UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

 

Washington, D.C. 20549

 

FORM 10-Q

 

Quarterly Report Pursuant to Section 13 or 15 (d) of the

Securities Exchange Act of 1934

 

For the quarterly period ended September 26, 2008

 

Commission File Number:   001-09249

 

 

GRACO INC.

 

 

(Exact name of registrant as specified in its charter)

 

 

 

 

Minnesota

 

41-0285640

 

(State of incorporation)

 

(I.R.S. Employer Identification Number)

 

 

88 - 11th Avenue N.E.

Minneapolis, Minnesota

 

 

55413

(Address of principal executive offices)

 

(Zip Code)

 

 

 

(612) 623-6000

 

 

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days.

 

 

Yes

X

 

No

 

 

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large Accelerated Filer

X

Accelerated Filer

 

Non-accelerated Filer

 

Smaller reporting company

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

Yes

 

 

No

X

 

 

59,513,000 shares of the Registrant’s Common Stock, $1.00 par value were outstanding as of October 16, 2008.


 

GRACO INC. AND SUBSIDIARIES

 

INDEX

 

Page Number

 

PART I

FINANCIAL INFORMATION

 

 

 

 

 

 

Item 1.

Financial Statements

 

 

 

 

 

 

 

Consolidated Statements of Earnings

3

 

 

Consolidated Balance Sheets

4

 

 

Consolidated Statements of Cash Flows

5

 

 

Notes to Consolidated Financial Statements

6

 

 

 

 

 

Item 2.

Management’s Discussion and Analysis

 

 

 

of Financial Condition and Results of Operations

15

 

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

20

 

 

 

 

 

Item 4.

Controls and Procedures

20

 

 

 

 

 

 

 

 

 

 

 

 

PART II

OTHER INFORMATION

 

 

 

 

 

 

Item 1A.

Risk Factors

21

 

 

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

21

 

 

 

 

 

Item 4.

Submission of Matters to a Vote of Security Holders

22

 

 

 

 

 

Item 6.

Exhibits

22

 

 

 

 

SIGNATURES

 

 

 

EXHIBITS

 

 

 

2

 


 

PART I

Item 1.

GRACO INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF EARNINGS

(Unaudited)

(In thousands except per share amounts)

 

 

 

Thirteen Weeks Ended

 

Thirty-nine Weeks Ended

 

 

Sep 26,

 

Sep 28,

 

Sep 26,

 

Sep 28,

 

 

2008

 

2007

 

2008

 

2007

 

 

 

 

 

 

 

 

 

Net Sales

$    207,231

 

$       207,270

 

$      650,581

 

$      636,149

 

 

 

 

 

 

 

 

 

 

Cost of products sold

97,071

 

96,624

 

299,805

 

298,409

 

 

 

 

 

 

 

 

 

Gross Profit

110,160

 

110,646

 

350,776

 

337,740

 

 

 

 

 

 

 

 

 

 

Product development

9,626

 

7,087

 

26,605

 

22,903

 

Selling, marketing and distribution

32,420

 

30,382

 

102,083

 

91,562

 

General and administrative

15,585

 

14,641

 

50,142

 

44,938

 

 

 

 

 

 

 

 

 

Operating Earnings

52,529

 

58,536

 

171,946

 

178,337

 

 

 

 

 

 

 

 

 

 

Interest expense

1,934

 

1,034

 

5,443

 

1,934

 

Other expense, net

623

 

39

 

606

 

25

 

 

 

 

 

 

 

 

 

Earnings Before Income Taxes

49,972

 

57,463

 

165,897

 

176,378

 

 

 

 

 

 

 

 

 

 

Income taxes

17,200

 

18,200

 

55,100

 

59,200

 

 

 

 

 

 

 

 

 

Net Earnings

$       32,772

 

$          39,263

 

$      110,797

 

$      117,178

 

 

 

 

 

 

 

 

 

Basic Net Earnings

 

 

 

 

 

 

 

 

per Common Share

$            0.55

 

$               0.61

 

$              1.83

 

$              1.78

 

 

 

 

 

 

 

 

 

Diluted Net Earnings

 

 

 

 

 

 

 

 

per Common Share

$            0.54

 

$               0.60

 

$              1.81

 

$              1.75

 

 

 

 

 

 

 

 

 

Cash Dividends Declared

 

 

 

 

 

 

 

 

per Common Share

$            0.19

 

$                .17

 

$              0.55

 

$              0.50

 

 

 

 

See notes to consolidated financial statements.

 

3

 


 

GRACO INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Unaudited)

(In thousands)

 

 

 

 

 

 

 

 

 

Sep 26, 2008

 

Dec 28, 2007

ASSETS

 

 

 

Current Assets

 

 

 

 

Cash and cash equivalents

$              5,250 

 

$               4,922 

 

Accounts receivable, less allowances of

 

 

 

 

 

$6,600 and $6,500

146,820 

 

140,489 

 

Inventories

95,313 

 

74,737 

 

Deferred income taxes

25,609 

 

21,650 

 

Other current assets

5,624 

 

7,034 

 

 

Total current assets

278,616 

 

248,832 

 

 

 

 

 

 

Property, Plant and Equipment

 

 

 

 

Cost

322,933 

 

306,073 

 

Accumulated depreciation

(176,030)

 

(165,479)

 

 

Property, plant and equipment, net

146,903 

 

140,594 

 

 

 

 

 

 

Prepaid Pension

34,264 

 

31,823 

Goodwill

87,224 

 

67,204 

Other Intangible Assets, net

53,505 

 

41,889 

Other Assets

6,884 

 

6,382 

 

 

Total Assets

$         607,396 

 

$           536,724 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS' EQUITY

