GRACO INC — Interim / Quarterly Report 2005

Aug 1, 2005

10-Q 1 graco2qtr2005form10q.htm GRACO INC.'S QUARTERLY REPORT ON FORM 10-Q Graco Inc. Form 10-Q, Second Quarter 2005 MARKER FORMAT-SHEET="Head Minor Center-Arial" FSL="Project"

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

MARKER FORMAT-SHEET="Head Minor Center-Arial" FSL="Project"

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 July 1, 2005

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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)

MARKER FORMAT-SHEET="Para Flush Lv 0-Arial" FSL="Default"

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 Exchange Act).

Yes X No

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68,704,000 common shares were outstanding as of July 22, 2005.

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GRACO INC. AND SUBSIDIARIES

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INDEX

PART I	FINANCIAL INFORMATION		Page Number
	Item 1.	Financial Statements
		Consolidated Statements of Earnings	3
		Consolidated Balance Sheets	4
		Consolidated Statements of Cash Flows	5
		Notes to Consolidated Financial Statements	6-12
	Item 2.	Management's Discussion and Analysis of Financial
		Condition and Results of Operations	13-16
	Item 4.	Controls and Procedures	16
PART II	OTHER INFORMATION
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	17
	Item 4.	Submission of Matters to a Vote of Security Holders	18
	Item 6.	Exhibits	18
SIGNATURES			19
EXHIBITS

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PART I

	GRACO INC. AND SUBSIDIARIES
Item I.	CONSOLIDATED STATEMENTS OF EARNINGS
	(Unaudited)
	(In thousands except per share amounts)

	Thirteen Weeks Ended — July 1, 2005	June 25, 2004	Twenty-six Weeks Ended — July 1, 2005	June 25, 2004
Net Sales	$ 198,221	$ 160,165	$ 369,165	$ 295,147
Cost of products sold	95,929	75,023	181,007	136,601
Gross Profit	102,292	85,142	188,158	158,546
Product development	6,615	5,445	12,859	10,567
Selling, marketing and distribution	28,272	25,130	54,679	49,527
General and administrative	13,061	9,570	25,109	20,013
Operating Earnings	54,344	44,997	95,511	78,439
Interest expense	508	98	847	269
Other expense, net	198	220	387	164
Earnings before Income Taxes	53,638	44,679	94,277	78,006
Income taxes	18,000	14,700	31,600	25,700
Net Earnings	$ 35,638	$ 29,979	$ 62,677	$ 52,306
Basic Net Earnings
per Common Share	$ .52	$ .43	$ .91	$ .76
Diluted Net Earnings
per Common Share	$ .51	$ .43	$ .89	$ .74
Cash Dividends Declared
per Common Share	$ .13	$ .09	$ .26	$ .19

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See notes to consolidated financial statements.

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

	July 1, 2005
ASSETS
Current Assets
Cash and cash equivalents	$ 7,111	$	60,554
Accounts receivable, less allowances of
$6,200 and $5,600	132,550		109,080
Inventories	59,011		40,219
Deferred income taxes	15,848		15,631
Other current assets	1,675		1,742
Total current assets	216,195		227,226
Property, Plant and Equipment
Cost	251,115		231,819
Accumulated depreciation	(146,074	)	(137,309	)
Property, plant and equipment, net	105,041		94,510
Prepaid Pension	28,606		27,556
Goodwill	49,174		9,199
Other Intangible Assets, net	38,089		8,959
Other Assets	4,349		4,264
Total Assets	$ 441,454	$	371,714
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Notes payable to banks	$ 47,752	$	6,021
Trade accounts payable	23,460		18,599
Salaries, wages and commissions	15,828		19,804
Dividends payable	8,931		8,990
Other current liabilities	43,133		43,359
Total current liabilities	139,104		96,773
Retirement Benefits and Deferred Compensation	32,623		33,092
Deferred Income Taxes	10,989		11,012
Shareholders' Equity
Common stock	68,698		68,979
Additional paid-in capital	108,574		100,180
Retained earnings	84,194		62,773
Other, net	(2,728	)	(1,095	)
Total shareholders' equity	258,738		230,837
Total Liabilities and Shareholders' Equity	$ 441,454	$	371,714

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See notes to consolidated financial statements.

