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 March 27, 2009

 

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

 

 

59,888,000 shares of the Registrant’s Common Stock, $1.00 par value were outstanding as of April 15, 2009.

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

14

 

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

19

 

 

 

 

 

Item 4.

Controls and Procedures

19

 

 

 

 

 

 

 

 

 

 

 

 

PART II

OTHER INFORMATION

 

 

 

 

 

 

Item 1A.

Risk Factors

20

 

 

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

20

 

 

 

 

 

Item 4.

Submission of Matters to a Vote of Security Holders

21

 

 

 

 

 

Item 6.

Exhibits

21

 

 

 

 

SIGNATURES

 

 

 

EXHIBITS

 

 

 

 

PART I

Item 1.

GRACO INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF EARNINGS

(Unaudited)

(In thousands except per share amounts)

 

 

 

Thirteen Weeks Ended

 

 

March 27,

 

March 28,

 

 

2009

 

2008

 

 

 

 

 

Net Sales

$          137,880

 

$         204,120  

 

 

 

 

 

 

Cost of products sold

73,552

 

92,267  

 

 

 

 

 

Gross Profit

64,328

 

111,853  

 

 

 

 

 

 

Product development

10,051

 

7,940  

 

Selling, marketing and distribution

31,933

 

33,821  

 

General and administrative

16,215

 

17,738  

 

 

 

 

 

Operating Earnings

6,129

 

52,354  

 

 

 

 

 

 

Interest expense

1,366

 

1,603  

 

Other expense (income), net

595

 

(115) 

 

 

 

 

 

Earnings Before Income Taxes

4,168

 

50,866  

 

 

 

 

 

 

Income taxes

1,400

 

15,300  

 

 

 

 

 

Net Earnings

$               2,768

 

$           35,566  

 

 

 

 

 

 

 

 

 

 

Basic Net Earnings per Common Share

$                 0.05

 

$                 0.58  

 

 

 

 

 

 

 

 

 

 

Diluted Net Earnings per Common Share

$                 0.05

 

$                0.57  

 

 

 

 

 

 

 

 

 

 

Cash Dividends Declared per Common Share

$                 0.19

 

$                0.19  

 

 

 

 

See notes to consolidated financial statements.

 

 

GRACO INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Unaudited)

(In thousands)

 

 

 

 

 

 

 

 

 

March 27,

 

December 26,

 

 

 

2009

 

2008

ASSETS

 

 

 

Current Assets

 

 

 

 

Cash and cash equivalents

$                    14,799  

 

$                   12,119 

 

Accounts receivable, less allowances of

 

 

 

 

 

$6,200 and $6,600

106,860 

 

127,505 

 

Inventories

85,577 

 

91,604 

 

Deferred income taxes

21,706 

 

23,007 

 

Other current assets

5,844 

 

6,360 

 

 

Total current assets

234,786 

 

260,595 

 

 

 

 

 

 

Property, Plant and Equipment

 

 

 

 

Cost

330,857 

 

326,729 

 

Accumulated depreciation

(181,070)

 

(176,975)

 

 

Property, plant and equipment, net

149,787 

 

149,754 

 

 

 

 

 

 

Goodwill

91,740 

 

91,740 

Other Intangible Assets, net

49,397 

 

52,231 

Deferred Income Taxes

19,337 

 

18,919 

Other Assets

6,262 

 

6,611 

 

 

Total Assets

$                 551,309 

 

$                 579,850 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS' EQUITY

 

 

 

Current Liabilities

 

 

 

 

Notes payable to banks

$                    16,532 

 

$                    18,311 

 

Trade accounts payable

14,732 

 

18,834 

 

Salaries, wages and commissions

12,550 

 

17,179 

 

Dividends payable

11,321 

 

11,312 

 

Other current liabilities

48,910 

 

55,524 

 

 

Total current liabilities

104,045 

 

121,160 

 

 

 

 

 

 

Long-term Debt

166,811 

 

180,000 

Retirement Benefits and Deferred Compensation

109,496 

 