 

 

 

Current Liabilities

 

 

 

 

Notes payable to banks

$           16,519 

 

$             18,991 

 

Trade accounts payable

24,559 

 

27,379 

 

Salaries, wages and commissions

19,408 

 

20,470 

 

Dividends payable

11,016 

 

11,476 

 

Other current liabilities

48,063 

 

47,561 

 

 

Total current liabilities

119,565 

 

125,877 

 

 

 

 

 

 

Long-term Debt

191,855 

 

107,060 

Retirement Benefits and Deferred Compensation

40,428 

 

40,639 

Uncertain Tax Positions

1,800 

 

5,400 

Deferred Income Taxes

19,257 

 

13,074 

 

 

 

 

 

 

Shareholders' Equity

 

 

 

 

Common stock

59,522 

 

61,964 

 

Additional paid-in-capital

172,107 

 

156,420 

 

Retained earnings

10,111 

 

32,986 

 

Accumulated other comprehensive income (loss)

(7,249)

 

(6,696)

 

 

Total shareholders' equity

234,491 

 

244,674 

 

 

Total Liabilities and Shareholders' Equity

$         607,396 

 

$            536,724

 

See notes to consolidated financial statements.

 

4

 


 

GRACO INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited) (In thousands)

 

 

 

 

 

Thirty-nine Weeks Ended

 

 

 

 

 

Sep 26, 2008

 

Sep 28, 2007

Cash Flows From Operating Activities

 

 

 

 

Net Earnings

$     110,797 

 

$    117,178 

 

 

Adjustments to reconcile net earnings to

 

 

 

 

 

net cash provided by operating activities

 

 

 

 

 

 

Depreciation and amortization

23,310 

 

20,770 

 

 

 

Deferred income taxes

(3,850)

 

(3,059)

 

 

 

Share-based compensation

7,072 

 

6,297 

 

 

 

Excess tax benefit related to share-based

 

 

 

 

 

 

 

payment arrangements

(2,923)

 

(4,154)

 

 

 

Change in

 

 

 

 

 

 

 

Accounts receivable

(4,989)

 

(7,383)

 

 

 

 

Inventories

(16,466)

 

(907)

 

 

 

 

Trade accounts payable

(775)

 

(1,477)

 

 

 

 

Salaries, wages and commissions

(1,236)

 

(7,697)

 

 

 

 

Retirement benefits and deferred compensation

(2,141)

 

(1,848)

 

 

 

 

Other accrued liabilities

788 

 

6,150 

 

 

 

 

Other

1,114 

 

(1,589)

Net cash provided by operating activities

110,701 

 

122,281 

 

 

 

 

 

 

 

 

Cash Flows From Investing Activities

 

 

 

 

Property, plant and equipment additions

(20,778)

 

(28,207)

 

Proceeds from sale of property, plant and equipment

1,633 

 

207 

 

Investment in life insurance

(1,499)

 

(1,499)

 

Capitalized software and other intangible asset additions

(1,130)

 

(43)

 

Acquisitions of businesses, net of cash acquired

(39,780)

 

-- 

Net cash used in investing activities

(61,554)

 

(29,542)

 

 

 

 

 

 

 

 

Cash Flows From Financing Activities

 

 

 

 

Net borrowings (payments) on short-term lines of credit

(2,779)

 

(1,704)

 

Borrowings on long-term line of credit

188,869 

 

85,680 

 

Payments on long-term line of credit

(104,074)

 

-- 

 

Excess tax benefit related to share-based

 

 

 

 

 

payment arrangements

2,923 

 

4,154 

 

Common stock issued

13,528 

 

22,545 

 

Common stock retired

(114,341)

 

(164,910)

 

Cash dividends paid

(33,693)

 

(32,800)

Net cash provided by (used in) financing activities

(49,567)

 

(87,035)

 

 

 

 

 

 

 

 

Effect of exchange rate changes on cash

748 

 

(1,804)

Net increase (decrease) in cash and cash equivalents

328 

3,900 

Cash and cash equivalents

     Beginning of year

4,922 

5,871 

     End of period

$        5,250 

$         9,771 

 

See notes to consolidated financial statements.

 

5

 


 

GRACO INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1.

The consolidated balance sheet of Graco Inc. and Subsidiaries (the Company) as of September 26, 2008 and the related statements of earnings for the thirteen and thirty-nine weeks ended September 26, 2008 and September 28, 2007, and cash flows for the thirty-nine weeks ended September 26, 2008 and September 28, 2007 have been prepared by the Company and have not been audited.

 

In the opinion of management, these consolidated financial statements reflect all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the financial position of Graco Inc. and Subsidiaries as of September 26, 2008, and the results of operations and cash flows for all periods presented.

 

Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. Therefore, these statements should be read in conjunction with the financial statements and notes thereto included in the Company’s 2007 Annual Report on Form 10-K.

 

The results of operations for interim periods are not necessarily indicative of results that will be realized for the full fiscal year.

2.