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

	Twenty-six Weeks Ended — July 1, 2005	June 25, 2004
Cash Flows from Operating Activities
Net Earnings	$ 62,677	$	52,306
Adjustments to reconcile net earnings to net cash
provided by operating activities
Depreciation and amortization	11,806		9,076
Deferred income taxes	(734	)	(958	)
Tax benefit related to stock options exercised	1,200		4,000
Change in
Accounts receivable	(16,747	)	(11,970	)
Inventories	1,491		(5,586	)
Trade accounts payable	(427	)	4,359
Salaries, wages and commissions	(5,540	)	(2,556	)
Retirement benefits and deferred compensation	(614	)	(551	)
Other accrued liabilities	(3,406	)	3,027
Other	51		216
Net cash provided by operating activities	49,757		51,363
Cash Flows from Investing Activities
Property, plant and equipment additions	(9,177	)	(6,377	)
Proceeds from sale of property, plant and equipment	46		115
Capitalized software additions	(402	)	(802	)
Acquisitions of businesses, net of cash acquired	(102,797	)	--
Net cash used in investing activities	(112,330	)	(7,064	)
Cash Flows from Financing Activities
Borrowings on notes payable and lines of credit	69,749		13,367
Payments on notes payable and lines of credit	(27,730	)	(8,961	)
Common stock issued	8,639		12,146
Common stock retired	(25,077	)	(23,773	)
Cash dividends paid	(17,964	)	(116,998	)
Net cash used in financing activities	7,617		(124,219	)
Effect of exchange rate changes on cash	1,513		241
Net increase (decrease) in cash and cash equivalents	(53,443	)	(79,679	)
Cash and cash equivalents
Beginning of year	60,554		112,118
End of period	$ 7,111	$	32,439

MARKER FORMAT-SHEET="Head Minor Center-Arial" FSL="Project"

See notes to consolidated financial statements.

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 July 1, 2005, and the related statements of earnings for the thirteen and twenty-six weeks ended July 1, 2005 and June 25, 2004, and cash flows for the twenty-six weeks ended July 1, 2005 and June 25, 2004 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 July 1, 2005, 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 2004 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. The following table sets forth the computation of basic and diluted earnings per share (in thousands, except per share amounts):

	Thirteen Weeks Ended — July 1, 2005	June 25, 2004	Twenty-six Weeks Ended — July 1, 2005	June 25, 2004
Net earnings available to
common shareholders	$ 35,638	$ 29,979	$ 62,677	$ 52,306
Weighted average shares
outstanding for basic
earnings per share	68,959	69,243	69,016	69,162
Dilutive effect of stock
options computed using the
treasury stock method and
the average market price	1,077	1,040	1,139	1,100
Weighted average shares
outstanding for diluted
earnings per share	70,036	70,283	70,155	70,262
Basic earnings per share	$ .52	$ .43	$ .91	$ .76
Diluted earnings per share	$ .51	$ .43	$ .89	$ .74

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Stock options to purchase 382,800 shares are not included in the 2005 calculation of diluted earnings per share because they would have been anti-dilutive.

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1. The Company accounts for 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 — July 1, 2005	June 25, 2004		Twenty-six Weeks Ended — July 1, 2005	June 25, 2004
Net earnings
As reported	$ 35,638	$	29,979	$ 62,677	$ 52,306
Stock-based compensation, net of
related tax effects	1,246		843	2,304	1,716
Pro forma	$ 34,392	$	29,136	$ 60,373	$ 50,590
Net earnings per common share
Basic as reported	$ .52	$	.43	$ .91	$ .76
Basic pro forma	.50	.	.42	.87	.73
Diluted as reported	.51		.43	.89	.74
Diluted pro forma	.49		.41	.86	.72

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In December 2004, the Financial Accounting Standards Board issued SFAS No. 123 (Revised 2004), “Share-Based Payment” that requires compensation costs related to share-based payment transactions to be recognized in the financial statements. This standard will be effective for the Company starting with the first quarter of 2006. Annual compensation cost, net of tax effects, related to unvested stock compensation as of July 1, 2005 is approximately $4.8 million in 2005, $2.6 million in 2006, $1.8 million in 2007 and $0.7 million in 2008 (as valued and calculated under SFAS 123 pro forma disclosures.) The Company has not yet determined how it will value future grants or whether it will elect to adjust prior periods upon adoption of SFAS No. 123 (Revised 2004).

