GRACO INC — Interim / Quarterly Report 2004

Apr 28, 2004

10-Q 1 graco10q1qtr04.htm GRACO 10-Q FOR PERIOD ENDING 3/26/04 Form 10-Q, First Quarter 2004 MARKER FORMAT-SHEET="Head Major Center Bold 1-Arial" FSL="Project"

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

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Washington, D.C. 20549

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FORM 10-Q

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Quarterly Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934

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For the quarterly period ended March 26, 2004

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Commission File Number: 001-9249

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)

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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

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Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).

Yes X No

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69,411,000 common shares were outstanding as of April 26, 2004.

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GRACO INC. AND SUBSIDIARIES

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INDEX

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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	6-9
	Item 2.	Management's Discussion and Analysis
		of Financial Condition and
		Results of Operations	10-12
	Item 4.	Controls and Procedures	13
PART II	OTHER INFORMATION
	Item 2.	Issuer Purchases of Equity Securities	14
	Item 4.	Submission of Matters to a Vote of Security Holders	14
	Item 6.	Exhibits and Reports on Form 8-K	15
SIGNATURES			16
EXHIBITS

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PART I

Item I.
(Unaudited)
(In thousands, except per share amounts)

	Thirteen Weeks Ended — March 26, 2004	March 28, 2003
Net Sales	$ 134,982	$	119,660
Cost of products sold	61,578		56,657
Gross Profit	73,404		63,003
Product development	5,122		4,473
Selling, marketing and distribution	24,397		22,897
General and administrative	10,443		8,512
Operating Earnings	33,442		27,121
Interest expense	171		128
Other expense (income), net	(56	)	(101	)
Earnings before Income Taxes	33,327		27,094
Income taxes	11,000		8,900
Net Earnings	$ 22,327	$	18,194
Basic Net Earnings per Common Share	$ .32	$	.26
Diluted Net Earnings per Common Share	$ .32	$	.25
Cash Dividends Declared per Common Share	$ .09	$	.06

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See notes to consolidated financial statements.

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GRACO INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands)

	March 26, 2004
ASSETS
Current Assets
Cash and cash equivalents	$ 23,688	$	112,118
Accounts receivable, less allowances of $6,200 and $5,700	100,305		98,853
Inventories	32,944		29,018
Deferred income taxes	15,776		14,909
Other current assets	1,242		1,208
Total current assets	173,955		256,106
Property, Plant and Equipment:
Cost	222,022		221,233
Accumulated depreciation	(128,090	)	(126,916	)
	93,932		94,317
Prepaid Pension	25,943		25,444
Goodwill	9,199		9,199
Other Intangible Assets, net	10,035		10,622
Other Assets	2,638		1,702
	$ 315,702	$	397,390
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Notes payable to banks	$ 9,678	$	4,189
Trade accounts payable	19,462		15,752
Salaries, wages and commissions	11,448		16,384
Accrued insurance liabilities	9,987		9,939
Accrued warranty and service liabilities	9,290		9,227
Income taxes payable	14,021		5,981
Dividends payable	6,459		110,304
Other current liabilities	14,326		16,171
Total current liabilities	94,671		187,947
Retirement Benefits and Deferred Compensation	31,139		30,567
Deferred Income Taxes	8,828		9,066
Shareholders' Equity
Common stock	46,166		46,040
Additional paid-in capital	91,410		81,405
Retained earnings	44,695		43,295
Other, net	(1,207	)	(930	)
Total shareholders' equity	181,064		169,810
	$ 315,702	$	397,390

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See notes to consolidated financial statements.

GRACO INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)

	Thirteen Weeks Ended — March 26, 2004	March 28, 2003
Cash Flows from Operating Activities
Net Earnings	$ 22,327	$	18,194
Adjustments to reconcile net earnings to net cash
provided by operating activities
Depreciation and amortization	4,602		4,401
Deferred income taxes	(901	)	(966	)
Tax benefit related to stock options exercised	2,500		500
Change in:
Accounts receivable	(1,550	)	388
Inventories	(3,949	)	(5,561	)
Trade accounts payable	3,717		(142	)
Salaries, wages and commissions	(4,911	)	(5,142	)
Retirement benefits and deferred compensation	(424	)	640
Other accrued liabilities	6,361		5,124
Other	83		30
	27,855		17,466
Cash Flows from Investing Activities
Property, plant and equipment additions	(3,838	)	(3,276	)
Proceeds from sale of property, plant and equipment	14		76
Capitalized software additions	(785	)	--
	(4,609	)	(3,200	)
Cash Flows from Financing Activities
Borrowings on notes payable and lines of credit	7,592		5,826
Payments on notes payable and lines of credit	(2,123	)	(10,977	)
Common stock issued	8,652		5,216
Common stock retired	(15,202	)	(55,258	)
Cash dividends paid	(110,590	)	(3,922	)
	(111,671	)	(59,115	)
Effect of exchange rate changes on cash	(5	)	(315	)
Net increase (decrease) in cash and cash equivalents	(88,430	)	(45,164	)
Cash and cash equivalents
Beginning of year	112,118		103,333
End of period	$ 23,688	$	58,169