The following table sets forth the computation of basic and diluted earnings per share (in thousands, except per share amounts):

 

 

Thirteen Weeks Ended

 

Thirty-nine Weeks Ended

 

 

Sep 26,

 

Sep 28,

 

Sep 26,

 

Sep 28,

 

 

2008

 

2007

 

2008

 

2007

 

 

 

 

 

 

 

 

 

Net earnings available to

 

 

 

 

 

 

 

 

common shareholders

$   32,772

 

$    39,263

 

$    110,797

 

$   117,178

 

 

 

 

 

 

 

 

 

Weighted average shares

 

 

 

 

 

 

 

 

outstanding for basic

 

 

 

 

 

 

 

 

earnings per share

59,769

 

64,797

 

60,521

 

65,836

 

 

 

 

 

 

 

 

 

Dilutive effect of stock

 

 

 

 

 

 

 

 

options computed using the

 

 

 

 

 

 

 

 

treasury stock method and

 

 

 

 

 

 

 

 

the average market price

596

 

921

 

647

 

998

 

 

 

 

 

 

 

 

 

Weighted average shares

 

 

 

 

 

 

 

 

outstanding for diluted

 

 

 

 

 

 

 

 

earnings per share

60,365

 

65,718

 

61,168

 

66,834

 

 

 

 

 

 

 

 

 

Basic earnings per share

$         0.55

 

$        0.61

 

$           1.83

 

$           1.78

Diluted earnings per share

$         0.54

 

$        0.60

 

$           1.81

 

$           1.75

 

6

 


 

Stock options to purchase 2,114,000 and 1,043,000 shares were not included in the 2008 and 2007 computations of diluted earnings per share, respectively, because they would have been anti-dilutive.

 

3.

Information on option shares outstanding and option activity for the thirty-nine weeks ended September 26, 2008 is shown below (in thousands, except per share amounts):

 

 

 

 

 

Weighted

 

 

 

Weighted

 

 

 

 

Average

 

 

 

Average

 

 

Option

 

Exercise

 

Options

 

Exercise

 

 

Shares

 

Price

 

Exercisable

 

Price

 

 

 

 

 

 

 

 

 

Outstanding, December 28, 2007

3,779 

 

$         28.63

 

2,228

 

$         21.41

 

Granted

779 

 

36.23

 

 

 

 

 

Exercised

(412)

 

16.66

 

 

 

 

 

Canceled

(210)

 

38.94

 

 

 

 

Outstanding, September 26, 2008

3,936 

 

$         30.85

 

2,193

 

$         24.94

 

The aggregate intrinsic value of exercisable option shares was $25.4 million as of September 26, 2008, with a weighted average contractual term of 4.5 years. There were approximately 3.9 million vested share options and share options expected to vest as of September 26, 2008, with an aggregate intrinsic value of $25.4 million, a weighted average exercise price of $30.76 and a weighted average contractual term of 6.4 years.

 

Information related to options exercised in the first nine months of 2008 and 2007 follows (in thousands):

 

 

 

Thirty-nine Weeks Ended

 

 

Sep 26, 2008

 

Sep 28, 2007

Cash received

$                  6,864

 

$                15,290

Aggregate intrinsic value

8,645

 

16,625

Tax benefit realized

3,100

 

6,200

 

The Company recognized year-to-date share-based compensation of $7.1 million in 2008 and $6.3 million in 2007. As of September 26, 2008, there was $9.8 million of unrecognized compensation cost related to unvested options, expected to be recognized over a weighted average period of 2.3 years.

 

7

 


 

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions and results:

 

 

 

Thirty-nine Weeks Ended

 

 

Sep 26, 2008

 

Sep 28, 2007

Expected life in years

6.0   

 

6.0   

Interest rate

3.2%

 

4.7%

Volatility

25.0%

 

26.1%

Dividend yield

2.1%

 

1.6%

Weighted average fair value per share

$     8.43 

 

$    12.01 

 

Under the Company’s Employee Stock Purchase Plan, the Company issued 216,000 shares in 2008 and 202,000 shares in 2007. The fair value of the employees’ purchase rights under this Plan was estimated on the date of grant. The benefit of the 15 percent discount from the lesser of the fair market value per common share on the first day and the last day of the plan year was added to the fair value of the employees’ purchase rights determined using the Black-Scholes option-pricing model with the following assumptions and results:

 

 

 

Thirty-nine Weeks Ended

 

 

Sep 26, 2008

 

Sep 28, 2007

Expected life in years

1.0   

 

1.0   

Interest rate

1.5%

 

4.9%

Volatility

27.1%

 

24.4%

Dividend yield

2.1%

 

1.6%

Weighted average fair value per share

$    8.14 

 

$    9.79 

 

 

 

8

 


4. The components of net periodic benefit cost (credit) for retirement benefit plans were as follows (in thousands):


 

 

Thirteen Weeks Ended

 

Thirty-nine Weeks Ended

 

Sep 26,

 

Sep 28,

 

Sep 26,

 

Sep 28,

 

2008

 

2007

 

2008

 

2007

Pension Benefits

 

 

 

 

 

 

 

Service cost

$           920 

 

$     1,231 

 

$        3,724 

 

$         4,211 

Interest cost

2,896 

 

2,855 

 

9,186 

 

8,622 

Expected return on assets

(4,536)

 

(4,496)

 

(14,236)

 

(14,096)

Amortization and other

233 

 

204 

 

528 

 

749 

Net periodic benefit cost (credit)

$           (487)

 

$       (206)

 

$         (798)

 

$           (514)

 

 

 

 

 

 

 

 

Postretirement Medical

 

 

 

 

 

 

 

Service cost

$          168 

 

$           75 

 

$           418 

 

$            375 

Interest cost

286 

 

360 

 

1,036 

 

975 

Amortization

(13)

 

(518)

 

(13)

 

55 

Net periodic benefit cost (credit)

$          441 

 

$         (83)

 

$       1,441 

 

$         1,405 

 

The Company paid $1.5 million in June 2008 and $1.5 million in June 2007 for contracts insuring the lives of certain employees who are eligible to participate in certain non-qualified pension and deferred compensation plans. These insurance contracts will be used to fund the non-qualified pension and deferred compensation arrangements. The insurance contracts are held in a trust and are available to general creditors in the event of the Company’s insolvency. Cash surrender value of $2.7 million and $1.5 million is included in other assets in the consolidated balance sheet as of September 26, 2008 and December 28, 2007, respectively.