108,656 

Uncertain Tax Positions

2,550 

 

2,400 

 

 

 

 

 

 

Shareholders' Equity

 

 

 

 

Common stock

59,884 

 

59,516 

 

Additional paid-in-capital

181,460 

 

174,161 

 

Retained earnings

(103)

 

8,445 

 

Accumulated other comprehensive income (loss)

(72,834)

 

(74,488)

 

 

Total shareholders' equity

168,407 

 

167,634 

Total Liabilities and Shareholders' Equity

$                  551,309 

$                  579,850

 

 

See notes to consolidated financial statements.

 

GRACO INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited) (In thousands)

 

 

 

 

 

Thirteen Weeks Ended

 

 

 

 

 

March 27,

 

March 28,

 

 

 

 

 

2009

 

2008

Cash Flows From Operating Activities

 

 

 

 

Net Earnings

$                    2,768  

 

$                 35,566  

 

 

Adjustments to reconcile net earnings to

 

 

 

 

 

net cash provided by operating activities

 

 

 

 

 

 

Depreciation and amortization

8,475 

 

7,395 

 

 

 

Deferred income taxes

(52)

 

(2,885)

 

 

 

Share-based compensation

2,417 

 

2,553 

 

 

 

Excess tax benefit related to share-based

 

 

 

 

 

 

 

payment arrangements

(200)

 

(1,723)

 

 

 

Change in

 

 

 

 

 

 

 

Accounts receivable

18,588 

 

(5,296)

 

 

 

 

Inventories

5,525 

 

(9,836)

 

 

 

 

Trade accounts payable

(4,044)

 

4,801 

 

 

 

 

Salaries, wages and commissions

(4,444)

 

(6,808)

 

 

 

 

Retirement benefits and deferred compensation

3,602 

 

(887)

 

 

 

 

Other accrued liabilities

(5,692)

 

9,204 

 

 

 

 

Other

758 

 

(228)

Net cash provided by operating activities

27,701 

 

31,856 

 

 

 

 

 

 

 

 

Cash Flows From Investing Activities

 

 

 

 

Property, plant and equipment additions

(5,732)

 

(5,130)

 

Proceeds from sale of property, plant and equipment

567 

 

39 

 

Capitalized software and other intangible asset additions

(46)

 

(222)

 

Acquisitions of businesses, net of cash acquired

-  

 

(35,266)

Net cash used in investing activities

(5,211)

 

(40,579)

 

 

 

 

 

 

 

 

Cash Flows From Financing Activities

 

 

 

 

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

(995)

 

(818)

 

Borrowings on long-term line of credit

34,211 

 

83,335 

 

Payments on long-term line of credit

(47,401)

 

(11,800)

 

Excess tax benefit related to share-based

 

 

 

 

 

payment arrangements

200 

 

1,723 

 

Common stock issued

4,949 

 

9,811 

 

Common stock retired

-  

 

(59,528)

 

Cash dividends paid

(11,308)

 

(11,376)

Net cash provided by (used in) financing activities

(20,344)

 

11,347 

 

Effect of exchange rate changes on cash

534  

 

(768)

 

 

 

 

 

 

 

 

Net increase (decrease) in cash and cash equivalents

2,680  

 

1,856 

Cash and cash equivalents

 

 

 

 

Beginning of year

12,119  

 

4,922 

 

End of period

$                 14,799  

 

$                   6,778 

 

See notes to consolidated financial statements.

 

GRACO INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1.