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See notes to consolidated financial statements.

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GRACO INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

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1. The consolidated balance sheet of Graco Inc. and Subsidiaries (the Company) as of March 26, 2004 and the related statements of earnings and cash flows for the thirteen weeks then ended have been prepared by the Company without being audited.

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In the opinion of management, these consolidated 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 26, 2004, and the results of operations and cash flows for all periods presented.

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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 2003 Form 10-K.

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

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1. On February 20, 2004, the Board of Directors declared a three-for-two split of the Company’s common stock. The split was distributed on March 30, 2004 to shareholders of record on March 16, 2004. Share and per share amounts for all periods presented reflect the stock split.

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

	Thirteen Weeks Ended — March 26, 2004	March 28, 2003
Net earnings available to common shareholders	$22,327	$18,194
Weighted average shares outstanding for basic
earnings per share	69,082	70,850
Dilutive effect of stock options computed
using the treasury stock method and the
average market price	1,160	999
Weighted average shares outstanding for
diluted earnings per share	70,242	71,849
Basic earnings per share	$ .32	$ .26
Diluted earnings per share	$ .32	$ .25

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1. The Company accounts for its stock option and purchase plans using the intrinsic value method and has adopted the “disclosure only” provisions of Statement of Financial Accounting Standards (SFAS) No. 123, as amended by SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure.” No compensation cost has been recognized for the Employee Stock Purchase Plan and stock options granted under the various stock incentive plans.

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Had compensation cost been determined based upon fair value (using the Black-Scholes option-pricing method) at the grant date for awards under these plans, the Company’s net earnings and earnings per share would have been reduced as follows (in thousands, except per share amounts):

	Thirteen Weeks Ended — March 26, 2004	March 28, 2003
Net earnings
As reported	$ 22,327	$ 18,194
Stock-based compensation, net of related tax effects	873	1,037
Pro forma	$ 21,454	$ 17,157
Net earnings per common share
Basic as reported	$ .32	$ .26
Basic pro forma	.31	.24
Diluted as reported	.32	.25
Diluted pro forma	.31	.24

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1. Total comprehensive income for the quarter was $22.0 million in 2004 and $18.4 million in 2003. There have been no significant changes to the components of comprehensive income from those noted on the 2003 Form 10-K.

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1. The Company has three reportable segments; Industrial/Automotive, Contractor and Lubrication. The Company does not identify assets by segment. Sales and operating earnings by segment for the thirteen weeks ended March 26, 2004 and March 28, 2003 were as follows (in thousands):

	Thirteen Weeks Ended — March 26, 2004	March 28, 2003
Net Sales
Industrial/Automotive	$ 63,251	$	52,417
Contractor	58,975		54,838
Lubrication	12,756		12,405
Consolidated	$ 134,982	$	119,660
Operating Earnings
Industrial/Automotive	$ 20,761	$	13,988
Contractor	12,017		10,757
Lubrication	3,002		3,147
Unallocated corporate expenses	(2,338	)	(771	)
Consolidated	$ 33,442	$	27,121

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

Finished products and components	March 26, 2004 — $ 27,307	$	25,548
Products and components in various stages
of completion	18,077		16,464
Raw materials and purchased components	15,591		15,408
	60,975		57,420
Reduction to LIFO cost	(28,031	)	(28,402	)
	$ 32,944	$	29,018

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

	Gross Carrying Value — March 26, 2004	Dec. 26, 2003	Accumulated Amortization — March 26, 2004	Dec. 26, 2003
Subject to Amortization:
Customer lists and distribution
network	$ 8,336	$ 8,336	$ 5,397	$ 4,980
Trademarks, trade names and
non-compete agreements	2,803	2,803	1,749	1,622
Patents and other	1,241	1,241	479	436
	12,380	12,380	$ 7,625	$ 7,038
Not Subject to Amortization:
Brand name	5,280	5,280
	$17,660	$17,660

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Amortization of intangibles during the first quarter of 2004 was $.6 million. Estimated annual amortization is as follows: $1.7 million in 2004, $1.1 million in 2005, $.9 million in 2006, $.9 million in 2007, $.4 million in 2008 and $.3 million thereafter.