5.

Total comprehensive income was as follows (in thousands):

 

 

 

Thirteen Weeks Ended

 

Thirty-nine Weeks Ended

 

 

Sep 26,

 

Sep 28,

 

Sep 26,

 

Sep 28,

 

 

2008

 

2007

 

2008

 

2007

 

 

 

 

 

 

 

 

 

Net earnings

$         32,772 

 

$          39,263 

 

$     110,797 

 

$      117,178 

Cumulative translation

 

 

 

 

 

 

 

 

adjustment

(346)

 

88 

 

(377)

 

202 

Pension and postretirement

 

 

 

 

 

 

 

 

medical liability adjustment

164 

 

64 

 

353 

 

194 

Gain (loss) on interest

 

 

 

 

 

 

 

 

rate hedge contracts

(211)

 

(89)

 

(634)

 

(89)

 

 

 

 

 

 

 

 

 

Income taxes

23 

 

 

107 

 

(40)

 

 

 

 

 

 

 

 

 

Comprehensive income

$          32,402 

 

$          39,335 

 

$     110,246 

 

$      117,445 

 

9


 

Components of accumulated other comprehensive income (loss) were (in thousands):

 

 

 

Sep 26, 2008

 

Dec 28, 2007

 

 

 

 

 

 

Pension and postretirement medical liability adjustment

 

$        (5,449)

 

$          (5,672)

Gain (loss) on interest rate hedge contracts

 

(1,471)

 

(1,072)

Cumulative translation adjustment

 

(329)

 

48 

Total

 

$        (7,249)

 

$          (6,696)

 

6.

The Company has three reportable segments: Industrial, Contractor and Lubrication. The Company does not track assets by segment. Sales and operating earnings by segment for the thirteen and thirty-nine weeks ended September 26, 2008 and September 28, 2007 were as follows (in thousands):

 

 

Thirteen Weeks Ended

 

Thirty-nine Weeks Ended

 

Sep 26,

 

Sep 28,

 

Sep 26,

 

Sep 28,

 

2008

 

2007

 

2008

 

2007

Net Sales

 

 

 

 

 

 

 

Industrial

$      117,685 

 

$      107,791 

 

$     365,028 

 

$      327,137 

Contractor

67,751 

 

76,649 

 

215,992 

 

240,631 

Lubrication

21,795 

 

22,830 

 

69,561 

 

68,381 

Consolidated

$      207,231 

 

$      207,270 

 

$      650,581 

 

$      636,149 

 

 

 

 

 

 

 

 

Operating Earnings

 

 

 

 

 

 

 

Industrial

$        35,874 

 

$        37,597 

 

$      117,847 

 

$      111,570 

Contractor

15,226 

 

21,016 

 

49,663 

 

66,662 

Lubrication

3,409 

 

2,584 

 

12,333 

 

7,844 

Unallocated corporate (expense)

(1,980)

 

(2,661)

 

(7,897)

 

(7,739)

Consolidated

$        52,529 

 

$        58,536 

 

$      171,946 

 

$      178,337 

 

7.

Major components of inventories were as follows (in thousands):

 

 

 

Sep 26, 2008

 

Dec 28, 2007

 

 

 

 

 

 

Finished products and components

 

$         53,954 

 

$           46,677 

Products and components in various

 

 

 

 

 

stages of completion

 

31,068 

 

24,805 

Raw materials and purchased components

 

43,977 

 

37,311 

 

 

 

128,999 

 

108,793 

Reduction to LIFO cost

 

(33,686)

 

(34,056)

Total

 

$          95,313 

 

$           74,737 

 

10

 


 

8.

Information related to other intangible assets follows (dollars in thousands):

 

 

 

 

Estimated

 

 

 

 

 

Foreign

 

 

 

 

 

Life

 

Original

 

Accumulated

 

Currency

 

Book

 

 

 

(years)

 

Cost

 

Amortization

 

Translation

 

Value

September 26, 2008

 

 

 

 

 

 

 

 

 

 

Customer relationships

 

3 - 8

 

$     37,820

 

$        (11,852)

 

$            (40)

 

$     25,928

Patents, proprietary technology

 

 

 

 

 

 

 

 

 

 

 

and product documentation

 

3 - 15

 

23,858

 

(10,373)

 

(17)

 

13,468

Trademarks, trade names

 

 

 

 

 

 

 

 

 

 

 

and other

 

3 - 10

 

4,714

 

(3,524)

 

 

1,199

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

66,392

 

(25,749)

 

(48)

 

40,595

Not Subject to Amortization:

 

 

 

 

 

 

 

 

 

 

 

Brand names

 

 

 

12,910

 

-

 

-- 

 

12,910

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

 

 

$      79,302

 

$        (25,749)

 

$            (48)

 

$      53,505

 

 

 

 

 

 

 

 

 

 

 

 

December 28, 2007

 

 

 

 

 

 

 

 

 

 

Customer relationships and

 

 

 

 

 

 

 

 

 

 

 

distribution network

 

4 - 8

 

$      26,102

 

$        (11,092)

 

$             29 

 

$      15,039

Patents, proprietary technology

 

 

 

 

 

 

 

 

 

 

 

and product documentation

 

5 - 15

 

22,243

 

(7,720)

 

16 

 

14,539

Trademarks, trade names

 

 

 

 

 

 

 

 

 

 

 

and other

 

3 - 10

 

4,684

 

(2,555)

 

22 

 

2,151

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

53,029

 

(21,367)

 

67 

 

31,729

Not Subject to Amortization:

 

 

 

 

 

 

 

 

 

 

 

Brand names

 

 

 

10,160

 

-

 

-- 

 

10,160

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

 

 

$     63,189

 

$        (21,367)

 

$             67 

 

$      41,889

 

Amortization of intangibles was $2.7 million in the third quarter of 2008 and $7.6 million year-to-date. Estimated annual amortization expense is as follows: $10.1 million in 2008, $9.7 million in 2009, $8.7 million in 2010, $7.7 million in 2011, $7.0 million in 2012 and $5.0 million thereafter.

