SUCH DEPOSITS, CREDITS OR OTHER PROPERTY OF THE
BORROWER ARE HEREBY KNOWINGLY, VOLUNTARILY AND IRREVOCABLY WAIVED.

            15.4 Notices. Any notice or demand upon any party hereto shall be
deemed to have been sufficiently given or served for all purposes hereof when
delivered in person or by nationally recognized overnight courier with receipt
requested, or two business days after it is mailed certified mail postage
prepaid, return receipt requested, addressed as follows:

            If to the Bank:     Fleet National Bank
                                One East Avenue
                                Rochester, New York 14638
                                Attention: Daniel C. Killigrew

            With a copy to:     Harris Beach & Wilcox, LLP
                                130 E. Main Street
                                Rochester, New York 14604
                                Attention: Christopher D. Jagel, Esq.

            If to Borrower:     Graham Corporation
                                20 Florence Avenue
                                Batavia, New York 14020

                                       26

<PAGE>

                                Attention: J. Ronald Hansen

            With a copy to:     William A. Smith, Esq.
                                Graham Corporation
                                20 Florence Avenue
                                Batavia, New York 14020

Any party may change, by notice in writing to the other parties, the address to
which notices to it shall be sent.

            15.5 Entire Agreement. This Agreement and the documents referred to
herein embody the entire agreement and understanding among the parties and
supersede all prior agreements and under-standings relating to the subject
matter hereof. This Agreement shall not be changed or amended without the
written agreement of all parties hereto. This Agreement embodies all commitments
to lend between the Bank and the Borrower and supersedes any prior commitments.

            15.6 Parties in Interest. All the terms and provisions of this
Agreement shall inure to the benefit of and be binding upon and be enforceable
by the parties and their respective successors and assigns and shall inure to
the benefit of and be enforceable by any holder of notes executed hereunder.
Upon any transfer of any Obligation or any interest therein the Bank may deliver
or otherwise transfer or assign to the holder any collateral or guarantees for
the Obligation, which holder shall thereupon have all the rights of the Bank.

            15.7 Business Days. Whenever any payment is due on a day which is
not a Business Day, such payment shall be extended to the next succeeding
Business Day, and such extension of time shall be including in computing
interest and fees in connection with such payment.

            15.8 Telecopy Requests. As a convenience to the Borrower, Borrower
hereby authorizes the Bank to rely upon requests made by the Borrower or its
authorized employees in writing or by telecopy, and to treat such requests as if
they were made in a writing delivered to the Bank. Any advance of funds made by
the Bank pursuant to any such request shall be deemed to be authorized by the
Borrower unless immediately repaid in full. Borrower shall identify for the Bank
its authorized employees in writing with updates as may be required.

            15.9 Severability. In the event that any one or more of the
provisions contained in this Agreement or any other agreement, document, or
guarantee related hereto shall, for any reason, be held invalid, illegal or
unenforceable in any respect, such invalidity, illegality or unenforceability
shall not affect any other provision of this Agreement or such other agreement,
document, or guarantee.

            15.10 Governing Law. This Agreement and the notes and agreements
hereunder, together with all of the rights and obligations of the parties
hereto, shall be construed, governed and enforced in accordance with the laws of
the State of New York without giving effect to the principles of conflicts of
laws.

            15.11 Assignments; Participations. (a) Bank shall have the
unrestricted right at any time or from time to time, and without Borrower's
consent, to assign all or any portion of its rights

                                       27

<PAGE>

and obligations hereunder to one or more banks or other financial institutions
(each, an "Assignee"), and Borrower agrees that it shall execute, or cause to be
executed, such documents, including without limitation, amendments to this
Agreement and to any other documents, instruments and agreements executed in
connection herewith as Bank shall deem necessary to effect the foregoing. In
addition, at the request of Bank and any such Assignee, Borrower shall issue one
or more new promissory notes, as applicable to any such Assignee and, if Bank
has retained any of its rights and obligations hereunder following such
assignment, to Bank, which new promissory notes shall be issued in replacement
of, but not in discharge of, the liability evidenced by the promissory note held
by Bank prior to such assignment and shall reflect the amount of the respective
commitments and loans held by such Assignee and Bank after giving effect to such
assignment. Upon the execution and delivery of appropriate assignment
documentation, amendments and any other documentation required by Bank in
connection with such assignment, and the payment by Assignee of the purchase
price agreed to by Bank, and such Assignee, such Assignee shall be a party to
this Agreement and shall have all of the rights and obligations of Bank
hereunder (and under any and all other guaranties, documents, instruments and
agreements executed in connection herewith) to the extent that such rights and
obligations have been assigned by Bank pursuant to the assignment documentation
between Bank and such Assignee, and Bank shall be released from its obligations
hereunder and thereunder to a corresponding extent.

            (b) Bank shall have the unrestricted right at any time and from time
to time, and without the consent of or notice to Borrower, to grant to one or
more banks or other financial institutions (each, a "Participant") participating
interests in Bank's obligation to lend hereunder and/or any or all of the loans,
held by Bank hereunder. In the event of any such grant by Bank of a
participating interest to a Participant, whether or not upon notice to Borrower,
Bank shall remain responsible for the performance of its obligations hereunder
and Borrower shall continue to deal solely and directly with Bank in connection
with Bank's rights and obligations hereunder.

            (c) Bank may furnish any information concerning Borrower in its
possession from time to time to prospective Assignees and Participants, provided
that Bank shall require any such prospective Assignee or Participant to agree in
writing to maintain the confidentiality of such information.

            15.12 Replacement of Prior Agreement. This Agreement supersedes and
replaces the Restated Credit Facility Agreement dated October 31, 1996 between
the Bank and the Borrower.

            15.13 Federal Reserve Pledge. Bank may at any time pledge all or any
portion of its rights under the loan documents including any portion of the
promissory note to any of the twelve (12) Federal Reserve Banks organized under
Section 4 of the Federal Reserve Act, 12 U.S. C. Section 341. No such pledge or
enforcement thereof shall release Bank from its obligations under any of the
loan documents.

            15.14 Replacement Documents. Upon receipt of an affidavit of an
officer of Bank as to the loss, theft, destruction or mutilation of any note or
any security document which is not of public record, and, in the case of any
such loss, theft, destruction or mutilation, upon surrender and cancellation of
such note or other security document, Borrower will issue, in lieu thereof, a
replacement note or other security document in the same principal amount thereof
and otherwise of like tenor.

                                       28

<PAGE>

            15.15 Waiver of Jury Trial. BORROWER AND BANK MUTUALLY HEREBY
KNOWINGLY, VOLUNTARILY AND INTENTIONALLY WAIVE THE RIGHT TO A TRIAL BY JURY IN
RESPECT OF ANY CLAIM BASED HEREON, ARISING OUT OF, UNDER OR IN CONNECTION WITH
THIS AGREEMENT OR ANY OTHER LOAN DOCUMENTS CONTEMPLATED TO BE EXECUTED IN
CONNECTION HEREWITH OR ANY COURSE OF CONDUCT, COURSE OF DEALINGS, STATEMENTS
(WHETHER VERBAL OR WRITTEN) OR ACTIONS OF ANY PARTY. THIS WAIVER CONSTITUTES A
MATERIAL INDUCEMENT FOR BANK TO ENTER INTO THIS AGREEMENT AND MAKE THE LOANS
COMPRISING THE OBLIGATIONS.

            IN WITNESS WHEREOF, the parties have executed this Agreement on the
date first above written.

FLEET NATIONAL BANK                          GRAHAM CORPORATION

________________________________             ________________________________

By:_____________________________             By:_____________________________

Title:__________________________             Title:__________________________

                                       29
<PAGE>

                                                                       EXHIBIT 1

                 AMENDED AND RESTATED CREDIT FACILITY AGREEMENT
                               AMENDMENT NUMBER 1

      THIS AMENDED AND RESTATED CREDIT FACILITY AGREEMENT AMENDMENT NUMBER 1
("Amendment") is made as of November 1, 2002 by and between GRAHAM CORPORATION
("Borrower"), a corporation formed under the laws of the State of Delaware with
offices at 20 Florence Avenue, Batavia, New York and FLEET NATIONAL BANK
("Bank"), a national banking association formed under the laws of the United
States of America with offices at One East Avenue, Rochester, New York 14638.

      This Agreement amends the Restated Credit Facility Agreement between
Graham Corporation (as successor by merger to Graham Manufacturing Co., Inc.)
and Fleet National Bank (as successor to Fleet Bank) dated as of October 31,
1996, as amended and restated by the Amended and Restated Credit Facility
Agreement between Borrower and Bank dated as of November 3, 1999 (the "Credit
Agreement").