MARKER FORMAT-SHEET="Para (List) Hang Lv 0-Arial" FSL="Default"

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

	Thirteen Weeks Ended — July 1, 2005		June 25, 2004		Twenty-six Weeks Ended — July 1, 2005		June 25, 2004
Pension Benefits
Service cost	$ 1,104		$ 1,025		$ 2,355		$ 2,085
Interest cost	2,482		2,182		4,971		4,361
Expected return on assets	(3,950	)	(3,523	)	(7,900	)	(7,048	)
Amortization and other	68		113		225		258
Net periodic benefit cost (credit)	$ (296	)	$ (203	)	$ (349	)	$ (344	)
Postretirement Medical
Service cost	$ 225		$ 135		$ 450		$ 385
Interest cost	410		363		820		751
Amortization of net loss	115		114		230		226
Net periodic benefit cost	$ 750		$ 612		$ 1,500		$ 1,362

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1. Total comprehensive income was as follows (in thousands):

	Thirteen Weeks Ended — July 1, 2005	June 25, 2004		Twenty-six Weeks Ended — July 1, 2005	June 25, 2004
Net income	$ 35,638	$	29,979	$ 62,677	$	52,306
Foreign currency translation
adjustments	(1,657	)	--	(1,774	)	--
Minimum pension liability
adjustment, net of tax	17		--	31		(366	)
Comprehensive income	$ 33,998	$	29,979	$ 60,934	$	51,940

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The functional currency of certain subsidiaries in Great Britain and Spain, each acquired in 2005, is local currency. Accordingly, adjustments resulting from the translation of those subsidiaries’ financial statements into U.S. dollars are charged or credited to accumulated other comprehensive income.

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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 and twenty-six weeks ended July 1, 2005 and June 25, 2004 were as follows (in thousands):

	Thirteen Weeks Ended — July 1, 2005	June 25, 2004		July 1, 2005		June 25, 2004
Net Sales
Industrial/Automotive	$ 93,775	$	66,471	$	181,644	$	129,722
Contractor	89,567		81,610		157,347		140,585
Lubrication	14,879		12,084		30,174		24,840
Consolidated	$ 198,221	$	160,165	$	369,165	$	295,147
Operating Earnings
Industrial/Automotive	$ 24,700	$	20,210	$	46,664	$	40,475
Contractor	25,754		23,371		40,840		35,296
Lubrication	4,047		2,648		8,246		5,650
Unallocated Corporate
expenses	(157	)	(1,232	)	(239	)	(2,982	)
Consolidated	$ 54,344	$	44,997	$	95,511	$	78,439

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Segment operating earnings for 2004 have been restated to conform to 2005, which includes amortization of intangibles formerly classified as unallocated corporate expense.

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

Finished products and components	July 1, 2005 — $ 43,338	$	29,263
Products and components in various stages
of completion	22,127		18,656
Raw materials and purchased components	22,066		19,929
	87,531		67,848
Reduction to LIFO cost	(28,520	)	(27,629	)
	$ 59,011	$	40,219

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

	Estimated Life (Years)	Original Cost	Amorti- zation	Foreign Currency Translation	Book Value
July 1, 2005
Customer relationships and
distribution network	4 - 8	$20,365	$(2,937)	$(322)	$17,106
Patents, proprietary technology
and product documentation	3 - 15	10,871	(1,291)	(131)	9,449
Trademarks, trade names
favorable lease and other	3 - 10	1,774	(679)	--	1,095
		33,010	(4,907)	(453)	27,650
Not Subject to Amortization:
Brand names		10,550	--	(111)	10,439
Total		$43,560	$(4,907)	$(564)	$38,089
December 31, 2004
Customer relationships and
distribution network	5	$ 3,765	$(1,543)	$ --	$ 2,222
Patents, proprietary technology
and product documentation	3 - 15	1,241	(611)	--	630
Trademarks, trade names and
other	2 - 10	1,494	(667)	--	827
		6,500	(2,821)	--	3,679
Not Subject to Amortization:
Brand names		5,280	--	--	5,280
Total		$11,780	$(2,821)	$ --	$ 8,959