The consolidated balance sheet of Graco Inc. and Subsidiaries (the Company) as of March 27, 2009 and the related statements of earnings and cash flows for the thirteen weeks then ended 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 March 27, 2009, 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 2008 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

 

 

March 27,

 

March 28,

 

 

2009

 

2008

 

 

 

 

 

 

 

 

 

 

Net earnings available to common shareholders

$               2,768

 

$            35,566

 

 

 

 

 

Weighted average shares outstanding for basic

 

 

 

 

earnings per share

59,638

 

61,254

 

 

 

 

 

Dilutive effect of stock options computed using the

 

 

 

 

treasury stock method and the average market price

265

 

663

 

 

 

 

 

Weighted average shares outstanding for diluted

 

 

 

 

earnings per share

59,903

 

61,917

 

 

 

 

 

Basic earnings per share

$                 0.05

 

$                 0.58

 

 

 

 

 

Diluted earnings per share

$                 0.05

 

$                 0.57

 

 

Stock options to purchase 4,034,000 and 2,215,000 shares were not included in the 2009 and 2008 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 thirteen weeks ended March 27, 2009 is shown below (in thousands, except per share amounts):

 

 

 

 

 

Weighted

 

 

 

Weighted

 

 

 

 

Average

 

 

 

Average

 

 

Option

 

Exercise

 

Options

 

Exercise

 

 

Shares

 

Price

 

Exercisable

 

Price

 

 

 

 

 

 

 

 

 

Outstanding, December 26, 2008

3,955 

 

$        30.77

 

2,186

 

$           24.98

 

Granted

1,111 

 

20.78

 

 

 

 

 

Exercised

(52)

 

6.98

 

 

 

 

 

Canceled

(45)

 

33.27

 

 

 

 

Outstanding, March 27, 2009

4,969 

 

$        28.76

 

2,494

 

$           27.41

 

The aggregate intrinsic value of exercisable option shares was $3.4 million as of March 27, 2009, with a weighted average contractual term of 4.7 years. There were approximately 4.9 million share options vested and expected to vest as of March 27, 2009, with an aggregate intrinsic value of $3.4 million, a weighted average exercise price of $28.76 and a weighted average contractual term of 6.8 years.

 

Information related to options exercised in the first three months of 2009 and 2008 follows (in thousands):

 

 

 

Thirteen Weeks Ended

 

 

March 27,

 

March 28,

 

 

2009

 

2008

Cash received

$                        360

 

$                     3,329

Aggregate intrinsic value

679

 

4,134

Tax benefit realized

250

 

1,500

 

 

The Company recognized year-to-date share-based compensation of $2.4 million in 2009 and $2.6 million in 2008. As of March 27, 2009, there was $11.4 million of unrecognized compensation cost related to unvested options, expected to be recognized over a weighted average period of 2.6 years.

 

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:

 

 

 

Thirteen Weeks Ended

 

 

March 27,

 

March 28,

 

 

2009

 

2008

Expected life in years

6.0      

 

6.0     

Interest rate

2.1%   

 

3.1%  

Volatility

29.9%   

  

25.0%  

Dividend yield

3.7%   

 

2.1%  

Weighted average fair value per share

$                    4.25

 

$                    8.32   

 

Under the Company’s Employee Stock Purchase Plan, the Company issued 312,000 shares in 2009 and 216,000 shares in 2008. 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:

 

 

 

Thirteen Weeks Ended

 

 

March 27,

 

March 28,

 

 

2009

 

2008

Expected life in years

1.0     

 

1.0     

Interest rate

0.7%  

 

1.5%  

Volatility

51.5%  

 

27.1%  

Dividend yield

4.5%  

 

2.1%  

Weighted average fair value per share

$                    5.60   

 

$                    8.14   

 

 

4.

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

 

 

Thirteen Weeks Ended

 

March 27,

 

March 28,

 

2009

 

2008

Pension Benefits

 

 

 

Service cost

$             1,279 

 

$             1,391 

Interest cost

3,220 

 

3,146 

Expected return on assets

(2,700)

 

(4,850)

Amortization and other

2,414 

 

152 

Net periodic benefit cost (credit)

$             4,213 

 

$              (161)

 

 

 

 

Postretirement Medical

 

 

 

Service cost

$                 150  

 

$                 125 

Interest cost

350  

 

375 

Amortization

-   

 

-   

Net periodic benefit cost (credit)

$                 500  

 

$                 500 

 

 

5.