      The parties hereby agrees as follows:

      1. The definition of "Break Costs" contained in Section 1.1 of the Credit
Agreement is hereby amended to read as follows:

            "Break Costs" shall mean such amount or amounts as shall be
            sufficient (in the reasonable opinion of the Bank) to compensate it
            for any loss, cost, or expense incurred as a result of (i) any
            payment of any Obligation bearing a rate based upon the LIBOR Rate
            other than on the last day of the applicable LIBOR Interest Period
            for such Obligation, (ii) any failure by Borrower to borrow an
            Obligation on the date specified in Borrower's written notice of
            intention to borrow such Obligation at a rate based upon the LIBOR
            Rate, (iii) any failure by Borrower to pay an Obligation bearing a
            rate based upon the LIBOR Rate on any date for payment specified in
            Borrower's written notice of intention to pay such Obligation.
            Without limiting the foregoing, the Borrower shall pay to the Bank a
            "yield maintenance fee" as part of Break Costs in an amount computed
            as follows: The current rate for United States Treasury securities
            (bills on a discounted basis shall be converted to a bond
            equivalent) with a maturity date closest to the last day of the
            applicable LIBOR Interest period of the particular Obligation as to
            which the prepayment is made shall be subtracted from the LIBOR in
            effect at the time of prepayment. If the result is zero or a
            negative number, there shall be no yield maintenance fee. If the
            result is a positive number, then the resulting percentage shall be
            multiplied by the amount of the principal balance being prepaid. The
            resulting amount shall be divided by 360 and multiplied by the
            number of days remaining until the end of the respective applicable
            LIBOR Interest Period. Said amount shall be reduced to present value
            calculated by using the above-referenced United States Treasury
            securities rate and the number of days remaining until the last day
            of the respective

<PAGE>

            applicable LIBOR Interest Period. The resulting amount shall be the
            yield maintenance fee due to Bank upon prepayment o the respective
            Obligation.

      2. The definition of "LIBOR" and contained in Section 1.1 of the Credit
Agreement is hereby amended to read in its entirety as follows:

            "LIBOR" shall mean the rate per annum as determined on the basis of
            the offered rates for deposits in United States Dollars, for a
            period of time comparable to the applicable LIBOR Interest Period
            which appears on the Telerate Page 3750 as of 11:00 a.m. London time
            on the day that is two London Banking Days preceding the first day
            of the applicable LIBOR Interest Period (the "Interest Setting
            Date"); provided, however, if the rate described above does not
            appear on the Telerate System on any applicable Interest Setting
            Date, the LIBOR rate shall be the rate (rounded upward, if
            necessary, to the nearest one hundred-thousandth of a percentage
            point) determined on the basis of the offered rates for deposits in
            United States Dollars for the applicable LIBOR Interest Period which
            are offered by four major banks in the London interbank market at
            approximately 11:00 a.m. London Time, on the day that is two (2)
            London Banking Days preceding the first day of such LIBOR Interest
            Period as selected by the Bank. The principal London office of each
            of the four major London banks will be requested to provide a
            quotation of its United States Dollar deposit offered rate. If at
            least two such quotations are provided, the rate for that date will
            be the arithmetic mean of the quotations. If fewer than two
            quotations are provided as requested, the rate for that date will be
            determined on the basis of the rates quoted for loans in United
            States Dollars to leading European banks for a period of time
            comparable to the applicable LIBOR Interest Period offered by major
            banks in New York City at approximately 11:00 a.m. New York City
            time, on the day of such LIBOR Interest Period. In the event that
            the Bank is unable to obtain any such quotation as provided above,
            it will be deemed that LIBOR for the LIBOR Interest Period cannot be
            determined.

            In the event that LIBOR cannot be determined, or there is any change
            in any law or application thereof that makes it unlawful, or any
            central bank or other governmental authority asserts that it is
            unlawful, for the Bank to hold obligations if the rate is determined
            with reference to the LIBOR, the Borrower shall not be entitled to
            elect an interest rate based upon the LIBOR Rate until LIBOR can
            again be determined or is lawful.

      3. Section 2.3 of the Credit Agreement is hereby amended to read in its
entirety as follows:

<PAGE>

                  2.3 Interest Rate and Payments. Outstanding amounts under the
            Revolving Line, except as specifically provided herein, shall bear
            interest until paid in full at the rate based upon the Prime Rate
            determined with reference to Table 2.3, below. Each of the two
            financial triggers applicable to a given rate in Table 2.3 must be
            satisfied for that rate to apply. If the Debt Service Coverage Ratio
            financial trigger in respect of a particular rate is satisfied but
            the Debt To Worth Ratio financial trigger is not satisfied, the
            applicable rate shall be twenty-five (25) basis points higher than
            the rate indicated based upon the Debt Service Coverage Ratio
            financial trigger. The financial performance triggers shall be
            measured quarterly and on a consolidated basis for the Borrower
            (with a rolling twelve-month period for the Debt Service Coverage
            Ratio) as of the end of each of the Borrower's fiscal quarters.

                  The Borrower, however, may from time to time elect to have the
            one-, two- or three-month LIBOR Rate determined in accordance with
            Table 2.3 apply to some or all of the amounts outstanding under the
            Revolving Line by giving at least two (2) business days' prior
            notice in writing or by telecopy to the Bank, provided, that after
            the first such election, any subsequent election may only be made at
            least two (2) business days' prior to, and to become effective on, a
            Rate Change Date. The notice shall specify the outstanding principal
            amount to bear interest at the LIBOR-based rate or rates (with any
            outstanding amounts from time to time under the Revolving Line, in
            excess of such specified amount, to bear interest at the applicable
            rate based upon the Prime Rate).

                                    TABLE 2.3

<TABLE>
<CAPTION>
DEBT TO WORTH RATIO                  DEBT SERVICE COVERAGE RATIO       LIBOR-BASED RATE             PRIME-BASED RATE
- -------------------                  ---------------------------       ----------------             ----------------
<S>                                  <C>                               <C>                          <C>
< or = 1.50:1                        < 1.50:1                           LIBOR + 275 bp               Prime Rate
< or = 1:50:1                        > or = 1.50:1 to ,< 2.00:1         LIBOR + 225 bp               Prime Rate -  25bp
< or = 1.25:1                        > or = 2:00:1 to < 2.50:1          LIBOR + 175 bp               Prime Rate -  50bp
< or = 1.00:1                        > or = 2.50:1 to < 3:00.1          LIBOR + 150 bp               Prime Rate -  75bp
< or = 1.00:1                        > or = 3.00:1                      LIBOR + 125 bp               Prime Rate - 100bp
</TABLE>

                  Changes in the rate of interest due to a change in the
            financial performance triggers contained in Table 2.3 shall be
            effective as of the first day of the first quarter subsequent to
            receipt by the Bank of the Borrower's financial statements (for
            example, if financial statements for the quarter ending on June 30
            are received on August 15, the rate change shall occur on October
            1). If required financial statements are not received by the Bank,
            it shall be assumed that the rates will be the highest rates

<PAGE>

            applicable under Table 2.3 until five business days following the
            date on which such financial statements are received. In addition to
            changes of rate due to financial performance triggers, changes in
            the rate of interest applicable to outstanding amounts under the
            Revolving Line Note bearing interest at a rate based upon the Prime
            Rate shall become effective automatically, immediately, and without
            notice or demand of any kind, at the time of changes in the Prime
            Rate. Any LIBOR-based rate of interest elected by Borrower shall be
            in effect during the applicable LIBOR Interest Period, subject to
            changes during the period due to financial performance triggers.

                  During any period in which LIBOR-based rate is in effect, if
            the principal amount outstanding under the Revolving line bearing
            interest at such rate is ever less than the principal amount stated
            in the related election notice, the Borrower shall pay Break Costs,
            if any.

                  Interest shall be calculated based on actual days elapsed
            divided by a year of 360 days.

      4. Section 2.5 of the Credit Agreement is hereby amended to read in its
entirety as follows:

                  2.5 Revolving Line Termination. Unless extended in writing by
            the Bank on terms and conditions then acceptable to the Bank, the
            Revolving Line will terminate on the earlier of (i) October 31,
            2005, or (ii) at the Bank's option upon written notice to Borrower
            upon an Event of Default.

      5. A new Section 3.3 shall be added to the Credit Agreement to read in its
entirety as follows:

                  3.3 Unreimbursed Days. The Borrower shall make immediate
            payment to the Bank of all amounts drawn under Letters of Credit,
            and authorizes the Bank to advance funds under the Revolving Line,
            to the extent available thereunder, to repay such amounts drawn. All
            amounts drawn under Letters of Credit shall bear interest at the
            rate based upon the Prime Rate then in effect pursuant to Table 2.3.

      6. Article 5 of the Credit Agreement is hereby amended to read in its
entirety as follows:

                   ARTICLE 5 - EXPENSES/DEFAULT RATE INCREASES

                  5.1 Costs and Expenses. Borrower shall pay on demand all
            expenses of Bank in connection with the preparation, administration,
            default, collection, waiver or amendment of the terms of the
            Obligations, or in connection with Bank's exercise,

<PAGE>

            preservation, or enforcement of any of its rights, remedies, or
            options hereunder, including without limitation, reasonable fees of
            outside legal counsel or the allocated costs of in-house legal
            counsel, accounting, consulting, brokerage or similar professional
            fees or expenses, and any fees or expenses associated with travel or
            other costs relating to any appraisals or examinations conducted in
            connection with any of the Obligations or any collateral therefor,
            and the amount of all such expenses shall, until paid, bear interest
            at the highest rate applicable to any Obligation (including any
            default rate) and be an Obligation secured by any collateral. Such
            payments shall be due from time to time upon the Bank giving the
            Borrower notice of the amount of such expenses and reasonable
            documentation in support of such amounts (it being understood that
            detailed descriptions of attorneys' services will not be required in
            order to preserve applicable privileges and confidences). The
            Borrower shall pay all costs associated with periodic updates of the
            condition of title to the Property requested by the Bank (for the
            purpose of assuring the Borrower's compliance with Section 11.1 and
            11.9 hereof), provided, that, prior to an Event of Default, the Bank
            shall not make such requests more than once in any calendar year.