MARKER FORMAT-SHEET="Para Flush Lv 1-Arial" FSL="Default"

Amortization of intangibles was $1.2 million in the second quarter of 2005 and $2.2 million year-to-date. Estimated annual amortization is as follows: $4.5 million in 2005, $4.6 million in 2006, $4.6 million in 2007, $3.9 million in 2008, $3.5 million in 2009 and $9.2 million thereafter.

MARKER FORMAT-SHEET="Para (List) Hang Lv 0-Arial" FSL="Project"

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

	July 1, 2005	Dec. 31, 2004
Accrued insurance liabilities	$ 9,007	$ 9,139
Accrued warranty and service liabilities	8,752	9,409
Accrued trade promotions	4,870	6,574
Payable for employee stock purchases	2,665	4,913
Income taxes payable	4,385	2,188
Other	13,454	11,136
	$43,133	$43,359

MARKER FORMAT-SHEET="Para Flush Lv 1-Arial" FSL="Default"

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

	Twenty-Six Weeks Ended July 1, 2005	Year Ended Dec. 31, 2004
Balance, beginning of year	$ 9,409	$ 9,227
Charged to expense	3,530	8,066
Margin on parts sales reversed	1,076	2,516
Reductions for claims settled	(5,263)	(10,400)
Balance, end of period	$ 8,752	$ 9,409

MARKER FORMAT-SHEET="Para (List) Hang Lv 0-Arial" FSL="Project"

1. Effective January 1, 2005, the Company purchased the stock of Liquid Control Corporation, Inc. and its affiliated company Profill Corp. for approximately $35 million cash. Liquid Control designs and manufactures highly engineered precision resin dispensing equipment, which will expand and complement the Company’s Industrial/Automotive business. Liquid Control had sales of approximately $26 million in 2004. Results of Liquid Control’s operations have been included in the Industrial/Automotive segment since the date of acquisition.

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

Accounts receivable and prepaid expenses	$ 2,900
Inventories	4,900
Property, plant and equipment	7,800
Identifiable intangible assets	16,100
Goodwill	8,600
Total purchase price	40,300
Liabilities assumed	(4,900)
Net assets acquired	$35,400

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

Customer relationships (8 years)	$10,100
Proprietary technology (8 years)	3,500
Total (8 years)	13,600
Brand names (indefinite useful life)	2,500
Total identifiable intangible assets	$16,100

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For tax purposes, the transaction will be treated as a purchase of assets and goodwill is expected to be fully deductible.

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Effective February 4, 2005, the Company purchased the stock of Gusmer Corporation Inc. and Gusmer Europe, S.L. for approximately $68 million cash. Gusmer designs and manufactures specialized two-component dispense equipment systems, which will expand and complement the Company’s Industrial/Automotive business. Gusmer had sales of approximately $43 million in 2004. Results of Gusmer’s operations have been included in the Industrial/Automotive segment since the date of acquisition.

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

Cash and cash equivalents	$
Accounts receivable	7,400
Inventories	15,600
Property, plant and equipment	2,900
Identifiable intangible assets	15,800
Goodwill	32,200
Total purchase price	74,400
Liabilities assumed	(6,500	)
Net assets acquired	$ 67,900

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

Customer relationships (7 years)	$
Proprietary technology (8 years)	4,400
Product documentation (5 years)	1,800
Favorable lease (3 years)	400
Total (7 years)	13,100
Brand names (indefinite useful life)	2,700
Total identifiable intangible assets	$ 15,800

MARKER FORMAT-SHEET="Para Flush Lv 1-Arial" FSL="Project"

For tax purposes, the transaction will be treated as a purchase of assets and goodwill is expected to be fully deductible.