 

11


 

9.

Components of other current liabilities were (in thousands):

 

 

 

 

Sep 26, 2008

 

Dec 28, 2007

 

 

 

 

 

 

Accrued self-insurance retentions

 

$             8,098

 

$             7,842

Accrued warranty and service liabilities

 

7,591

 

7,084

Accrued trade promotions

 

5,727

 

6,480

Payable for employee stock purchases

 

4,107

 

5,829

Income taxes payable

 

3,132

 

678

Other

 

19,408

 

19,648

Total

 

$          48,063

 

$          47,561

 

A liability is established for estimated future warranty and service claims that relate to current and prior period sales. The Company estimates warranty costs based on historical claim experience and other factors including evaluating specific product warranty issues. Following is a summary of activity in accrued warranty and service liabilities (in thousands):

 

 

 

 

Thirty-nine

 

 

 

 

 

Weeks Ended

 

Year Ended

 

 

 

Sep 26, 2008

 

Dec 28, 2007

 

 

 

 

 

 

Balance, beginning of year

 

$          7,084 

 

$          6,675 

Charged to expense

 

4,931 

 

6,053 

Margin on parts sales reversed

 

3,014 

 

3,186 

Reductions for claims settled

 

(7,438)

 

(8,830)

Balance, end of period

 

$          7,591 

 

$          7,084 

 

10.

The examination of the Company’s U.S. income tax returns for 2004 and 2005 was completed in the first quarter of 2008. Completion of the examination resulted in a payment of approximately $1 million and reductions of uncertain tax positions totaling approximately $4 million. The settlement of the examination decreased the Company’s effective tax rate for the year-to-date to 33 percent.

With few exceptions, the Company is no longer subject to U.S. federal, state and local, or foreign income tax examinations by tax authorities for years prior to 2002.

12

 




 

11.

In February 2008, the Company acquired GlasCraft Inc. for approximately $35 million cash. GlasCraft has an office and manufacturing facility in Indianapolis, Indiana and had sales of approximately $18 million in 2007. It designs, manufactures and sells spray systems for the composites manufacturing industry and high performance dispense systems for the polyurethane foam and polyurea coatings industries. The products, brands, distribution channels and engineering capabilities of GlasCraft expand and complement the Company’s Industrial Equipment business.

The purchase price was allocated based on estimated fair values as follows (in thousands):

Accounts receivable and prepaid expenses

 

$         2,200 

Inventories

 

 

3,700 

Deferred income taxes

 

700 

Property, plant and equipment

 

700 

Identifiable intangible assets

 

18,200 

Goodwill

 

 

17,700 

Total purchase price

 

43,200 

Current liabilities assumed

 

(1,000)

Deferred income taxes

 

(6,900)

Net assets acquired

 

$      35,300 

 

Identifiable intangible assets and weighted average estimated useful life are as follows (dollars in thousands):

Product documentation (5 years)

 

$     900

Customer relationships (6 years)

 

14,100

Proprietary technology (3 years)

 

500

Total (6 years)

15,500

Brand name (indefinite useful life)

 

2,700

Total identifiable intangible assets

 

$18,200

 

None of the goodwill or identifiable intangible assets is expected to be deductible for tax purposes.

In fiscal September, the Company acquired the assets of Lubrication Scientifics, Inc. (LubeSci) for approximately $5 million cash. LubeSci designed and manufactured automated lubrication equipment used in industrial markets and had sales of approximately $3 million in 2007.

The purchase price has not been finalized and is subject to final determination of acquired asset and liability balances. The preliminary purchase price was allocated based on estimated fair values as follows (in thousands):

 

13

 


 

Inventories and other current assets

 

$           500

Property, plant and equipment

 

600

Identifiable intangible assets

 

900

Goodwill

 

 

2,500

Net assets acquired

 

$          4,500

 
            Identifiable intangible assets and weighted average estimated useful life are as follows (dollars in
            thousands):
 

Customer relationships (5 years)

 

$  600

Proprietary technology (5 years)

 

300

Total (5 years)

$  900

            Goodwill and identifiable intangible assets are expected to be deductible for tax purposes.

12.

In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 157, “Fair Value Measurements.” This statement establishes a consistent framework for measuring fair value and expands disclosures on fair value measurements. SFAS No. 157 was effective for the Company starting in fiscal 2008 with respect to financial assets and liabilities. The impact of the initial adoption of SFAS No. 157 in 2008 had no impact on the consolidated financial statements.

The Company uses significant other observable inputs to value the derivative instruments used to hedge interest rate volatility and net monetary positions. The fair market value of such instruments follows (in thousands):

 

 

Sep 26, 2008

 

Dec 28, 2007

 

 

 

 

 

Gain (loss) on interest rate hedge contracts

 

$             (2,334)

 

$             (1,700)

Gain (loss) on foreign currency forward contracts

 

324 

 

(282)

Total

 

$             (2,010)

 

$             (1,982)

 

With respect to non-financial assets and liabilities, SFAS No. 157 is effective for the Company starting in fiscal 2009. The Company has not determined the impact, if any, the adoption of this statement as it pertains to non-financial assets and liabilities will have on its consolidated financial statements.

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities.” This statement expands disclosures but does not change accounting for derivative instruments and hedging activities. The statement is effective for the Company starting in fiscal 2009.