                  5.2 Application of Payments. All payments shall be applied
            first to the payment of all fees, expenses and other amounts due to
            the Bank (excluding principal and interest), then to accrued
            interest, and the balance on account of outstanding principal;
            provided, however, that after an Event of Default, payments will be
            applied to the Obligations as Bank determines in its sole
            discretion.

                  5.3 Default Interest Rate. Upon the failure of the Borrower to
            comply with any covenant contained in Section 10.1 or Article 12 of
            this Agreement, upon any Default (whether or not Bank has
            accelerated payment of the Obligations), after maturity, or after
            judgment has been rendered with respect to any of the Obligations,
            Borrower's right to select pricing options shall cease and the
            unpaid principal of all Obligations shall, at the option the Bank,
            bear interest at a rate which is one and one-half (1.5) percentage
            points per annum greater than that which would otherwise be
            applicable.

                  5.4 Late Payment Fees. If the entire amount of any required
            principal and/or interest is not paid in full under any of the Loan
            Documents within ten (10) days after the same is due, Borrower shall
            pay to the Bank a late fee equal to five percent (5%) of the
            required payment.

                  5.5 Prepayments Upon Default. If by reason of an Event of
            Default the Bank elects to declare the Obligations to be

<PAGE>

            immediately due and payable then any Break Costs with respect to the
            Obligations shall become due and payable in the same manner as
            though the Borrower had exercised a right of prepayment.

                  5.6 Method of Payment. All payments shall be made by Borrower
            to Bank at the address for Bank first shown above in this Agreement
            or such other place as Bank may from time to time specify in writing
            in lawful currency of the United States of America in immediately
            available funds, without counterclaim or setoff and free and clear
            of, and without deduction or withholding for, any taxes or other
            payments.

      7. Section 12.1 of the Credit Agreement is hereby amended to read in its
entirety as follows:

                  12.1 Minimum Tangible Net Worth. Maintain a minimum Tangible
            Net Worth of $17,500,000 at all times as shown in each case on the
            quarterly and annual financial statements for the Borrower provided
            to the Bank.

      8. Section 11.4 of the Credit Agreement is hereby amended to read in its
entirety as follows:

                  11.4 Mergers, Sales and Acquisitions/Change in Ownership
            Interests. (i) Sell, lease, transfer, or otherwise dispose of any
            material portion of its assets except in the ordinary course of
            business, or (ii) enter into any merger or consolidation, or acquire
            all or substantially all the stock or other ownership interests or
            assets of any person, firm, joint venture, corporation, or other
            entity; provided, however, that such mergers, consolidations, or
            acquisitions shall be permitted if they do not exceed $7,000,000 in
            the aggregate and if, on a pro forma basis, the Borrower will
            continue to comply with the covenants contained in this Agreement,
            including without limitation the covenants contained in Article 12
            hereof, on a going forward basis after completion of such merger,
            consolidation, or acquisition.

      9. Section 11.5 of the Credit Agreement is hereby amended to read in its
entirety as follows:

                  11.5 Dividends and Distributions. Make any cash or property
            dividends or distributions with respect to any of its shareholder or
            ownership interests, or apply any of its property or assets to the
            purchase, redemption or other retirement of, or set apart any sum
            for the payment of any cash dividends on or distributions with
            respect to, or for the purchase, redemption or other retirement of,
            or make any other distribution by reduction of capital or otherwise
            in respect of, any shareholder or ownership interests in Borrower;
            provided, however, that Borrower may make dividends in the aggregate
            maximum amount of $400,000

<PAGE>

            per year and may repurchase or redeem stock in the aggregate maximum
            amount of $500,000 per year so long as after any such transactions
            no Event of Default exists and the Borrower continues to comply with
            Article 12 hereof.

      10. Section 15.3 of the Credit Agreement is hereby amended to read in its
entirety as follows:

                  15.3 Additional Security Setoff. The Borrower hereby grants to
            Bank a continuing lien, security interest, and right of set off as
            security for the Obligations, whether now existing or hereafter
            arising, upon and against all deposits, credits, collateral and
            property, now or hereafter in the possession, custody, safekeeping
            or control of Bank or any entity under the control of FleetBoston
            Financial Corporation and its successors and assigns or in transit
            to any of them. At any time without demand or notice (any such
            notice being expressly waived by Borrower), Bank may set off the
            same or any part thereof and apply the same to any Obligation of
            Borrower even though unmatured and regardless of the adequacy of any
            other collateral securing the Obligations. ANY AND ALL RIGHTS TO
            REQUIRE BANK TO EXERCISE ITS RIGHTS OR REMEDIES WITH RESPECT TO ANY
            OTHER COLLATERAL WHICH SECURES THE OBLIGATIONS, PRIOR TO EXERCISING
            ITS RIGHT OF SET OFF WITH RESPECT TO SUCH DEPOSITS, CREDITS, OR
            OTHER PROPERTY OF BORROWER [OR GUARANTOR] ARE HEREBY KNOWINGLY,
            VOLUNTARILY, AND IRREVOCABLY WAIVED.

      11. Section 15.4 of the Credit Agreement is hereby amended to change the
address for notices to the Bank as follows:

            If to the Bank:  Fleet National Bank
                             One East Avenue
                             Rochester, New York 14638
                             Attention: John M. Pitton

            With a copy to:  Harris Beach LLP
                             99 Garnsey Road
                             Pittsford, New York 14534
                             Attention: Beth Ela Wilkins, Esq.

      12. Section 15.10 of the Credit Agreement is hereby amended to read in its
entirety as follows:

                  15.10 Governing Law. This Agreement and the rights and
            obligations of the parties hereunder, shall be construed,
            interpreted, governed and enforced in accordance with the laws of

<PAGE>

            the State of New York (excluding the laws applicable to conflicts or
            choice of law).

      13. Section 15.15 of the Credit Agreement is hereby amended to read in its
entirety as follows:

                  15.15 WAIVER OF TRIAL BY JURY. BORROWER AND BANK (BY
            ACCEPTANCE OF THIS AGREEMENT) MUTUALLY HEREBY KNOWINGLY, VOLUNTARILY
            AND INTENTIONALLY WAIVE THE RIGHT TO A TRIAL BY JURY IN RESPECT OF
            ANY CLAIM BASED HEREON, ARISING OUT OF, UNDER OR IN CONNECTION WITH
            THIS AGREEMENT OR ANY OTHER LOAN DOCUMENTS OR, ANY COURSE OF
            CONDUCT, COURSE OF DEALINGS, STATEMENTS (WHETHER VERBAL OR WRITTEN)
            OR ACTIONS OF ANY PARTY, INCLUDING WITHOUT LIMITATION, ANY COURSE OF
            CONDUCT, COURSE OF DEALINGS, STATEMENTS OR ACTIONS OF BANK RELATING
            TO THE ADMINISTRATION OF THE LOAN OR ENFORCEMENT OF THE LOAN
            DOCUMENTS, AND AGREE THAT NEITHER PARTY WILL SEEK TO CONSOLIDATE ANY
            SUCH ACTION WITH ANY OTHER ACTION IN WHICH A JURY TRIAL CANNOT BE OR
            HAS NOT BEEN WAIVED. EXCEPT AS PROHIBITED BY LAW, BORROWER HEREBY
            WAIVES ANY RIGHT IT MAY HAVE TO CLAIM OR RECOVER IN ANY LITIGATION
            ANY SPECIAL,

                  EXEMPLARY, PUNITIVE, OR CONSEQUENTIAL DAMAGES OR ANY DAMAGES
            OTHER THAN, OR IN ADDITION TO, ACTUAL DAMAGES. BORROWER CERTIFIES
            THAT NO REPRESENTATIVE, AGENT, OR ATTORNEY OF BANK HAS REPRESENTED,
            EXPRESSLY OR OTHERWISE, THAT BANK WOULD NOT, IN THE EVENT OF
            LITIGATION, SEEK TO ENFORCE THE FOREGOING WAIVER. THIS WAIVER
            CONSTITUTES A MATERIAL INDUCEMENT FOR BANK TO ACCEPT THIS AGREEMENT
            AND MAKE THE LOANS CONTEMPLATED HEREUNDER.

      14. Schedule 11.1 to the Credit Agreement is hereby amended to add
thereto:

            Indebtedness, mortgages, and liens exclusively related to Borrower's
            UK subsidiary,                             Graham Precision
            Pumps Limited.                         By:

      15. The Borrower shall pay the Bank a facility fee of one-half percent
(0.50%) of the maximum amount available under the Revolving Line (i.e., $65,000)
in connection with this Amendment.

<PAGE>

      IN WITNESS WHEREOF, the parties have executed this Agreement on the date
first above written.

                                   FLEET NATIONAL BANK

                                   By:_________________________________________

                                   Its:________________________________________

                                              GRAHAM CORPORATION

                                   By:_________________________________________

                                   Its:________________________________________
<PAGE>

                                                                       EXHIBIT 2

                  SECOND AMENDMENT TO CREDIT FACILITY AGREEMENT

            THIS SECOND AMENDMENT, dated as of the 31st day of March, 2004, to
that certain Amended and Restated Credit Facility Agreement dated as of November
3, 1999, as amended by an Amendment Number 1 dated as of November 1, 2002 (the
"Agreement"), between FLEET NATIONAL BANK, a national banking association with
an office at One East Avenue, Rochester, New York 14638 (the "Bank"), and GRAHAM
CORPORATION, a corporation formed under the laws of the State of Delaware with
offices at 20 Florence Avenue, Batavia, New York 14020 (the "Borrower").