Total comprehensive income was as follows (in thousands):

 

 

 

 

Thirteen Weeks Ended

 

 

March 27,

 

March 28,

 

 

2009

 

2008

 

 

 

 

 

Net earnings

$             2,768 

 

$           35,566 

Cumulative translation adjustment

234 

 

(5)

Pension and postretirement

 

 

 

 

medical liability adjustment

2,329 

 

124 

Gain (loss) on interest rate hedge contracts

(73)

 

(2,775)

Income taxes

(836)

 

977 

Comprehensive income

$             4,422 

 

$           33,887 

 

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

 

 

 

March 27,

 

December 26,

 

 

2009

 

2008

 

 

 

 

 

Pension and postretirement medical liability adjustment

 

$            (68,855)

 

$            (70,322)

Gain (loss) on interest rate hedge contracts

 

(3,156)

 

(3,109)

Cumulative translation adjustment

 

(823)

 

(1,057)

Total

 

$            (72,834)

 

$            (74,488)

 

 

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 weeks ended March 27, 2009 and March 28, 2008 were as follows (in thousands):

 

 

Thirteen Weeks Ended

 

March 27,

 

March 28,

 

2009

 

2008

Net Sales

 

 

 

Industrial

$           75,232 

 

$        114,251 

Contractor

47,448 

 

66,180 

Lubrication

15,200 

 

23,689 

Consolidated

$        137,880 

 

$        204,120 

 

 

 

 

Operating Earnings

 

 

 

Industrial

$           11,495 

 

$           37,898 

Contractor

1,239 

 

13,696 

Lubrication

(1,436)

 

4,317 

Unallocated corporate (expense)

(5,169)

 

(3,557)

Consolidated

$             6,129 

 

$           52,354 

 

7.

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

 

 

 

 

March 27,

 

December 26,

 

 

 

2009

 

2008

 

 

 

 

 

 

Finished products and components

 

$           49,779 

 

$           50,703 

Products and components in various

 

 

 

 

 

stages of completion

 

32,070 

 

24,938 

Raw materials and purchased components

 

39,130 

 

51,348 

 

 

 

120,979 

 

126,989 

Reduction to LIFO cost

 

(35,402)

 

(35,385)

Total

 

$           85,577 

 

$           91,604 

 

8.

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

 

 

 

 

 

Estimated

 

 

 

 

 

Foreign

 

 

 

 

 

Life

 

Original

 

Accumulated

 

Currency

 

Book

 

 

 

(years)

 

Cost

 

Amortization

 

Translation

 

Value

March 27, 2009

 

 

 

 

 

 

 

 

 

 

Customer relationships

 

3 - 8

 

$        41,075

 

$       (14,017)

 

$           (181)

 

$        26,877

Patents, proprietary technology

 

 

 

 

 

 

 

 

 

 

 

and product documentation

 

3 - 15

 

22,737

 

(11,153)

 

(87)

 

11,497

Trademarks, trade names

 

 

 

 

 

 

 

 

 

 

 

and other

 

3 - 10

 

5,514

 

(4,290)

 

(11)

 

1,213

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

69,326

 

(29,460)

 

(279)

 

39,587

Not Subject to Amortization:

 

 

 

 

 

 

 

 

 

 

 

Brand names

 

 

 

9,810

 

-

 

-

 

9,810

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

 

 

$        79,136

 

$       (29,460)

 

$           (279)

 

$        49,397

 

 

 

 

 

 

 

 

 

 

 

 

December 26, 2008

 

 

 

 

 

 

 

 

 

 

Customer relationships

 

3 - 8

 

$        41,075

 

$       (12,470)

 

$           (181)

 

$        28,424

Patents, proprietary technology

 

 

 

 

 

 

 

 

 

 

 

and product documentation

 

3 - 15

 

23,780

 

(11,290)

 

(87)

 

12,403

Trademarks, trade names

 

 

 

 

 

 

 

 

 

 

 

and other

 

3 - 10

 

5,514

 

(3,908)

 