13.

In October, the Company acquired the Airlessco® assets of Durotech Co. for approximately $15 million cash. Airlessco® is a line of spray-painting equipment that complements the Company’s Contractor Equipment business.

 

14

 




Item 2.

GRACO INC. AND SUBSIDIARIES

 

 

 

 

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

 

Overview

The Company designs, manufactures and markets systems and equipment to move, measure, control, dispense and spray fluid materials. Management classifies the Company’s business into three reportable segments: Industrial, Contractor and Lubrication. Key strategies include development of new products, expansion of distribution, new market penetration and completion of acquisitions.

The following Management’s Discussion and Analysis reviews significant factors affecting the Company’s results of operations and financial condition. This discussion should be read in conjunction with the financial statements and the accompanying notes to the financial statements.

Results of Operations

 

Net sales, net earnings and earnings per share were as follows (in millions except per share amounts and percentages):

 

 

Thirteen Weeks Ended

 

Thirty-nine Weeks Ended

 

Sep 26,

 

Sep 28,

 

%

 

Sep 26,

 

Sep 28,

 

%

 

2008

 

2007

 

Change

 

2008

 

2007

 

Change

 

 

 

 

 

 

 

 

 

 

 

 

Net Sales

$      207.2

 

$     207.3

 

(0)%

 

$     650.6

 

$     636.1

 

2 %

Net Earnings

$        32.8

 

$       39.3

 

(17)%

 

$     110.8

 

$     117.2

 

(5)%

Diluted Net Earnings

 

 

 

 

 

 

 

 

 

 

 

per Common Share

$         0.54

 

$       0.60

 

(10)%

 

$       1.81

 

$       1.75

 

3 %

 

Foreign currency translation rates had a favorable impact on sales and net earnings. Translated at consistent exchange rates, sales for the quarter and year-to-date were 2 percent and 1 percent lower than last year, respectively, and net earnings decreased 20 percent for the quarter and 12 percent year-to-date.

 

Sales include $9 million from GlasCraft operations since the date of acquisition, with $3.5 million in the third quarter.

 

Deteriorating economic conditions in the U.S. and other parts of the world affected sales growth. Strategic investments in product and market development, along with rising costs of doing business, continued to apply pressure on earnings.

 

Purchases and retirement of approximately 3.1 million shares of Company common stock, including approximately 0.9 million shares in the third quarter, had a positive impact on earnings per share.

 

15

 




Consolidated Results

 

Sales by geographic area were as follows (in millions):

 

 

Thirteen Weeks Ended

 

Thirty-nine Weeks Ended

 

Sep 26,

 

Sep 28,

 

Sep 26,

 

Sep 28,

 

2008

 

2007

 

2008

 

2007

 

 

 

 

 

 

 

 

Americas 1

$        112.8

 

$        124.4

 

$        360.5

 

$        386.4

Europe 2

57.8

 

53.1

 

189.4

 

161.1

Asia Pacific

36.6

 

29.8

 

100.7

 

88.6

Consolidated

$        207.2

 

$        207.3

 

$        650.6

 

$        636.1

 

 

 

 

 

 

 

 

1 North and South America, including the U.S.

 

 

 

 

 

2 Europe, Africa and Middle East

 

 

 

 

 

 

 

Growth in Europe and Asia Pacific offset decreases in contractor and lubrication sales in the Americas. In Europe, sales for the quarter and year-to-date were 9 percent and 18 percent higher than last year, respectively. Translated at consistent exchange rates, sales in Europe increased 2 percent for the quarter and 7 percent year-to-date. Sales in Asia Pacific increased by 23 percent for the quarter and 14 percent year-to-date.

Gross profit margin, expressed as a percentage of sales, was 53.2 percent for the quarter, close to last year’s percentage of 53.4 percent. Changes in geographic and product sales mix in Europe affected the margin rate for the quarter. Year-to-date gross profit margin percentage was 53.9 percent, up from 53.1 percent last year. Favorable currency translation rates added 1.1 percentage points to the year-do-date gross profit margin rate. The effects of higher material and other costs on gross margin rate have been offset by the impact of pricing and manufacturing efficiencies.

Operating expenses are up 11 percent for the quarter and 12 percent for the year-to-date. The effects of currency translation contributed approximately 2 percentage points of the increase for the quarter and 3 percentage points year-to-date. Operating expenses in 2008 include $1.5 million for the quarter from acquired GlasCraft operations and $4 million year-to-date. Continued strategic investments in product and market development also contributed to the increase in operating expenses, including expenses related to the introduction of new product lines in the home center channel, new product development teams and additional sales and marketing personnel in developing countries. Compared to last year, product development expense was up $2.5 million for the quarter and $3.7 million year-to-date.

Year-to-date interest expense is $3.5 million higher than last year due to borrowings used for the purchase and retirement of Company shares and for business acquisitions. Graco repurchased approximately 3.1 million shares of its common stock for $114 million in the first nine months of 2008.

The Company’s effective tax rate for the third quarter was 34 percent, up from 32 percent last year. The lower rate in 2007 resulted from expiring statutes of limitations and a higher than expected benefit upon filing of prior year tax returns. The completion of the examination of the Company’s income tax returns in the first quarter of 2008 resulted in a lower year-to-date effective tax rate compared to last year.