      The parties hereby agree as follows:

      1. Agreement Ratified. Except as expressly amended hereby, the Agreement
is in all respects ratified and confirmed, and all of the terms, provisions and
conditions thereof shall be and remain in full force and effect, and this
Amendment and all of its terms, provisions and conditions shall be deemed to be
a part of the Agreement. All capitalized terms used herein and not defined shall
have the meanings given them in the Agreement.

      2. New Definitions. The following definitions shall be added to Article 1
of the Agreement:

            "Distributions" shall mean dividends, payments, or distributions of
      any kind (including without limitation cash or property) in respect of the
      capital stock, securities or other equity interests or rights to acquire
      such equity interests of the applicable entity except distributions in the
      form of such stock, equity securities, equity interests, or rights to
      acquire equity interests.

            "EBITDA" shall mean, for any period and determined in accordance
      with GAAP, Net Income (calculated before Interest Expense, provision for
      taxes, depreciation and amortization of intangibles).

            "Interest Expense" shall mean for the applicable period, all
      interest paid, capitalized, or accrued, and amortization of debt discount
      with respect to all Debt less all related interest income during such
      period and determined after giving effect to the net cost associated with
      financial arrangements of any kind made to protect against fluctuations in
      interest rates such as interest rate swap contracts, interest rate cap
      agreements, and the like.

            "Letter of Credit" shall mean any Letter of Credit issued pursuant
      to Article 3 hereof.

            "Net Income" shall mean the gross revenues for such period less all
      expenses and other proper charges but without deduction for Interest
      Expense and provision for taxes, determined in accordance with GAAP
      consistently applied, but excluding in any event:

            (a)   any gains or losses (not in the ordinary course of business)
                  on the sale or other disposition of investments or fixed or
                  capital assets, and any taxes on

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<PAGE>

                  such excluded gains and any tax deductions or credits on
                  account of any such excluded losses;

            (b)   the proceeds of any life insurance policy;

            (c)   net earnings and losses of any corporation substantially all
                  the assets of which have been acquired in any manner, realized
                  by such other corporation prior to the date of such
                  acquisition;

            (d)   net earnings and losses of any corporation with which the
                  Borrower shall have consolidated or which shall have merged
                  into or with the Borrower prior to the date of such
                  consolidation or merger;

            (e)   earnings resulting from any reappraisal, revaluation or
                  write-up of assets;

            (f)   any gain arising from the acquisition of any securities of the
                  Borrower;

            (g)   any reversal of any contingency reserve, except to the extent
                  that provision for such contingency reserve shall have been
                  made from income arising during such period;

            (h)   amortization of negative goodwill net of goodwill,

            (i)   income or loss attributable to equity in Affiliates, and

            (j)   other extraordinary or unusual items, but excluding contract
                  cancellation fees and other related items in the ordinary
                  course of business.

            "Reactivation Date" shall mean the date on which the Borrower
      advises the Bank, in writing, that it is in compliance with the Minimum
      Debt Service Coverage Ratio covenant contained in Section 12.3 of the
      Agreement, and that it intends to remain in compliance with such covenant
      for the remaining term of the Agreement.

      3. Definitions Deleted. The definitions of "Term Loan" and "Term Loan
Note" shall be deleted from the Agreement.

      4. Section 2.1. Section 2.1 of the Agreement shall be amended in its
entirety to read as follows:

            2.1 Revolving Line. Subject to the terms and conditions of this
      Agreement, the Bank hereby establishes for the benefit of the Borrower a
      revolving line of credit in the maximum principal amount of Eight Million
      Dollars ($8,000,000.00) outstanding at any one time. The proceeds of the
      Revolving Line shall be used to meet Borrower's letter of credit, foreign
      exchange, and working capital requirements as follows: (i) the Borrower
      may use up to Five Million Dollars ($5,000,000.00) for Revolving Loans for
      working capital purposes ("Working Capital Loans"), and (ii) the Borrower
      may use up to Three Million Dollars ($3,000,000.00) for Letters of Credit
      issued pursuant to Article 3 hereof.

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<PAGE>

      Revolving Line amounts available for Working Capital Loans shall not be
      available for Letters of Credit and Revolving Line amounts available for
      Letters of Credit shall not be available for Working Capital Loans. The
      Borrower may, however, use a portion of the Revolving Line available for
      Working Capital Loans to fund, with the prior written approval of the
      Bank, a foreign exchange guidance line of credit not to exceed (a)
      $500,000.00 for foreign exchange contracts maturing on any one day, and
      (b) $3,333,333.00 for total foreign exchange contracts (with respect to
      forward contracts, not to exceed one year from the date of contract)
      outstanding at any one time. With respect to advances other than for
      foreign exchange under the Revolving Line, the entire $500,000 foreign
      exchange sublimit will be reserved for purposes of determining
      availability under the Revolving Line, irrespective of the amounts
      actually advanced under the foreign exchange guidance line. Subject to the
      terms of this Agreement, the Borrower may borrow, repay, and reborrow
      under the Revolving Line so long as the aggregate principal amount
      outstanding at any time for Working Capital Loans (including the foreign
      exchange sublimit) plus the aggregate face amount of Letters of Credit
      issued or available to be issued pursuant to Article 3 hereof does not
      exceed $8,000,000.00.

      5. Amended and Restated Revolving Line Note. The Borrower shall execute,
together with this Amendment, a note evidencing Obligations related to the
Revolving Line in the form of Exhibit A attached hereto and made a part hereof.
This new Revolving Line Note shall amend and restate the Revolving Line Note
executed and delivered by the Borrower to the Bank pursuant to the Agreement.

      6. Section 2.3. Section 2.3 of the Agreement shall be amended in its
entirety to read as follows:

            2.3 Interest Rate. Outstanding amounts under the Revolving Line Note
      shall bear interest at a variable rate per annum until paid in full
      (including without limitation after acceleration, maturity, and judgment),
      except as otherwise specifically provided herein, equal to the Prime Rate
      in effect from time to time. Changes in the interest rate shall become
      effective automatically and without notice at the time of changes in the
      Prime Rate.

            The Borrower from time to time, however, may elect to have portions
      of the principal outstanding under the Revolving Line Note bear interest
      at a rate per annum rate equal to 275 basis points (2.75%) above the
      one-month, two-month, or three-month LIBOR Rate for the period applicable
      to that rate by giving at least two (2) business days' prior notice in
      writing or by telecopy to the Bank. The notice shall specify (i) the rate
      chosen, (ii) the outstanding principal amount to bear interest at the
      applicable LIBOR Rate which shall not be less than $100,000 (with any
      outstanding amounts from time to time under the Revolving Line Note, in
      excess of such specified amount, to bear interest at the rate based upon
      the Prime Rate), and (iii) the commencement date for such rate. No LIBOR
      Interest Period may be elected that would extend beyond the maturity date
      of the Revolving Line Note. The rate of interest so elected shall be in
      effect for the respective applicable LIBOR Interest Period. The Borrower
      shall be responsible for all Break Costs including without limitation
      those applicable if during any period in which a LIBOR based rate or rates
      is or are in effect, if the principal amount outstanding under

                                       3

<PAGE>

      the Revolving Line Note bearing interest at such respective rate or rates
      is ever less than the principal amount stated in the respective election
      notice or notices for such period.

            Notwithstanding the foregoing, however, after the Reactivation Date
      all Revolving Loans shall bear interest at the rates and in the manner set
      forth in Section 2.3 of the Agreement as amended to November 1, 2002, but
      without giving effect to this Amendment.

            Interest shall continue to accrue after maturity, acceleration, and
      judgment at the rate required by this Agreement until the Revolving Line
      Note is paid in full. All computations of interest shall be made on the
      basis of a three hundred sixty (360) day year and the actual number of
      days elapsed.

      7. Section 2.7. Section 2.7 of the Agreement shall be amended in its
entirety to read as follows:

            2.7 Unused Fee. The Borrower shall pay the Bank a quarterly fee as
      follows: (i) at all times prior to the Reactivation Date in an amount
      equal to of one-half percent (.50%) per annum times the average unused
      availability under the Revolving Line during the preceding quarter, and
      (ii) at all times after a Reactivation Date in an amount equal to
      one-quarter percent (.25%) per annum times the average unused availability
      under the Revolving Line during the preceding quarter. For purposes of
      calculating such average unused availability, the face amounts of
      outstanding Letters of Credit and foreign exchange transactions shall be
      aggregated with amounts borrowed under the Revolving Line in determining
      what portion of the Revolving Line has been used. At the end of each
      fiscal quarter, the Bank will bill the Borrower for the unused fee.

      8. Section 3.1. Section 3.1 of the Agreement shall be amended in its
entirety to read as follows:

            3.1 Letters of Credit. Subject to the terms and conditions of this
      Agreement, the Bank will make Letters of Credit available for the account
      of the Borrower in an aggregate stated face amount not exceeding the
      lesser of (a) Three Million Dollars ($3,000,000.00), or (b) the remaining
      availability under the Revolving Line for the purposes of issuing Letters
      of Credit. Letters of Credit will be made promptly available for the
      Borrower's work in process (to support customer progress payments) or as
      otherwise reasonably requested by the Borrower with respect to customer
      contracts, for warranty work on completed products, and, subject to a
      sublimit of $500,000.00, to fund the Borrower's worker's compensation
      program. The stated amount outstanding under all Letters of Credit at all
      times shall reduce, dollar for dollar, the amount available for advances
      under the Letters of Credit Line. The Letters of Credit shall be in form
      satisfactory to the Bank. Up to $3,000,000 face amount of Letters of
      Credit may have maturity dates which are not more than three (3) years
      after the Revolving Line Termination Date.