(12)

 

1,594

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

70,369

 

(27,668)

 

(280)

 

42,421

Not Subject to Amortization:

 

 

 

 

 

 

 

 

 

 

 

Brand names

 

 

 

9,810

 

-

 

-

 

9,810

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

 

 

$        80,179

 

$       (27,668)

 

$           (280)

 

$        52,231

 

Amortization of intangibles was $2.8 million in the first quarter of 2009. Estimated annual amortization expense is as follows: $10.7 million in 2009, $9.7 million in 2010, $8.6 million in 2011, $7.7 million in 2012, $4.1 million in 2013 and $1.6 million thereafter.

9. Components of other current liabilities were (in thousands):

        

 

 

 

March 27,

 

December 26,

 

 

 

2009

 

2008

 

 

 

 

 

 

Accrued self-insured retentions

 

$                  7,967

 

$                  7,896

Accrued warranty and service liabilities

 

7,677

 

8,033

Accrued trade promotions

 

5,348

 

9,001

Payable for employee stock purchases

 

619

 

5,473

Income taxes payable

 

965

 

904

Other

 

26,334

 

24,217

Total

 

$               48,910

 

$               55,524

 

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):

 

 

 

 

Thirteen

 

 

 

 

 

Weeks Ended

 

Year Ended

 

 

 

March 27,

 

December 26,

 

 

 

2009

 

2008

 

 

 

 

 

 

Balance, beginning of year

 

$                  8,033 

 

$                  7,084 

Charged to expense

 

1,078 

 

6,793 

Margin on parts sales reversed

 

902 

 

3,698 

Reductions for claims settled

 

(2,336)

 

(9,542)

Balance, end of period

 

$                  7,677 

 

$                  8,033 

 

10.

The Company accounts for all derivatives, including those embedded in other contracts, as either assets or liabilities and measures those financial instruments at fair value. The accounting for changes in the fair value of derivatives depends on their intended use and designation.

As part of its risk management program, the Company may periodically use forward exchange contracts and interest rate swaps to manage known market exposures. Terms of derivative instruments are structured to match the terms of the risk being managed and are generally held to maturity. The Company does not hold or issue derivative financial instruments for trading purposes. All other contracts that contain provisions meeting the definition of a derivative also meet the requirements of, and have been designated as, normal purchases or sales. The Company’s policy is to not enter into contracts with terms that cannot be designated as normal purchases or sales.

 

In 2007, the Company entered into interest rate swap contracts that effectively fix the rates paid on a total of $80 million of variable rate borrowings. One contract fixed the rate on $40 million of borrowings at 4.7 percent plus the applicable spread (depending on cash flow leverage ratio) until December 2010. The second contract fixed an additional $40 million of borrowings at 4.6 percent plus the applicable spread until January 2011. Both contracts have been designated as cash flow hedges against interest rate volatility. Consequently, changes in the fair market value are recorded in accumulated other comprehensive income (loss) (AOCI). Amounts included in AOCI will be reclassified to earnings as interest rates increase and as the swap contracts approach their expiration dates. Net amounts paid or payable under terms of the contracts were charged to interest expense and totaled $0.6 million in the first quarter of 2009.

 

The Company periodically evaluates its monetary asset and liability positions denominated in foreign currencies. The Company enters into forward contracts or options, or borrows in various currencies, in order to hedge its net monetary positions. These instruments are recorded at current market values and the gains and losses are included in other expense (income), net. There were eight contracts outstanding as of March 27, 2009, with notional amounts totaling $15.6 million.  There were 26 contracts outstanding during all or part of the first quarter of 2009, with net gains of $0.4 million partially offsetting $0.6 million of exchange losses on net monetary positions, included in other expense (income), net. The Company believes it uses strong financial counterparts in these transactions and that the resulting credit risk under these hedging strategies is not significant.