MARKER FORMAT-SHEET="Para Flush Lv 1-Arial" FSL="Default"

The following pro forma information assumes the acquisitions of Liquid Control and Gusmer occurred as of the beginning of each quarter presented. The pro forma information is not necessarily indicative of what would have actually occurred or of future results (in thousands, except per share amounts).

	Thirteen Weeks Ended — July 1, 2005	June 25, 2004	Twenty-six Weeks Ended — July 1, 2005	June 25, 2004
Net sales	$198,221	$177,725	$373,784	$330,266
Net earnings	35,638	29,357	62,094	49,614
Basic earnings per share	.52	.42	.90	.72
Diluted earnings per share	.51	.42	.88	.71

	GRACO INC. AND SUBSIDIARIES
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:

	Thirteen Weeks Ended — July 1, 2005		June 25, 2004		Twenty-six Weeks Ended — July 1, 2005		June 25, 2004
Net Sales	100	.0%	100	.0%	100	.0%	100	.0%
Cost of products sold	48	.4	46	.8	49	.0	46	.3
Gross Profit	51	.6	53	.2	51	.0	53	.7
Product development	3	.3	3	.4	3	.5	3	.6
Selling, marketing and distribution	14	.3	15	.7	14	.8	16	.7
General and administrative	6	.6	6	.0	6	.8	6	.8
Operating Earnings	27	.4	28	.1	25	.9	26	.6
Interest expense	0	.2	0	.1	0	.2	0	.1
Other (income) expense, net	0	.1	0	.1	0	.1	0	.1
Earnings Before Income Taxes	27	.1	27	.9	25	.6	26	.4
Income taxes	9	.1	9	.2	8	.6	8	.7
Net Earnings	18	.0%	18	.7%	17	.0%	17	.7%

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Net Sales

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

	Thirteen Weeks Ended — July 1, 2005	June 25, 2004	Twenty-six Weeks Ended — July 1, 2005	June 25, 2004
By Segment
Industrial/Automotive	$ 93,775	$ 66,471	$181,644	$129,722
Contractor	89,567	81,610	157,347	140,585
Lubrication	14,879	12,084	30,174	24,840
Consolidated	$198,221	$160,165	$369,165	$295,147
By Geographic Area
Americas 1	$132,571	$107,767	$246,590	$197,042
Europe 2	40,317	33,078	76,026	60,992
Asia Pacific	25,333	19,320	46,549	37,113
Consolidated	$198,221	$160,165	$369,165	$295,147

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

MARKER FORMAT-SHEET="Para Flush Lv 1-Arial" FSL="Project"

2 Europe, Africa and Middle East

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Compared to last year, consolidated sales increased by 24 percent for the quarter and 25 percent year-to-date. Sales from acquired businesses contributed 12 percentage points to the quarter increase and 11 percentage points to the year-to-date increase. The favorable impact of currency translations contributed 1 percentage point to the quarter increase and 2 percentage points year-to-date. All operating segments and geographic regions experienced double-digit percentage growth in sales for both the quarter and year-to-date.

MARKER FORMAT-SHEET="Para Flush Lv 0-Arial" FSL="Project"

Industrial / Automotive segment sales increased 41 percent for the quarter and 40 percent year-to-date. Acquired businesses contributed 27 and 25 percentage points to the quarterly and year-to date increases, respectively, and favorable currency translations contributed 3 percentage points to both the quarter and year-to-date. The remaining increase was due to strong demand in the Americas and Asia Pacific.

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Contractor segment sales increased 10 percent for the quarter and 12 percent year-to-date. In the Americas, sales were higher in both the professional paint store and home center channels due to new products and strong underlying demand. In Europe, demand for the segment’s products remained strong, resulting in double-digit percentage sales growth.

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Lubrication segment sales increased 23 percent for the quarter and 21 percent year-to-date. Sales were higher in all major products and all geographic regions.

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Gross Profit

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Gross profit as a percentage of sales was 51.6 percent for the second quarter and 51.0 percent year-to-date, down from 53.2 percent and 53.7 percent, respectively, last year. Most of the decrease was due to the impact of acquisitions, including lower margins on acquired products and the recognition of costs assigned to inventories as part of the valuation of assets acquired. Gross profit rate is expected to improve as most of the acquired inventory has been sold. Other factors affecting the gross profit rate include higher material costs and the favorable impact of currency translation.