      9. Deletion of Term Loans. Article 4 of the Agreement, together with all
references to any Term Loan or Term Loans, shall be deleted in its entirety, and
the Bank shall have no obligation to make any Term Loans to the Borrower.

                                       4

<PAGE>

      10. Monthly Financial Statements. The following paragraph shall be added
at the end of Section 10.1 of the Agreement:

            Beginning with the month ended April 30, 2004, not later than the
      25th day of each month, the Borrower shall deliver to the Bank copies of
      consolidated financial statements for the prior month prepared in
      accordance with GAAP. Such statements shall include at least a balance
      sheet, a statement of profit and loss, and an update to its monthly cash
      flow forecast for the subsequent twelve (12) month period. Monthly
      financial statements are for reporting purposes only; covenants shall
      continue to be calculated at each quarter and fiscal year end.

      11. Section 11.4. Section 11.4 of the Agreement shall be amended in its
entirety to read as follows:

            11.4 Mergers, Sales and Acquisitions, Changes in Ownership
      Interests. Enter into any merger or consolidation, (ii) acquire all or
      substantially all the stock or other ownership interests or assets of any
      person, firm, joint venture, corporation, or other entity, or (iii) sell,
      lease, transfer, or otherwise dispose of any material portion of its
      assets without the Bank's consent.

      12. Section 11.5. Section 11.5 of the Agreement shall be amended in its
entirety to read as follows:

            11.5 Distributions. Make any Distributions or apply any of its
      property or assets to Distributions or set apart any sum or asset for the
      purpose of Distributions, except that the Borrower may pay dividends (i)
      if the dividend rate is not increased from the dividend rate in effect on
      the date of this Amendment, and (ii) if there is sufficient cash (net of
      Revolving Loan borrowings) available for such dividends. In addition to
      these limitations, the Borrower may pay dividends after September 30,
      2004, only with the prior written consent of the Bank. Repurchases,
      redemptions, or acquisitions of capital stock, securities, or other equity
      interests or rights to acquire such equity interests, are prohibited
      without the Bank's consent.

      13. Section 11.10. The following Section 11.10 shall be added to the
Agreement:

            11.10 Material Adverse Change. Permit any change in the Borrower's
      business or operations, or in any factor affecting the Borrower's business
      or operations, or regarding any obligation or agreement of the Borrower,
      or in the financial condition of Borrower or in the collateral for the
      Borrower's Obligations, or any other condition affecting Borrower, as
      compared to the projections provided by the Borrower to the Bank dated
      February 13, 2004.

      14. Section 12.1. Section 12.1 of the Agreement shall be amended in its
entirety to read as follows:

                                       5

<PAGE>

            12.1 Minimum Tangible Net Worth. Maintain a minimum Tangible Net
      Worth of $16,500,000 from the date hereof through March 31, 2004,
      $15,850,000 from April 1, 2004 through June 30, 2004, and $14,850,000 at
      all times thereafter.

      15. Section 12.3. Section 12.3 of the Agreement shall be amended in its
entirety to read as follows:

            12.3 Minimum Debt Service Coverage Ratio. Commencing on the
      Reactivation Date and at all times thereafter, maintain a minimum Debt
      Service Coverage Ratio of 1.3 to 1.0, as shown on each year-end financial
      statement provided to the Bank.

      16. Section 12.4. Section 12.4 of the Agreement shall be amended in its
entirety to read as follows:

            12.4 Minimum Working Capital. Maintain minimum net working capital
      of $8,000,000 at all times, as shown on the most recent financial
      statement provided to the Bank. All Revolving Loan borrowings will be
      excluded from the calculation of working capital once any such liabilities
      are recognized as current in accordance with GAAP.

      17. Section 12.5. The following new Section 12.5 shall be added to the
Agreement:

            12.5 Minimum EBITDA and/or Maximum EBITDA Losses. Commencing on the
      earlier of (i) December 31, 2004, and (ii) the date that the Borrower's
      average net borrowing position exceeds $2,000,000 for the most recently
      ended fiscal quarter, the Borrower will not generate an EBITDA loss,
      measured on a rolling four quarter basis, exceeding the limits set forth
      below:

<TABLE>
<CAPTION>
($000'S)                         AT 6/30/04      AT 9/30/04      AT 12/31/04     AT 3/31/05      AT 6/30/05      AT 9/30/05
- --------                         ----------      ----------      -----------     ----------      ----------      ----------
<S>                              <C>             <C>             <C>             <C>             <C>             <C>
Maximum EBITDA loss               ($1,400)        ($2,500)         ($1,000)       ($1,000)           $0             $500
for prior four quarters
</TABLE>

      18. Field Audit. The Borrower agrees that the Bank may conduct a field
audit of its accounts, and inventories, and cash flow projections, at the
Borrower's expense, in no event later than the time when the Borrower's average
net borrowing position exceeds $2,000,000 for the most recent fiscal quarter.
The field audit will be performed by Freed Maxick ABL Services, Inc., or a
similar firm to be chosen by the Bank in its sole discretion. The Borrower
further agrees that pending results from any field audit , the Bank shall have
the right, upon notice to the Borrower, to limit the amount of Revolving Credit
Loans to amounts which would be available under a borrowing base formula based
on a certain percentage of the Borrower's eligible accounts receivable and
eligible inventories, all to be determined by the Bank in its sole discretion.
The Borrower agrees to execute and deliver to the Bank an amendment to the
Agreement implementing this borrowing base, in form and substance satisfactory
to the Bank and its counsel. To the extent that collateral values and resulting
borrowing base indicate availability in an amount less than the amount of loans
then outstanding, then a prepayment will be required to bring outstandings in
compliance with the borrowing base. Such prepayment will be made within 10
business days. The Borrower further agrees that the Bank may perform such

                                       6

<PAGE>

additional field audits as it deems necessary or advisable in its sole
discretion, all at the Borrower's expense.

      19. Amendment Fee. The Borrower shall pay the Bank an amendment fee in the
amount of $20,000.00

      20. Reaffirmation of Security Agreements. The Borrower reaffirms to the
Bank that all of the terms and provisions of its Amended and Restated Security
Agreement (Accounts, Inventory, Chattel Paper, Documents, Technology, and
General Intangibles) dated as of November 3, 1999, and of its Amended and
Restated Security Agreement (Goods and Equipment) dated as of November 3, 1999,
continue in full force and effect with respect to all present and future
indebtedness of the Borrower to the Bank, including without limitation the
indebtedness represented by this Second Amendment and the Amended and Restated
Revolving Line Note to be executed in connection herewith, and that all of such
indebtedness constitutes Obligations under such Security Agreements which are
secured by the Collateral defined therein.

      21. Representations and Warranties. The Borrower confirms the accuracy of
and remakes as of the date hereof all of its representations, warranties
contained in the Agreement. The Borrower further represents and warrants to the
Bank that all necessary action on the part of the Borrower relating to
authorization of the execution and delivery of this Amendment and the Amended
and Restated Revolving Line Note (collectively, the "Additional Loan
Documents"), and the performance of the Obligations of the Borrower thereunder
has been taken. The Additional Loan Documents constitute legal, valid and
binding obligations of the Borrower, enforceable in accordance with their
respective terms. The Borrower has no defenses, offsets, claims, or
counterclaims with respect to its obligations arising under the Additional Loan
Documents. The execution and delivery by the Borrower of the Additional Loan
Documents, and the performance by the Borrower of the Additional Loan Documents,
will not violate any provision of law or the Borrower's Certificate of
Incorporation or By-laws or organizational or other documents or agreements. The
execution, delivery and performance of the Additional Loan Documents, and the
consummation of the transactions contemplated thereby will not violate, be in
conflict with, result in a breach of, or constitute a default under any
agreement to which the Borrower is a party or by which any of its properties is
bound, or any order, writ, injunction, or decree of any court or governmental
instrumentality, and will not result in the creation or imposition of any lien,
charge or encumbrance upon any of its properties.

      22. Conditions Precedent. The following conditions must be satisfied
before the Bank shall have any obligations under this Amendment:

            (a) The Borrower shall have executed and delivered to the Bank the
      Additional Loan Documents and any related documents necessary or desirable
      in connection therewith; and

            (b) The Borrower shall have delivered a certificate of its corporate
      secretary certifying resolutions duly adopted by the Board of Directors of
      the Borrower authorizing the execution, delivery and performance of the
      Additional Loan Documents, and the consummation of the transactions
      contemplated thereby, which resolutions shall remain

                                       7

<PAGE>

      in full force and effect so long as any of the Obligations are outstanding
      or any commitment to lend exists under the Agreement.

      23. No Events of Default. The Borrower confirms that as of the date
hereof, there exists no condition or event that constitutes (or that would after
expiration of applicable grace or cure periods constitute) an Event of Default
as described in Article 14 of the Agreement.

      24. No Offsets. As of the date hereof, the Borrower has no defenses,
offsets, claims or counterclaims with respect to its obligations arising under
the Agreement or this Amendment and all related documents and instruments.

      25. Costs and Expenses. Borrower agrees to pay any and all reasonable
costs incurred in connection with preparation for closing, the closing, and
post-closing items relating to this Amendment including without limitation the
legal fees and disbursements of Bank's counsel.

      26. Governing Law. This Amendment, together with all of the rights and
obligations of the parties hereto, shall be construed and interpreted in
accordance with the laws of the State of New York, excluding the laws applicable
to conflicts or choice of law.