 

16




Segment Results

 

Certain measurements of segment operations compared to last year are summarized below:

 

Industrial

 

 

 

 

 

 

 

 

 

 

 

 

 

Thirteen Weeks Ended

 

Thirty-nine Weeks Ended

 

 

 

 

Sep 26,

 

Sep 28,

 

Sep 26,

 

Sep 28,

 

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

 

 

 

 

 

 

 

 

Net sales (in millions)

 

 

 

 

 

 

 

 

 

Americas

 

 

$         54.1

 

$       51.6

 

$      169.0

 

$      156.7

 

Europe

 

 

36.4

 

34.7

 

122.2

 

104.0

 

Asia Pacific

 

 

27.2

 

21.5

 

73.8

 

66.4

 

Total

 

 

$      117.7

 

$     107.8

 

$      365.0

 

$      327.1

 

 

 

 

 

 

 

 

 

 

 

Operating earnings as a

 

 

 

 

 

 

 

 

 

percentage of net sales

 

30%

 

35%

 

32%

 

34%

 

Strong sales in Asia Pacific (up 27 percent) drove the increase in Industrial segment sales for the quarter. Sales in this segment were 5 percent higher in the Americas and in Europe, although the increase in Europe came from currency translation. Year-to-date sales in this segment are up 18 percent in Europe (approximately 11 percentage points from currency translation), 11 percent in Asia Pacific and 8 percent in the Americas. Most of the sales growth in this segment came from high performance coatings and foam products.

Operating earnings in this segment were affected by selling and product development initiatives and costs and expenses resulting from acquisition and integration related activities. The move of GlasCraft operations from Indiana to the Company’s facilities in Ohio, South Dakota and Minnesota will be completed in the fourth quarter.

 

Contractor

 

 

 

 

 

 

 

 

 

 

 

 

 

Thirteen Weeks Ended

 

Thirty-nine Weeks Ended

 

 

 

 

Sep 26,

 

Sep 28,

 

Sep 26,

 

Sep 28,

 

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

 

 

 

 

 

 

 

 

Net sales (in millions)

 

 

 

 

 

 

 

 

 

Americas

 

 

$         41.7

 

$         53.5

 

$      135.5

 

$      171.2

 

Europe

 

 

19.4

 

16.6

 

61.3

 

52.1

 

Asia Pacific

 

 

6.7

 

6.6

 

19.2

 

17.3

 

Total

 

 

$         67.8

 

$         76.7

 

$      216.0

 

$      240.6

 

 

 

 

 

 

 

 

 

 

 

Operating earnings as a

 

 

 

 

 

 

 

 

 

percentage of net sales

 

22%

 

27%

 

23%

 

28%

In the Contractor segment, sales growth in Europe lessened the impact of continued softness in both the North American paint store and home center channels. Sales for the quarter in this segment were up 16 percent in Europe (including 6 percentage points from currency translation), flat in Asia Pacific and down 22 percent in the Americas. Year-to-date increases in Europe (18 percent increase, including 11 percentage points from currency translation) and in

17


Asia Pacific (11 percent increase, including 2 percentage points from currency translation) were not enough to offset the 21 percent decrease in the Americas.

The decrease in sales without a corresponding decrease in expenses had a large impact on the operating earnings of this segment. Strategic spending in this segment was for developing products for new markets and the launch and production of new paint sprayer units in the home center channel.

 

Lubrication

 

 

 

 

 

 

 

 

 

 

 

 

 

Thirteen Weeks Ended

 

Thirty-nine Weeks Ended

 

 

 

 

Sep 26,

 

Sep 28,

 

Sep 26,

 

Sep 28,

 

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

 

 

 

 

 

 

 

 

Net sales (in millions)

 

 

 

 

 

 

 

 

 

Americas

 

 

$         17.0

 

$         19.3

 

$         56.1

 

$         58.4

 

Europe

 

 

2.1

 

1.8

 

5.8

 

5.1

 

Asia Pacific

 

 

2.7

 

1.7

 

7.7

 

4.9

 

Total

 

 

$        21.8

 

$         22.8

 

$         69.6

 

$         68.4

 

 

 

 

 

 

 

 

 

 

 

Operating earnings as a

 

 

 

 

 

 

 

 

 

percentage of net sales

 

16%

 

11%

 

18%

 

11%

 

In the Lubrication segment, third quarter sales increases in Europe and Asia Pacific were not enough to offset a decrease in the Americas. Year-to-date, the increases in Europe and Asia Pacific offset the decrease in the Americas.

 

Improvement in year-to-date operating profitability is related to the integration and consolidation of Lubrication operations completed in 2007, although segment profitability has also been affected by a sales decline in the higher-margin vehicle services products.

 

Management intends to integrate all LubeSci operations (acquired in fiscal September) into the Company’s facility in Anoka, MN.

 

Liquidity and Capital Resources

 

In the first nine months of 2008, the Company used cash and borrowings under its long-term line of credit to purchase and retire $114 million of Company shares. Other significant uses of cash included $40 million for business acquisitions, $34 million for payment of dividends and $21 million for capital additions. Significant uses of cash in the first nine months of 2007 included $165 million for purchases and retirement of Company common stock, $33 million for payment of dividends and $28 million for capital additions.

 

The increase in inventories since the end of 2007 reflects the acquisition of GlasCraft operations, the higher level of business activity in Europe and Asia Pacific, and a buildup to improve service levels and facilitate integration activities.

 

At September 26, 2008, the Company had various lines of credit totaling $303 million, of which $98 million was unused. Internally generated funds and unused financing sources provide the Company with the financial flexibility to meet liquidity needs.

18

 


 

Outlook

 

The renewal of R&D tax credits will have a favorable impact, estimated at approximately $1.5 million, on the Company’s provision for income taxes and effective tax rate for the fourth quarter.