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1. 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 customer warranty issues. Following is a summary of activity in accrued warranty and service liabilities (in thousands):

Balance, beginning of year	Thirteen Weeks Ended March 26, 2004 — $ 9,227	$	6,294
Charged to expense	2,065		9,490
Margin on parts sales reversed	795		4,697
Reductions for claims settled	(2,797	)	(11,254	)
Balance, end of period	$ 9,290	$	9,227

Item 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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Results of Operations

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The following table sets forth items from the Company’s Consolidated Statements of Earnings as percentages of net sales:

March 26, 2004		March 28, 2003
Net Sales	100	.0%	100	.0%
Cost of products sold	45	.6	47	.3
Gross Profit	54	.4	52	.7
Product development	3	.8	3	.8
Selling, marketing and distribution	18	.1	19	.1
General and administrative	7	.7	7	.1
Operating Earnings	24	.8	22	.7
Interest expense	0	.1	0	.1
Other (income) expense, net		--	(0	.1)
Earnings Before Income Taxes	24	.7	22	.7
Income taxes	8	.2	7	.5
Net Earnings	16	.5%	15	.2%

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Net Sales

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Sales by segment and geographic area were as follows (in thousands):

	Thirteen Weeks Ended — March 26, 2004	March 28, 2003
By Segment
Industrial/Automotive	$ 63,251	$ 52,417
Contractor	58,975	54,838
Lubrication	12,756	12,405
Consolidated	$134,982	$119,660
By Geographic Area
Americas 1	$ 89,275	$ 82,191
Europe 2	27,914	23,564
Asia Pacific	17,793	13,905
Consolidated	$134,982	$119,660

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1 North and South America, including the U.S. 2 Europe, Africa and Middle East

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Consolidated sales increased by 13 percent compared to the first quarter last year; 9 percent when translated at consistent exchange rates. All operating segments and geographic regions had increases. Most of the translation effect came from the strengthening of the European euro. Sales in Europe increased 3 percent in local currencies, 18 percent when translated into U.S. dollars.

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Industrial/Automotive sales increased by 21 percent, 14 percent translated at consistent exchange rates. Volume was higher in all three regions with double-digit increases in both the Americas and Asia Pacific. Demand for this segment’s products strengthened in the fourth quarter of 2003 and continued to be strong in the first quarter of 2004.

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Contractor segment sales increased by 8 percent, 5 percent translated at consistent exchange rates. In the Americas, sales were higher in both the professional paint store channel and the home center channel. In the professional paint store channel, sales increased in nearly every product category, with strong increases in larger paint sprayers. Home center channel sales posted strong gains over the first quarter of last year.

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Lubrication segment sales increased by 3 percent, 1 percent translated at consistent exchange rates. Increases from successful sales promotions offset a decrease in control system sales. Sales in the first quarter of 2003 included $1 million from the Matrix fluid dispensing system. Sales of the Matrix system have been suspended pending completion of design changes and successful field-testing.

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Gross Profit

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Gross profit as a percentage of sales increased to 54.4 percent from 52.7 percent primarily due to favorable currency translation rates. Changes in exchange rates have less impact on the cost of products sold than on sales because most product costs are incurred in U.S. dollars, which had the effect of increasing gross profit rate in the first quarter of 2004 when compared to the same period last year.

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Manufacturing productivity and process improvements, savings from the closing of the old Main Plant facility in Minneapolis, Minnesota and segment sales mix (higher proportion of sales from Industrial/Automotive) also had a favorable impact on the gross profit rate.

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Operating Expenses

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Higher product development expenses reflect the Company’s plans to increase development activity. Such expenses did not change as a percentage of sales.

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Selling, marketing and distribution expenses increased by 7 percent, but decreased as a percentage of sales. Changes in exchange rates used to translate expenses incurred in foreign currencies, routine salary rate increases, Sharpe expenses (acquired in the second quarter of 2003) and higher warranty costs all contributed to the increase in selling, marketing and distribution expenses.