      IN WITNESS WHEREOF, the parties have executed this Amendment on the date
first above written.

FLEET NATIONAL BANK                   GRAHAM CORPORATION

By:_______________________________    By: ________________________________

Title:____________________________    Title:______________________________

                                       8

<PAGE>

                                    EXHIBIT A

                    AMENDED AND RESTATED REVOLVING LINE NOTE

$8,000,000.00                                                     March 31, 2004

            THIS AMENDED AND RESTATED REVOLVING LINE NOTE EVIDENCES THE SAME
OBLIGATIONS AS, AND AMENDS AND RESTATES IN ITS ENTIRETY, (1) THE AMENDED AND
RESTATED REVOLVING LINE NOTE DATED NOVEMBER 3, 1999, BETWEEN THE BANK AND THE
BORROWER IN THE MAXIMUM PRINCIPAL FACE AMOUNT OF $13,000,000.

            FOR VALUE RECEIVED, the undersigned ("Borrower") hereby promises to
pay to the order of FLEET NATIONAL BANK (the "Bank"), at any of its banking
offices, or at such other places as Bank may specify in writing to Borrower, the
principal sum of Eight Million Dollars ($8,000,000.00), or if less, the
aggregate unpaid principal amount of all advances made by Bank to Borrower. Bank
shall maintain a record of amounts of principal and interest payable by Borrower
from time to time, and the records of Bank maintained in the ordinary course of
business shall be prima facie evidence of the existence and amounts of the
Borrower's obligations recorded therein. In addition, Bank may mail or deliver
periodic statements to Borrower indicating the date and amount of each advance
hereunder (but any failure to do so shall not relieve Borrower of the obligation
to repay any advance). Unless Borrower questions the accuracy of an entry on any
periodic statement within fifteen business days after such mailing or delivery
by Bank, Borrower shall be deemed to have accepted and be obligated by the terms
of each such periodic statement as accurately representing the advances
hereunder. In the event of transfer of this Note, or if the Bank shall otherwise
deem it appropriate, Borrower hereby authorizes Bank to endorse on this Note the
amount of advances and payments to reflect the principal balance outstanding
from time to time. Bank is hereby authorized to honor borrowing and other
requests received from purported representatives of Borrower orally, by
telecopy, in writing, or otherwise. Oral requests shall be conclusively presumed
to have been made by an authorized person and Bank's crediting of Borrower's
account with the amount requested shall conclusively establish Borrower's
obligation to repay the amount advanced.

            CREDIT AGREEMENT. This Note is made in connection with an Amended
and Restated Credit Facility Agreement dated November 3, 1999, as amended on
November 1, 2002 and on the date hereof, and as the same it may be further
modified, extended, or replaced from time to time hereafter (the "Credit
Agreement"). Capitalized terms not otherwise defined in this Note shall have the
meanings given to them in the Credit Agreement.

            INTEREST. Outstanding amounts under this Revolving Line Note shall
bear interest at a variable rate per annum until paid in full (including without
limitation after acceleration, maturity, and judgment), except as otherwise
specifically provided herein, equal to the Prime Rate in effect from time to
time. Changes in the interest rate shall become effective automatically and
without notice at the time of changes in the Prime Rate.

                                       9

<PAGE>

            The Borrower from time to time, however, may elect to have portions
of the principal outstanding under this Revolving Line Note bear interest at the
variable rate per annum equal to 275 basis points (2.75%) above the one-month,
two-month, or three-month LIBOR Rate for the period applicable to that rate by
giving at least two (2) business days' prior notice in writing or by telecopy to
the Bank. The notice shall specify (i) the rate chosen, (ii) the outstanding
principal amount to bear interest at the applicable LIBOR Rate which shall not
be less than $100,000 (with any outstanding amounts from time to time hereunder,
in excess of such specified amount, to bear interest at the rate based upon the
Prime Rate), and (iii) the commencement date for such rate. No LIBOR Interest
Period may be elected that would extend beyond the maturity date of this
Revolving Line Note. The rate of interest so elected shall be in effect for the
respective applicable LIBOR Interest Period. The Borrower shall be responsible
for all Break Costs including without limitation those applicable if during any
period in which a LIBOR based rate or rates is or are in effect, if the
principal amount outstanding under this Revolving Line Note bearing interest at
such respective rate or rates is ever less than the principal amount stated in
the respective election notice or notices for such period.

            Notwithstanding the foregoing, however, after the Reactivation Date
all Revolving Loans shall bear interest at the rates and in the manner set forth
in Section 2.3 of the Agreement as amended on November 1, 2002, without giving
effect to the Amendment of even date herewith.

            Interest shall continue to accrue after maturity, acceleration, and
judgment at the rate required by this Agreement until this Revolving Line Note
is paid in full. All computations of interest shall be made on the basis of a
three hundred sixty (360) day year and the actual number of days elapsed.

            PAYMENTS. Payments of all accrued interest hereunder shall be made
on the first day of each month.

            In the event the Borrower becomes aware, or receives notice (oral or
written) from the Bank, that principal amounts outstanding under the Revolving
Line at any time exceed the maximum available amount described in Sections 2.1
of the Credit Agreement, Borrower promptly shall make a principal payment to the
Bank sufficient to reduce outstanding principal amounts to the maximum amount
available hereunder.

            All remaining outstanding principal and accrued interest shall be
due and payable in full on the Revolving Line Termination Date.

            All payments shall be made by Borrower to Bank at One East Avenue,
Rochester, New York 14638, or such other place as Bank may form time to time
specify in writing in lawful currency of the United States in immediately
available funds, without counterclaim or setoff and free and clear of, and
without any deduction or withholding for, any taxes or other payments.

            Unless canceled in writing by Borrower, Borrower authorizes Bank to
debit its accounts at Bank to make payments due hereunder, but such authority
shall not relieve Borrower of the obligation to assure that payments are made
when due. Unless Bank exercises its right to debit Borrower's account, Bank
agrees that Borrower may make payments hereunder by check.

                                       10

<PAGE>

            All payments shall be applied first to the payment of all fees,
expenses and other amounts due to the Bank (excluding principal and interest),
then to accrued interest, and the balance on account of outstanding principal;
provided, however, that after default, payments will be applied to the
obligations of Borrower to Bank as Bank determines in its sole discretion.

            LATE CHARGE. If the entire amount of any required principal and/or
interest payment is not paid in full within ten (10) days after the same is due,
Borrower shall pay to the Bank a late fee equal to five percent (5%) of the
required payment.

            MAXIMUM RATE. All agreements between Borrower and Bank are hereby
expressly limited so that in no contingency or event whatsoever, whether by
reason of acceleration of maturity of the indebtedness evidenced hereby or
otherwise, shall the amount paid or agreed to be paid to Bank for the use or the
forbearance of the indebtedness evidenced hereby exceed the maximum permissible
under applicable law. As used herein, the term "applicable law" shall mean the
law in effect as of the date hereof provided, however that in the event there is
a change in the law which results in a higher permissible rate of interest, then
this Note shall be governed by such new law as of its effective date. In this
regard, it is expressly agreed that it is the intent of Borrower and Bank in the
execution, delivery and acceptance of this Note to contract in strict compliance
with the laws of the State of New York from time to time in effect. If, under or
from any circumstances whatsoever, fulfillment of any provision hereof or of any
other documents between the Borrower and the Bank at the time of performance of
such provision shall be due, shall involve transcending the limit of such
validity prescribed by applicable law, then the obligation to be fulfilled shall
automatically be reduced to the limits of such validity, and if under or from
circumstances whatsoever Bank should ever receive as interest and amount which
would exceed the highest lawful rate, such amount which would be excessive
interest shall be applied to the reduction of the principal balance evidenced
hereby and not to the payment of interest. This provision shall control every
other provision of all agreements between Borrower and Bank.

            PREPAYMENT. This Revolving Line Note is prepayable to the extent
allowed by, and on the terms provided by, the Credit Agreement.

            HOLIDAYS. If this Note or any payment hereunder becomes due on a
Saturday, Sunday or other holiday on which the Bank is authorized to close, the
due date of this Note or payment shall be extended to the next succeeding
business day, but any interest or fees shall be calculated based upon the actual
time of payment. As used herein, "Business Day" shall mean any day other than a
Saturday, Sunday or day which shall be in the State of New York a legal holiday
or day on which banking institutions are required or authorized to close.

            EVENTS OF DEFAULT. At Bank's option, this Note shall become
immediately due and payable in full, without further presentment, protest,
notice, or demand, upon the happening of any Event of Default and the expiration
of any cure periods.

            DEFAULT RATE. Upon any default or after maturity or after judgment
has been rendered with respect to the Obligations, or upon an Event of Default,
the unpaid principal of all Obligations shall, at the option the Bank, bear
interest at a rate which is four (4) percentage points per annum greater than
that which would otherwise be applicable.

                                       11

<PAGE>

            MODIFICATION OF TERMS. The terms of this Note cannot be changed, nor
may this Note be discharged in whole or in part, except by a writing executed by
Bank. In the event that Bank demands or accepts partial payments of this Note,
such demand or acceptance shall not be deemed to constitute a waiver of the
right to demand the entire unpaid balance of this Note at any time in accordance
with the terms hereof. Any delay or omission by Bank in exercising any rights
hereunder shall not operate as a waiver of such rights.