 

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 and balance sheet classification of such instruments follows:

 

 

 

Balance Sheet

March 27,

December 26,

 

 

Classification

2009

2008

Gain (loss) on interest

 

 

 

rate hedge contracts

Other current liabilities

$                       (5,009)

$                   (4,936)

Gain (loss) on foreign

 

 

 

currency forward contracts

 

 

               Gains

706 

1,868 

               Losses

       (555)

(670)

               Net

Accounts receivable

151 

1,198 

 

 

11.

In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 157, “Fair Value Measurements.” This statement establishes a consistent framework for measuring fair value and expands disclosures on fair market value measurements. SFAS No. 157 was effective for the Company starting in fiscal 2008 for financial assets and liabilities. With respect to non-financial assets and liabilities, the statement was effective for the Company starting in fiscal 2009. The adoption of this statement as it pertains to non-financial assets and liabilities had no significant impact on the consolidated financial statements.

 

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 and new market penetration.

 

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

 

March 27,

 

March 28,

 

%

 

2009

 

2008

 

Change

 

 

 

 

 

 

Net Sales

$          137.9

 

$           204.1

 

(32)%

Net Earnings

$                2.8

 

$             35.6

 

(92)%

Diluted Net Earnings per Common Share

$             0.05

 

$             0.57

 

(91)%

 

 

Operating results were severely affected by the depth of the recession and its impact on the markets served by the Company. Sales and orders decreased in all segments and regions. Currency translation had an unfavorable effect on sales ($6 million) and net earnings ($2 million). The Company recorded $4 million of cost related to an additional workforce reduction in March, as part of continued efforts to align operations with market and economic conditions.

 

Consolidated Results

 

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

 

 

Thirteen Weeks Ended

 

March 27,

 

March 28,

 

2009

 

2008

 

 

 

 

Americas 1

$             80.2

 

$          115.8

Europe 2

35.8

 

59.5

Asia Pacific

21.9

 

28.8

Consolidated

$           137.9

 

$          204.1

 

 

 

 

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

 

 

 

2 Europe, Africa and Middle East

 

 

 

 

 

Consolidated sales decreased 32 percent (29 percent at consistent exchange rates). Sales decreased 31 percent in the Americas, 40 percent in Europe (32 percent at consistent exchange rates) and 24 percent in Asia Pacific.

 

Gross profit margin, expressed as a percentage of sales, was 46.7 percent, down from 54.8 percent last year, due to lower production volumes (approximately 4 percentage points), unfavorable currency translation rates (approximately 2 percentage points), workforce reduction costs (approximately 1½ percentage points) and increased pension cost (approximately 1 percentage point).

 

Total operating expenses were slightly lower than last year. Product development expense increased by $2 million as continued investment in new and improved products is a key component of the Company’s strategy for future growth. Offsetting this increase was a decrease of $2 million from translation effects. Increases in pension expense ($3 million) and severance expense related to the additional workforce reduction in 2009 ($1 million) were offset by the effects of the work force reduction in the fourth quarter of 2008, lower incentive and bonus provisions and other spending reductions.

 

The effective tax rate of 34 percent for the first quarter was higher than last year’s first quarter rate of 30 percent due to the settlement of the examination of the Company’s income tax returns in the first quarter of 2008.

 

 

Segment Results

 

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

 

Industrial

 

 

 

 

 

Thirteen Weeks Ended

 

 

March 27,

 

March 28,

 

 

2009

 

2008

 

 

 

 

 

Net sales (in millions)

 

 

 

 

Americas

$           35.8 

 

$            53.4

 

Europe

     23.8 

 

39.7

 

Asia Pacific

15.6 

 

21.2

 

Total

$           75.2 

 

$         114.3

 

 

 

 

 

Operating earnings as a percentage of net sales

15%

 

33%

 

Industrial segment sales decreased 33 percent in the Americas, 40 percent in Europe (32 percent at consistent translation rates) and 27 percent in Asia Pacific.

 

The impacts of low factory volume, workforce reduction costs, currency translation and increased product development spending contributed to the decrease in operating earnings as a percentage of sales.

