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 June 27, 1997 Commission File Number: 1-9249 GRACO INC. ------------------------------------------------------ (Exact name of Registrant as specified in its charter) Minnesota 41-0285640 - ------------------------ --------------------------------------- (State of incorporation) (I.R.S. Employer Identification Number) 4050 Olson Memorial Highway Golden Valley, Minnesota (55422) - ---------------------------------------- ---------- (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 ------ ------ 17,063,799 common shares were outstanding as of July 31, 1997. GRACO INC. AND SUBSIDIARIES INDEX Page Number ----------- PART I FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Statements of Earnings 4 Consolidated Balance Sheets 5 Consolidated Statements of Cash Flows 6 Notes to Consolidated Financial Statements 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 8-11 PART II OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security Holders 12 Item 6. Exhibits and Reports on Form 8-K 13 SIGNATURES 14 Restated Bylaws Exhibit 3 Seventh Amendment to Credit Agreement dated May 27, 1997 Exhibit 4 between the Company and First Bank National Association. Key Employee Agreement. Form of agreement with officers Exhibit 10.1 and other key employees, dated April 2, 1997. First Amendment of Graco Inc. Deferred Compensation Exhibit 10.2 Plan Restated, effective September 1, 1996. 2 INDEX (cont.) Long Term Stock Incentive Plan as amended May 6, 1997. Exhibit 10.3 Nonemployee Director Stock Plan as amended May 6, 1997. Exhibit 10.4 Nonemployee Director Stock Option Plan as amended May 6, 1997. Exhibit 10.5 Stock Option Agreement Amendment. Form of amendment, Exhibit 10.6 dated April 14, 1997, used to add change of control provision to non-incentive stock options to executive officers dated May 2, 1994, March 1, 1995 and March 1, 1996. Stock Option Agreement Amendment. Form of amendment, Exhibit 10.7 dated April 14, 1997, used to add change of control provision to non-incentive stock options to selected officers dated December 15, 1994. Stock Option Agreement Amendment. Form of amendment, Exhibit 10.8 dated April 14, 1997, used to add change of control provision to non-incentive stock options to one executive officer dated December 15, 1995. Stock Option Agreement. Form of agreement used for Exhibit 10.9 award of non-incentive stock option to one executive officer, dated April 23, 1997. Stock Option Agreement. Form of agreement used for Exhibit 10.10 award of nonstatutory stock options to nonemployee directors, dated May 6, 1997. Executive Long Term Incentive Agreement. Form of Exhibit 10.11 restricted stock award agreement used for award to one executive officer, dated May 6, 1997. Stock Option Agreement. Form of agreement used for Exhibit 10.12 non-incentive stock option to two executive officers, dated May 6, 1997. Computation of Net Earnings per Common Share Exhibit 11 Financial Data Schedule Exhibit 27 3 PART I GRACO INC. AND SUBSIDIARIES Item I. CONSOLIDATED STATEMENTS OF EARNINGS (Unaudited) Thirteen Weeks Ended Twenty-Six Weeks Ended -------------------- ---------------------- June 27, 1997 June 28, 1996 June 27, 1997 June 28,1996 ------------- ------------- ------------- ------------ (In thousands except per share amounts) Net Sales ............................................. $ 111,721 $ 97,099 $ 203,820 $ 187,252 Cost of products sold .............................. 58,322 47,677 105,888 92,993 ------------- ------------- ------------- ------------ Gross Profit .......................................... 53,399 49,422 97,932 94,259 Product development ................................ 4,828 4,623 9,653 8,852 Selling ............................................ 23,764 21,240 45,397 41,090 General and administrative ......................... 8,284 10,005 16,839 21,680 ------------- ------------- ------------- ------------ Operating Profit ...................................... 16,523 13,554 26,043 22,637 Interest expense ................................... 240 345 447 577 Other (income) expense, net ........................ 615 (1,323) 247 (757) ------------- ------------- ------------- ------------ Earnings Before Income Taxes .......................... 