            COLLECTION COSTS. Borrower shall pay on demand all reasonable
expenses of Bank in connection with the preparation, administration, default,
collection, waiver or amendment of loan terms, or in connection with Bank's
exercise, preservation or enforcement of any of its rights, remedies or options
hereunder, including, without limitation, fees of outside legal counsel or the
allocated costs of in-house legal counsel, accounting, consulting, brokerage or
other similar professional fees or expenses, and any fees or expenses associated
with travel or other costs relating to any appraisals of examinations conducted
in connection with the loan evidenced by this Note of any collateral therefor,
and the amount of all such expenses shall, until paid, bear interest at the rate
applicable to principal hereunder (including any default rate) and be an
obligation secured by any collateral.

            MISCELLANEOUS. Except for such notice as may be required under
Section 14.1 of the Agreement, to the fullest extent permissible by law,
Borrower waives presentment, demand for payment, protest, notice of nonpayment,
and all other demands or notices otherwise required by law in connection with
the delivery, acceptance, performance, default, or enforcement of this Note.
Borrower consents to extensions, postponements' indulgences, amendments to notes
and agreements, substitutions or releases of collateral, and substitutions or
releases of other parties primarily or secondarily liable herefor, and agrees
that none of the same shall affect Borrower's obligations under this Note which
shall be unconditional.

            LAWS. This Note and the rights and obligations of the parties
hereunder shall be construed and interpreted in accordance with the laws of the
State of New York, excluding the laws applicable to conflicts or choice of law.

            ADDITIONAL SECURITY/SETOFF. The Borrower hereby grants to the Bank a
lien, security interest, and right of set off as security for the Obligations
upon and against all deposits, credits, collateral and property, now or
hereafter in the possession, custody, safekeeping or control of Bank or any
entity under the control of FleetBoston Financial Corporation, and its
successors and assigns, or in transit to any of them. At any time without demand
or notice, the Bank may set off the same or any part thereof and apply the same
to any liability or obligation of Borrower even though unmatured and regardless
of the adequacy of any other collateral securing the Obligations. ANY AND ALL
RIGHTS TO REQUIRE BANK TO EXERCISE ITS RIGHTS OR REMEDIES WITH RESPECT TO ANY
OTHER COLLATERAL WHICH SECURES THE OBLIGATIONS, PRIOR TO EXERCISING ITS RIGHT OF
SET OFF WITH RESPECT TO SUCH DEPOSITS, CREDITS, OR OTHER PROPERTY OF BORROWER
ARE HEREBY KNOWINGLY, VOLUNTARILY, AND IRREVOCABLY WAIVED.

            REPLACEMENT OF PROMISSORY NOTE. Upon receipt of an affidavit of an
officer of the Bank as to the loss, theft, destruction or mutilation of this
Note or any other security document which is not of public record, and, in the
case of any such loss, theft, destruction or mutilation, upon cancellation of
such Note or other security document, Borrower will issue, in

                                       12

<PAGE>

lieu thereof, a replacement note or other security document in the same
principal amount thereof and otherwise of like tenor.

            JURISDICTION/TRIAL BY JURY. BORROWER AGREES THAT ANY SUIT FOR THE
ENFORCEMENT OF THIS NOTE MAY BE BROUGHT IN THE COURTS OF THE STATE OF NEW YORK
OR ANY FEDERAL COURT SITTING THEREIN AND CONSENTS TO THE NONEXCLUSIVE
JURISDICTION OF SUCH COURT AND SERVICE OF PROCESS IN ANY SUCH SUIT BEING MADE
UPON BORROWER BY MAIL AT THE ADDRESS SET FORTH FOR NOTICES GIVEN UNDER THE
CREDIT AGREEMENT. BORROWER HEREBY WAIVES ANY OBJECTION THAT IT MAY NOW OR
HEREAFTER HAVE TO THE VENUE OF ANY SUCH SUIT OR ANY SUCH COURT OR THAT SUCH SUIT
IS BROUGHT IN AN INCONVENIENT FORUM.

            BORROWER AND BANK (BY ACCEPTANCE OF THIS NOTE) MUTUALLY HEREBY
KNOWINGLY, VOLUNTARILY AND INTENTIONALLY WAIVE THE RIGHT TO A TRIAL BY JURY IN
RESPECT OF ANY CLAIM BASED HEREON, ARISING OUT OF, UNDER OR IN CONNECTION WITH
THIS NOTE OR ANY OTHER LOAN DOCUMENTS OR ANY COURSE OF CONDUCT, COURSE OF
DEALINGS, STATEMENTS (WHETHER VERBAL OR WRITTEN) OR ACTIONS OF ANY PARTY,
INCLUDING WITHOUT LIMITATION, ANY COURSE OF CONDUCT, COURSE OF DEALINGS,
STATEMENTS OR ACTIONS OF BANK RELATING TO THE ADMINISTRATION OF THE LOAN OR
ENFORCEMENT OF THE LOAN DOCUMENTS, AND AGREE THAT NEITHER PARTY WILL SEEK TO
CONSOLIDATE ANY SUCH ACTION WITH ANY OTHER ACTION IN WHICH A JURY TRIAL CANNOT
BE OR HAS NOT BEEN WAIVED. EXCEPT AS PROHIBITED BY LAW, BORROWER HEREBY WAIVES
ANY RIGHT IT MAY HAVE TO CLAIM OR RECOVER IN ANY LITIGATION ANY SPECIAL ,
EXEMPLARY, PUNITIVE, OR CONSEQUENTIAL DAMAGES OR ANY DAMAGES OTHER THAN, OR IN
ADDITION TO, ACTUAL DAMAGES. BORROWER CERTIFIES THAT NO REPRESENTATIVE, AGENT,
OR ATTORNEY OF BANK HAS REPRESENTED, EXPRESSLY OR OTHERWISE, THAT BANK WOULD
NOT, IN THE EVENT OF LITIGATION, SEEK TO ENFORCE THE FOREGOING WAIVER. THIS
WAIVER CONSTITUTES A MATERIAL INDUCEMENT FOR BANK TO ACCEPT THIS NOTE AND MAKE
THE LOANS CONTEMPLATED HEREUNDER.

                                   GRAHAM CORPORATION

                                   By:______________________________________

                                   Title:___________________________________

                                       13
<PAGE>

                                                                       EXHIBIT 3

                  THIRD AMENDMENT TO CREDIT FACILITY AGREEMENT

            THIS THIRD AMENDMENT, dated as of the 11th day of March, 2005, to
that certain Amended and Restated Credit Facility Agreement dated as of November
3, 1999, as amended by an Amendment Number 1 dated as of November 1, 2002, and
the Second Amendment dated as of March 31, 2004 (the "Agreement"), between FLEET
NATIONAL BANK, a national banking association with an office at One East Avenue,
Rochester, New York 14638 (the "Bank"), and GRAHAM CORPORATION, a corporation
formed under the laws of the State of Delaware with offices at 20 Florence
Avenue, Batavia, New York 14020 (the "Borrower").

      The parties hereby agree as follows:

      1. Agreement Ratified. Except as expressly amended hereby, the Agreement
is in all respects ratified and confirmed, and all of the terms, provisions and
conditions thereof shall be and remain in full force and effect, and this
Amendment and all of its terms, provisions and conditions shall be deemed to be
a part of the Agreement. All capitalized terms used herein and not defined shall
have the meanings given them in the Agreement.

      2. New Definition. The definition of "Net Income" in Article 1 of the
Agreement shall be amended as follows:

            (i)   income or loss attributable to equity in Affiliates;

            (j)   any income or losses from the disposition and operations of
                  Graham Vacuum and Heat Transfer, Ltd and its subsidiaries; and

            (k)   other extraordinary or unusual items, but excluding contract
                  cancellation fees and other related items in the ordinary
                  course of business.

      3. Section 2.1. Section 2.1 of the Agreement shall be amended as follows:

            Subject to the terms and conditions of this Agreement, the Bank
      hereby establishes for the benefit of the Borrower a revolving line of
      credit in the maximum principal amount of Eight Million Dollars
      ($8,000,000.00) outstanding at any one time. The proceeds of the Revolving
      Line shall be used to meet Borrower's letter of credit, foreign exchange,
      and working capital requirements. A portion of the Revolving Line may be
      used by the Borrower to fund, with the prior written approval of the Bank,
      a foreign exchange guidance line of credit not to exceed (a) $500,000.00
      for foreign exchange contracts maturing on any one day, and (b)
      $3,333,333.00 for total foreign exchange contracts (with respect to
      forward contracts, not to exceed one year from the date of contract)
      outstanding at any one time. With respect to advances other than for
      foreign exchange under the Revolving Line, the entire $500,000 foreign
      exchange sublimit will be reserved for purposes of determining
      availability under the Revolving Line, irrespective of the amounts
      actually advanced under the foreign exchange guidance line. Subject to the
      terms of this Agreement, the Borrower may borrow, repay, and

                                                                               1

<PAGE>

      reborrow under the Revolving Line so long as the aggregate principal
      amount outstanding at any time for Working Capital Loans (including the
      foreign exchange sublimit) plus the aggregate face amount of Letters of
      Credit issued or available to be issued pursuant to Article 3 hereof does
      not exceed $8,000,000.00.