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Operating Expenses

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Total operating expenses increased due mostly to the expenses of acquired operations. Expenses as a percentage of sales were 24.2 percent for the quarter and 25.1 percent year-to-date, down from 25.1 percent and 27.1 percent last year, respectively.

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In addition to the expenses of acquired operations, the Company continued to increase product development spending to meet its stated objective of creating sales growth from new products. Higher payroll costs, including incentives, and information systems spending contributed to the increase in general and administrative expenses in the second quarter.

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General and administrative expense includes approximately $2 million from the amortization of intangible assets related to the businesses acquired in 2005. The annual recurring non-cash expense associated with amortization of intangible assets from those acquired companies is expected to be approximately $4 million.

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Liquidity and Capital Resources

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Significant uses of cash in the first half of 2005 included $103 million for acquisitions of businesses, $25 million for purchases and retirement of Company common stock and $18 million of dividends paid. The Company used cash on hand and a $40 million advance from a line of credit to fund the acquisitions. Accounts receivable balances increased since year-end 2004 due to acquisitions and higher sales activity. Days of sales in accounts receivable improved since year-end 2004.

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Significant uses of cash in the first half of 2004 included $117 million of dividends paid (including $104 million for a one-time special dividend) and $24 million for purchases and retirement of company common stock.

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The Company had unused lines of credit available at July 1, 2005 totaling $80 million. Cash balances of $7 million at July 1, 2005, 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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The Company expects the businesses acquired in 2005 to begin contributing to net earnings in the second half of this year. Management is working with those operations to bring profitability closer to the levels generated by the rest of the Company within the next two years. The Company plans to consolidate the Florida operations of Liquid Control with similar businesses in New Jersey and Ohio by the end of 2005. The Company is also planning to move production of spray equipment from acquired Gusmer factories to existing Minnesota and South Dakota factories beginning in the third quarter of 2005 and continuing into 2006. These actions are not expected to have a material impact on 2005 earnings.

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Management continues to be optimistic about the remainder of 2005.

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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 2004 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.

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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. Unregistered Sales of Equity Securities and Use of Proceeds

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Issuer Purchases of Equity Securities

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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 stock 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)
Apr 2, 2005 - Apr 29, 2005	75,500	$34.37	75,500	1,713,200
Apr 30, 2005 - May 27, 2005	220,000	$34.53	220,000	1,493,200
May 28, 2005 - Jul 1, 2005	227,500	$34.59	227,500	1,265,700

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

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At the Annual Meeting of Shareholders held on April 22, 2005, four directors were elected to the Board of Directors with the following votes:

	For	Withheld
Lee R. Mitau	61,318,575	1,244,183
James H. Moar	61,963,677	599,081
Martha A. Morfitt	62,250,434	312,324
David A. Roberts	62,227,701	335,057

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At the same meeting, the selection of Deloitte & Touche LLP as independent auditors for the current year was approved and ratified, with the following votes:

For	Against	Abstentions	Broker Non-Vote
60,074,328	2,413,869	74,561	--

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No other matters were voted on at the meeting.

ITEM 6. Exhibits

10.1	Deferred Compensation Plan (2005 statement) as amended.
10.2	Deferred Compensation Plan Restated, effective December 1, 1992. (Incorporated
by reference to Exhibit 2 to the Company’s Report on Form 8-K dated March 11, 1993.)
Amendment 1 dated September 1, 1996. (Incorporated by reference to the Company’s
Report on Form 10-Q for the twenty-six weeks ended June 27, 1997, File No. 001-09249.)
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.

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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:	August 1, 2005	By:	GRACO INC. — /s/David A. Roberts
			David A. Roberts
			President and Chief Executive Officer
Date:	August 1, 2005	By:	/s/James A. Graner
			James A. Graner
			Vice President and Controller
Date:	August 1, 2005	By:	/s/Mark W. Sheahan
			Mark W. Sheahan
			Vice President and Treasurer