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General and administrative expenses in 2004 included a $1 million contribution to the Graco Foundation – no contribution was made in the first quarter of 2003. General and administrative expenses also include $.5 million in 2004 for the demolition of the Company’s Main Plant facility. Amortization of intangibles and expenses related to Sharpe operations also contributed to the increase in general and administrative expenses.

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Liquidity and Capital Resources

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During the quarter, significant uses of cash included $111 million of dividends paid (including $104 million for a one-time special dividend) and $15 million for purchases and retirement of Company common stock.

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The Company had unused lines of credit available at March 26, 2004 totaling $47 million. Cash balances of $24 million at March 26, 2004, internally generated funds and unused financing sources provide the Company with the financial flexibility to meet liquidity needs.

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Outlook

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Management is encouraged by the increased demand for its Industrial/Automotive products over the last six months. In addition to the large increase in Industrial/Automotive, the Contractor segment continues to show higher sales. These increases are evidence that the economy is strengthening and management continues to look for higher sales and net earnings this year.

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SAFE HARBOR CAUTIONARY STATEMENT

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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, as well as 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.

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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 Exhibit 99 to the Company’s Annual Report on Form 10-K for fiscal year 2003 for a more comprehensive discussion of these and other risk factors.

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Investors should realize that factors other than those identified above and in 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 4. CONTROLS AND PROCEDURES

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Evaluation of disclosure controls and procedures

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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, Vice President and Controller, Vice President and Treasurer, and 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.

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Changes in internal controls

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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.

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PART II

Item 2 Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities

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Issuer Purchases of Equity Securities 1

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On February 22, 2002, the Board of Directors authorized a plan for the Company to purchase up to a total of 2,700,000 shares of its outstanding common stock, primarily through open-market transactions. This plan effectively expired upon approval of a new plan on February 20, 2004, authorizing the purchase of up to 3,000,000 shares and expiring on February 28, 2006.

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In addition to shares purchased under the plan, 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.

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Information on issuer purchases of equity securities follows:

Period	(a) Total Number of Shares Purchased	(b) Average Price Paid per Share	(c) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs	(d) Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs (at end of period)
Dec 27, 2003 - Jan 23, 2004	--	--	--	2,360,850
Jan 24, 2004 - Feb 20, 2004	294,782	$27.42	293,550	3,000,000
Feb 21, 2004 - Mar 26, 2004	258,201	$27.57	234,000	2,766,000

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1 All share and per share data reflects the three-for-two stock splits distributed on June 6, 2002 and March 30, 2004.

ITEM 4. Submission of Matters to a Vote of Security Holders

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None

ITEM 6. Exhibits and Reports on Form 8-K

(a)	Exhibits
	3.1	Restated Articles of Incorporation as amended February 20, 2004
	10.1	2004 Corporate & SBU Bonus Plan
	10.2	Stock Option Agreement. Form of agreement used
for award of non-incentive stock options to
executive officers under the Graco Inc. Stock
Incentive Plan. Amended form of agreement for
awards made to executive officers in 2004.
	10.3	Stock Option Agreement. Form of agreement used
for award of nonstatutory stock options to
nonemployee directors under the Graco Inc. Stock
Incentive Plan. Amended form of agreement for
award made to nonemployee directors in 2004.
	10.4	Stock Option Agreement. Form of agreement used
for award of non-incentive stock options to
executive officers under the Graco Inc. Stock
Incentive Plan. Amended form of agreement for
awards made to Chief Executive Officer in 2004.
	31.1	Certification of President and Chief Executive Officer pursuant to Rule
13a-14(a)
	31.2	Certification of Vice President and Controller pursuant to Rule 13a-14(a)
	31.3	Certification of Vice President and Treasurer pursuant to Rule 13a-14(a)
	32	Certification of President and Chief Executive Officer, Vice President
and Controller, and Vice President and
Treasurer pursuant to Section 1350 of Title 18, U.S.C.
(b)	Reports on Form 8-K
	The following Current Report on Form 8-K was furnished during the quarter ended March 26,
2004: On January 23, 2004, Graco Inc. furnished a current report on Form 8-K to furnish
its earnings release for the year ended December 26, 2003.

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SIGNATURES

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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.

Date:	April 27, 2004	By:	GRACO INC. — /s/David A. Roberts
			David A. Roberts
			President & Chief Executive Officer
Date:	April 27, 2004	By:	/s/James A. Graner
			James A. Graner
			Vice President & Controller Chief Accounting Officer
Date:	April 27, 2004	By:	/s/Mark W. Sheahan
			Mark W.Sheahan
			Vice President & Treasurer Principal Financial Officer