      4. Section 3.1. Section 3.1 of the Agreement shall be amended as follows:

            Subject to the terms and conditions of this Agreement, the Bank will
      make Letters of Credit available for the account of the Borrower in an
      aggregate stated face amount not exceeding the lesser of (a) Four Million
      Dollars ($4,000,000.00), or (b) the remaining availability under the
      Revolving Line for the purposes of issuing Letters of Credit. Letters of
      Credit will be made promptly available for the Borrower's work in process
      (to support customer progress payments) or as otherwise reasonably
      requested by the Borrower with respect to customer contracts, for warranty
      work on completed products, and, subject to a sublimit of $500,000.00, to
      fund the Borrower's worker's compensation program. The stated amount
      outstanding under all Letters of Credit at all times shall reduce, dollar
      for dollar, the amount available for advances under the Letters of Credit
      Line. The Letters of Credit shall be in form satisfactory to the Bank. Up
      to $4,000,000 face amount of Letters of Credit may have maturity dates
      which are not more than three (3) years after the Revolving Line
      Termination Date.

      5.    Section 11.4. Section 11.4 of the Agreement shall be waived in order
            to permit the sale and/or transfer of Graham Precision Pumps
            Limited.

      6. Section 11.6. Section 11.6 of the Agreement shall be waived in order to
      permit the appointment of William Johnson as the Borrower's new President
      and CEO.

      7. Representations and Warranties. The Borrower confirms the accuracy of
and remakes as of the date hereof all of its representations, warranties
contained in the Agreement. The Borrower further represents and warrants to the
Bank that all necessary action on the part of the Borrower relating to
authorization of the execution and delivery of this Amendment, and the
performance of the Obligations of the Borrower thereunder has been taken. This
Amendment constitute legal, valid and binding obligations of the Borrower,
enforceable in accordance with their respective terms. The Borrower has no
defenses, offsets, claims, or counterclaims with respect to its obligations
arising under the Amendment. The execution and delivery by the Borrower of the
Amendment, and the performance by the Borrower of the Amendment, will not
violate any provision of law or the Borrower's Certificate of Incorporation or
By-laws or organizational or other documents or agreements. The execution,
delivery and performance of the Amendment, and the consummation of the
transactions contemplated thereby will not violate, be in conflict with, result
in a breach of, or constitute a default under any agreement to which the
Borrower is a party or by which any of its properties is bound, or any order,
writ, injunction, or decree of any court or governmental instrumentality, and
will not result in the creation or imposition of any lien, charge or encumbrance
upon any of its properties.

                                                                               2

<PAGE>

      7. No Events of Default. The Borrower confirms that as of the date hereof,
there exists no condition or event that constitutes (or that would after
expiration of applicable grace or cure periods constitute) an Event of Default
as described in Article 14 of the Agreement.

      8 No Offsets. As of the date hereof, the Borrower has no defenses,
offsets, claims or counterclaims with respect to its obligations arising under
the Agreement or this Amendment and all related documents and instruments.

      9. Governing Law. This Amendment, together with all of the rights and
obligations of the parties hereto, shall be construed and interpreted in
accordance with the laws of the State of New York, excluding the laws applicable
to conflicts or choice of law.

      IN WITNESS WHEREOF, the parties have executed this Amendment on the date
first above written.

FLEET NATIONAL BANK                        GRAHAM CORPORATION

By:__________________________________      By: ________________________________

Title:_______________________________      Title:______________________________

                                                                               3
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-23.1
<SEQUENCE>3
<FILENAME>l13696aexv23w1.txt
<DESCRIPTION>EXHIBIT 23.1
<TEXT>
<PAGE>

                                                                    EXHIBIT 23.1


CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



Graham Corporation

We consent to the incorporation by reference in Registration Statement Nos.
33-82432, 333-00401, and Post-Effective Amendment No. 1 to Registration
Statement No. 33-82432 on Forms S-3 and Registration Statement Nos. 2-83432,
2-82275, 333-113426 and Post-Effective Amendment No. 1 to Registration Statement
No. 333-113426 on Forms S-8 of our reports dated June 15, 2005 (which reports
express an unqualified opinion and include an explanatory paragraph concerning
a change in accounting method for construction-type contracts in 2005),
appearing in this Annual Report on Form 10-K of Graham Corporation and
subsidiaries for the year ended March 31, 2005.


/s/ Deloitte & Touche LLP
- -------------------------
Deloitte & Touche LLP
Rochester, New York
June 23, 2005

</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-31.1
<SEQUENCE>4
<FILENAME>l13696aexv31w1.txt
<DESCRIPTION>EXHIBIT 31.1
<TEXT>
<PAGE>

                                                                    EXHIBIT 31.1

                                CERTIFICATION OF
                            CHIEF EXECUTIVE OFFICER

I, William C. Johnson, certify that:

     1. I have reviewed this annual report on Form 10-K for the fiscal year
ended March 31, 2005 of Graham Corporation;

     2. Based on my knowledge, this report does not contain any untrue statement
of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by this report;

     3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;

     4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

          (a) Designed such disclosure controls and procedures, or caused such
     disclosure controls and procedures to be designed under our supervision, to
     ensure that material information relating to the registrant, including its
     consolidated subsidiaries, is made known to us by others within those
     entities, particularly during the period in which this report is being
     prepared;

          (b) Evaluated the effectiveness of the registrant's disclosure
     controls and procedures, and presented in this report our conclusions about
     the effectiveness of the disclosure controls and procedures as of the end
     of the period covered by this report based on such evaluation; and

          (c) Disclosed in this report any change in the registrant's internal
     control over financial reporting that occurred during the registrant's most
     recent fiscal quarter (the registrant's fourth fiscal quarter in the case
     of an annual report) that has materially affected, or is reasonably likely
     to materially affect, the registrant's internal control over financial
     reporting; and
<PAGE>

     5. The registrant's other certifying officer(s) and I have disclosed, based
on our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of the registrant's board of
directors (or persons performing the equivalent function):

          (a) All significant deficiencies and material weaknesses in the design
     or operation of internal controls over financial reporting which are
     reasonably likely to adversely affect the registrant's ability to record,
     process, summarize and report financial information; and

          (b) Any fraud, whether or not material, that involves management or
     other employees who have a significant role in the registrant's internal
     control over financial reporting.

                                                  /s/ WILLIAM C. JOHNSON
                                          --------------------------------------
                                                    William C. Johnson
                                          President and Chief Executive Officer

Date: June 15, 2005
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-31.2
<SEQUENCE>5
<FILENAME>l13696aexv31w2.txt
<DESCRIPTION>EXHIBIT 31.2
<TEXT>
<PAGE>

                                                                    EXHIBIT 31.2

                                CERTIFICATION OF
                            CHIEF FINANCIAL OFFICER

I, J. Ronald Hansen, certify that:

     1. I have reviewed this annual report on Form 10-K for the fiscal year
ended March 31, 2005 of Graham Corporation;

     2. Based on my knowledge, this report does not contain any untrue statement
of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by this report;

     3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;

     4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

          (a) Designed such disclosure controls and procedures, or caused such
     disclosure controls and procedures to be designed under our supervision, to
     ensure that material information relating to the registrant, including its
     consolidated subsidiaries, is made known to us by others within those
     entities, particularly during the period in which this report is being
     prepared;

          (b) Evaluated the effectiveness of the registrant's disclosure
     controls and procedures, and presented in this report our conclusions about
     the effectiveness of the disclosure controls and procedures as of the end
     of the period covered by this report based on such evaluation; and

          (c) Disclosed in this report any change in the registrant's internal
     control over financial reporting that occurred during the registrant's most
     recent fiscal quarter (the registrant's fourth fiscal quarter in the case
     of an annual report) that has materially affected, or is reasonably likely
     to materially affect, the registrant's internal control over financial
     reporting; and
<PAGE>

     5. The registrant's other certifying officer(s) and I have disclosed, based
on our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of the registrant's board of
directors (or persons performing the equivalent function):

          (a) All significant deficiencies and material weaknesses in the design
     or operation of internal controls over financial reporting which are
     reasonably likely to adversely affect the registrant's ability to record,
     process, summarize and report financial information; and

          (b) Any fraud, whether or not material, that involves management or
     other employees who have a significant role in the registrant's internal
     control over financial reporting.

                                                   /s/ J. RONALD HANSEN
                                          --------------------------------------
                                                     J. Ronald Hansen
                                                 Vice President-Finance &
                                                    Administration and
                                                 Chief Financial Officer

Date: June 15, 2005

                                        2
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-32
<SEQUENCE>6
<FILENAME>l13696aexv32.txt
<DESCRIPTION>EXHIBIT 32
<TEXT>
<PAGE>

                                                                      EXHIBIT 32

                           CERTIFICATION PURSUANT TO
                             18 U.S.C. SECTION 1350
                             AS ADOPTED PURSUANT TO
                 SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

     In connection with the Annual Report of Graham Corporation (the "Company")
on Form 10-K for the fiscal year ended March 31, 2005 as filed with the
Securities and Exchange Commission on the date hereof (the "Report"), each of
the undersigned certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002 that:

          1) the Report fully complies with the requirements of Section 13(a) or
     15(d) of the Securities Exchange Act of 1934; and

          2) the information contained in the Report fairly presents, in all
     material respects, the financial condition and results of operations of the
     Company.

<Table>
<S>                                            <C>
            /s/ WILLIAM C. JOHNSON                          /s/ J. RONALD HANSEN
- ---------------------------------------------- ----------------------------------------------
              William C. Johnson                              J. Ronald Hansen
    President and Chief Executive Officer                 Chief Financial Officer
                June 15, 2005                                  June 15, 2005
</Table>

     A signed original of this written statement required by Section 906 has
been provided to Graham Corporation and will be retained by Graham Corporation
and furnished to the Securities and Exchange Commission or its staff upon
request.
</TEXT>
</DOCUMENT>
</SEC-DOCUMENT>
-----END PRIVACY-ENHANCED MESSAGE-----