 

Contractor

 

 

 

 

 

Thirteen Weeks Ended

 

 

March 27,

 

March 28,

 

 

2009

 

2008

 

 

 

 

 

Net sales (in millions)

 

 

 

 

Americas

$             31.7

 

$             42.4

 

Europe

10.9

 

18.0

 

Asia Pacific

4.8

 

5.8

 

Total

$             47.4

 

$             66.2

 

 

 

 

 

Operating earnings as a percentage of net sales

3%

 

21%

 

Contractor segment sales decreased 25 percent in the Americas, 40 percent in Europe (31 percent at consistent translation rates) and 17 percent in Asia Pacific.

 

The impacts of low factory volume, channel sales mix, workforce reduction costs, currency translation and increased product development spending contributed to the decrease in operating earnings as a percentage of sales. This segment continued to incur expenses related to the rollout of entry-level paint sprayers to additional paint and home center stores in 2009.

 

Lubrication

 

 

 

 

 

Thirteen Weeks Ended

 

 

March 27,

 

March 28,

 

 

2009

 

2008

 

 

 

 

 

Net sales (in millions)

 

 

 

 

Americas

$             12.6

 

$             20.1

 

Europe

1.1

 

1.9

 

Asia Pacific

1.5

 

1.7

 

Total

$             15.2

 

$             23.7

 

 

 

 

 

Operating earnings as a percentage of net sales

(9)%

 

18%

 

Lubrication segment sales decreased 37 percent in the Americas, 43 percent in Europe (39 percent at consistent translation rates) and 15 percent in Asia Pacific.

 

The impacts of low factory volume, product sales mix, workforce reduction costs, increased product development spending and costs related to discontinued products contributed to the decrease in operating earnings as a percentage of sales.

 

Liquidity and Capital Resources

 

In the first quarter of 2009, the Company used cash to reduce the borrowings under its long-term line of credit by $13 million and paid dividends of $11 million. Significant uses of cash and borrowings in the first quarter of 2008 included $60 million for purchases and retirement of Company common stock, $35 million for a business acquisition and $11 million for payment of dividends.

 

Since the end of 2008, inventories have been reduced by $6 million. Accounts receivable decreased by $21 million from continuing collections and lower sales levels.

 

At March 27, 2009, the Company had various lines of credit totaling $279 million, of which $98 million was unused. Internally generated funds and unused financing sources are expected to provide the Company with the flexibility to meet its liquidity needs in 2009.

 

Outlook

 

Management expects that global economic conditions will continue to present a challenging operating environment in the near term. Workforce reductions initiated in 2008 and the further reduction announced in March of 2009 were made to align operations with market conditions and are expected to yield $18 million in annualized savings. To the extent permitted by working capital resources, management intends to protect its human capital and continue making targeted investments in strategic operating and growth initiatives, including new product development, improving manufacturing efficiencies, expanding distribution and entering new markets.

 

Working capital management will continue to be a high priority for the remainder of 2009. The Company plans to reduce inventory by an additional $25 million. Additional focus will be on collection of receivables over their normal cycle. Given the uncertainty in world economies and the possibility of continued weakness in markets served, the Company is considering cost-effective alternative liquidity options.

 

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 2008 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.

 

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 2008 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.

 

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 2008 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.

No shares were purchased in the first quarter of 2009. As of March 27, 2009, there were 3,068,234 shares that may yet be purchased under the Board authorization.

 

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.

 

 

 

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:

 

By:

 

 

 

 

Patrick J. McHale

 

 

 

President and Chief Executive Officer

 

 

 

(Principal Executive Officer)

 

 

 

 

 

 

 

 

 

 

 

 

Date:

 

By:

 

 

 

 

James A. Graner

 

 

 

Chief Financial Officer and Treasurer

 

 

 

(Principal Financial Officer)

 

 

 

 

 

 

 

 

 

 

 

 

Date:

 

By:

 

 

 

 

Caroline M. Chambers

 

 

 

Vice President and Controller

 

 

 

(Principal Accounting Officer)