 

While economic conditions have made it difficult to see progress, management continues to implement strategies for business growth. The addition of the Airlessco® product line in October complements the Company’s contractor business and the LubeSci acquisition in late August expands its presence in the industrial lubrication business. The strength of the Company’s Industrial and international business thus far has softened the effect on financial results. As difficult economic conditions spread to other parts of the world, management will monitor and manage the business accordingly. The Company’s strong financial condition and cash flow enable management to continue making long-term investments in key growth strategies including new product development, expanding distribution, entering new markets and pursuing strategic acquisitions.

 

SAFE HARBOR CAUTIONARY STATEMENT

 

A forward-looking statement is any statement made in this report and other reports that the Company files periodically with the Securities and Exchange Commission, or in press or earnings releases, analyst briefings and conference calls, which reflects the Company’s current thinking on market trends and the Company’s future financial performance at the time they are made. All forecasts and projections are forward-looking statements.

 

The Company desires to take advantage of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995 by making cautionary statements concerning any forward-looking statements made by or on behalf of the Company. The Company cannot give any assurance that the results forecasted in any forward-looking statement will actually be achieved. Future results could differ materially from those expressed, due to the impact of changes in various factors. These risk factors include, but are not limited to: economic conditions in the United States and other major world economies, currency fluctuations, political instability, changes in laws and regulations, and changes in product demand. Please refer to Item 1A of, and Exhibit 99 to, the Company’s Annual Report on Form 10-K for fiscal year 2007 for a more comprehensive discussion of these and other risk factors.

 

Investors should realize that factors other than those identified above and in Item 1A and Exhibit 99 might prove important to the Company’s future results. It is not possible for management to identify each and every factor that may have an impact on the Company’s operations in the future as new factors can develop from time to time.

 

19


 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

There have been no material changes related to market risk from the disclosures made in the Company’s 2007 Annual Report on Form 10-K.

 

 

 

Item 4.

Controls and Procedures

 

 

Evaluation of disclosure controls and procedures

As of the end of the fiscal quarter covered by this report, the Company carried out an evaluation of the effectiveness of the design and operation of its disclosure controls and procedures. This evaluation was done under the supervision and with the participation of the Company’s President and Chief Executive Officer, the Chief Financial Officer and Treasurer, the Vice President and Controller, and the Vice President, General Counsel and Secretary. Based upon that evaluation, they concluded that the Company’s disclosure controls and procedures are effective in gathering, analyzing and disclosing information needed to satisfy the Company’s disclosure obligations under the Exchange Act.

Changes in internal controls

During the quarter, there was no change in the Company’s internal control over financial reporting that has materially affected or is reasonably likely to materially affect the Company’s internal control over financial reporting.

 

20

 


 

PART II

OTHER INFORMATION

 

 

 

 

Item 1A.

Risk Factors

 

There have been no material changes to the Company’s risk factors from those disclosed in the Company’s 2007 Annual Report on Form 10-K.

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

Issuer Purchases of Equity Securities

 

On September 28, 2007, the Board of Directors authorized the Company to purchase up to 7,000,000 shares of its outstanding common stock, primarily through open-market transactions. This authorization expires on September 30, 2009.

 

In addition to shares purchased under the Board authorizations, the Company purchases shares of common stock held by employees who wish to tender owned shares to satisfy the exercise price or tax withholding on option exercises.

 

Information on issuer purchases of equity securities follows:

 

 

 

 

 

 

 

 

 

Maximum

 

 

 

 

 

 

Total

 

Number of

 

 

 

 

 

 

Number

 

Shares that

 

 

 

 

 

 

of Shares

 

May Yet Be

 

 

 

 

 

 

Purchased

 

Purchased

 

 

 

 

 

 

as Part of

 

Under the

 

 

Total

 

Average

 

Publicly

 

Plans or

 

 

Number

 

Price

 

Announced

 

Programs

 

 

of Shares

 

Paid per

 

Plans or

 

(at end of

Period

 

Purchased

 

Share

 

Programs

 

period)

 

 

 

 

 

 

 

 

 

Jun 28, 2008 – Jul 25, 2008

 

408,566

 

$    37.95

 

408,566

 

3,542,234

 

 

 

 

 

 

 

 

 

Jul 26, 2008 – Aug 22, 2008

 

399,000

 

$    37.40

 

399,000

 

3,143,234

 

 

 

 

 

 

 

 

 

Aug 23, 2008 – Sep 26, 2008

 

  60,000

 

$    37.24

 

  60,000

 

3,083,234

 

 

21

 


 

Item 4.

Submission of Matters to a Vote of Security Holders

 

None.

 

 

 

Item 6.

Exhibits

 

 

 

 

31.1

Certification of President and Chief Executive Officer pursuant to Rule 13a-14(a).

 

 

 

 

31.2

Certification of Chief Financial Officer and Treasurer pursuant to Rule 13a-14(a).

 

 

 

 

32

Certification of the President and Chief Executive Officer and the Chief Financial Officer and Treasurer pursuant to Section 1350 of Title 18, U.S.C.

 

 

22

 


 

SIGNATURES

 

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

GRACO INC.

 

 

 

 

 

 

 

 

 

 

 

 

 

Date:

October 22, 2008

By:

/s/Patrick J. McHale

 

 

 

Patrick J. McHale

 

 

 

President and Chief Executive Officer

 

 

 

(Principal Executive Officer)

 

 

 

 

 

 

 

 

 

 

 

 

Date:

October 22, 2008

By:

/s/James A. Graner

 

 

 

James A. Graner

 

 

 

Chief Financial Officer and Treasurer

 

 

 

(Principal Financial Officer)

 

 

 

 

 

 

 

 

 

 

 

 

Date:

October 22, 2008

By:

/s/Caroline M. Chambers

 

 

 

Caroline M. Chambers

 

 

 

Vice President and Controller

 

 

 

(Principal Accounting Officer)