15,668 14,532 25,349 22,817 Income taxes ....................................... 5,250 4,500 8,750 7,200 ------------- ------------- ------------- ------------ Net Earnings .......................................... $ 10,418 $ 10,032 $ 16,599 $ 15,617 ============= ============= ============= ============ Net Earnings Per Common and Common Equivalent Share ............................ $ .60 $ .57 $ .95 $ .89 ============= ============= ============= ============ Cash Dividend Per Common Share ........................ $ .14 $ .12 $ .28 $ .24 ============= ============= ============= ============ See notes to consolidated financial statements. 4 GRACO INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands) June 27, 1997 December 27, 1996 ------------- ----------------- ASSETS (Unaudited) Current Assets: Cash and cash equivalents $2,258 $6,535 Accounts receivable, less allowances of $4,224 and $4,700 89,903 83,474 Inventories 43,405 41,531 Deferred income taxes 12,306 11,633 Other current assets 1,536 1,321 --------- --------- Total current assets 149,408 144,494 Property, Plant and Equipment: Cost 191,600 183,085 Accumulated depreciation (92,078) (88,913) ---------- --------- 99,522 94,172 Other Assets 9,398 9,148 --------- --------- $258,328 $247,814 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities: Notes payable to banks $12,321 $3,813 Current portion of long-term debt 1,827 1,845 Trade accounts payable 14,589 13,854 Salaries, wages & commissions 12,990 14,808 Accrued insurance liabilities 11,692 10,925 Income taxes payable 7,086 4,647 Other current liabilities 20,897 30,718 --------- --------- Total current liabilities 81,402 80,610 Long-term Debt, less current portion 7,222 8,075 Retirement Benefits and Deferred Compensation 34,161 33,079 Shareholders' Equity: Common stock 17,064 17,047 Additional paid-in capital 21,106 22,254 Retained earnings 95,856 85,232 Other, net 1,517 1,517 --------- --------- 135,543 126,050 --------- --------- $258,328 $247,814 ========= ========= See notes to consolidated financial statements. 5 GRACO INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) Twenty-Six Weeks ---------------- June 27, 1997 June 28, 1996 ------------- ------------- CASH FLOWS FROM OPERATING ACTIVITIES: (In thousands) Net Earnings $16,599 $15,617 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization 7,284 6,563 Deferred income taxes (1,715) 841 Change in: Accounts receivable (8,832) (3,358) Inventories (3,042) (5,779) Trade accounts payable 950 (1,025) Retirement benefits and deferred compensation 1,286 628 Other accrued liabilities (7,633) 1,786 Other (1,055) (774) --------- --------- 3,842 14,499 --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Property, plant and equipment additions (12,881) (9,600) Proceeds from sale of property, plant, and equipment 1,555 6 --------- --------- (11,326) (9,594) --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Borrowing on notes payable and lines of credit 37,420 12,657 Payments on notes payable and lines of credit (28,805) (11,650) Borrowing on long-term debt - 142 Payments on long-term debt (714) (1,028) Common stock issued 2,850 2,309 Retirement of common stock (5,145) (3,540) Cash dividends paid (4,836) (4,221) --------- --------- 770 (5,331) --------- --------- Effect of exchange rate changes on cash 2,437 1,123 --------- --------- Net increase (decrease) in cash and cash equivalents (4,277) 697 Cash and cash equivalents: Beginning of year 6,535 1,643 --------- --------- End of period $2,258 $2,340 ========= ========= See notes to consolidated financial statements. 6 GRACO INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. The consolidated balance sheet of Graco Inc. and Subsidiaries (the Company) as of June 27, 1997 and the related statements of earnings for the thirteen and twenty-six weeks ended June 27, 1997, and June 28, 1996, and cash flows for the twenty-six weeks ended June 27, 1997, and June 28, 1996, have been prepared by the Company without being audited. In the opinion of management, these consolidated statements reflect all adjustments necessary to present fairly the financial position of Graco Inc. and Subsidiaries as of June 27, 1997, 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 1996 Form 10-K. The results of operations for interim periods are not necessarily indicative of results which will be realized for the full fiscal year. 2. Major components of inventories were as follows (in thousands): June 27, 1997 Dec 28, 1996 ------------- ------------ Finished products and components $43,349 $38,707 Products and components in various stages of completion 25,708 24,691 Raw materials 12,382 15,192 ------------- ------------ 81,439 78,590 Reduction to LIFO cost (38,034) (37,059) ------------- ------------ $43,405 $41,531 ============= ============ 3. Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share," was issued in February, 1997 and requires adoption for annual periods ending after December 15, 1997. Earnings per Share determined in accordance with SFAS No. 128 are not materially different than the current disclosure under APB Opinion No. 15. 7 Item 2. GRACO INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Results of Operations - --------------------- Net earnings of $10.4 million for the quarter ended June 27, 1997 increased 4 percent over the second quarter of 1996 earnings of $10.0 million. For the six months ended June 27, 1997, net earnings of $16.6 million were 6 percent over 1996 earnings of $15.6 million. The quarterly earnings improvement was driven by higher sales. A decrease in gross profit margins, a slight increase in operating expenses, exchange losses due to currency fluctuations and a higher effective tax rate partially offset the enhanced sales results. Also, the second quarter of 1996 includes the receipt of a $1.5 million pretax settlement of a lawsuit. The following table sets forth items from the Company's Consolidated Statements of Earnings as percentages of net sales: Second Quarter Six Months (13 weeks) Ended (26 weeks) Ended ------------------- ------------------- June 27 June 28 June 27 June 28 1997 1996 1997 1996 ------- ------- ------- ------- Net Sales 100.0% 100.0% 100.0% 100.0% ------- ------- ------- ------- Cost of Products Sold 52.2 49.1 52.0 49.7 Product Development 4.3 4.8 4.7 4.7 Selling 21.3 21.8 22.3 21.9 General and Administrative 7.4 10.3 8.3 11.6 ------- ------- ------- ------- Operating Profit 14.8 14.0 12.7 12.1 ------- ------- ------- ------- Interest Expense (.2) (.4) (.2) (.3) ------- ------- ------- ------- Other Income(Expense), Net (.6) 1.4 (.1) .4 ------- ------- ------- ------- Earnings Before Income Taxes 14.0 15.0 12.4 12.2 Income Taxes 4.7 4.7 4.3 3.9 ------- ------- ------- ------- Net Earnings 9.3% 10.3% 8.1% 8.3% ======= ======= ======= ======= Net Sales Net sales in the second quarter of $111.7 million were 15 percent higher than the same period last year. Year-to-date sales of $203.8 million were 9 percent higher than the first six months of 1996. The improved sales level was achieved despite a negative currency impact, which reduced sales by 3 percent for the quarter and 2 percent for the six month period. 8 Industrial/Automotive Division sales improved 9 percent to $57.2 million, driven by strong demand for industrial products in the Americas and Europe as well as automotive systems in Europe. Sales for the six month period ended June 27, 1997 in Industrial/Automotive of $107.4 million were 7 percent higher than 1996. Second quarter Contractor Division sales of $42.1 million were 27 percent higher than last year due primarily to new product introductions. Additionally, a new pricing structure in the Contractor Division implemented in 1997 is resulting in a seasonal change in demand from 1996 when price promotions forced more activity into the first quarter. Year-to-date sales in the Contractor division were up 11 percent to $73.4 million. Lubrication Division quarterly sales increased 9 percent to $12.4 million, reflecting a healthy North American economy and an increased key distributor base. Sales of $23.0 million for the first six months in Lubrication were up 8 percent over the same period last year. Geographically, sales in the Americas (North, South and Central) increased 19 percent to $75.9 million for the quarter primarily due to strong Contractor activity, partially offset by sluggish automotive systems activity. Year-to-date sales in the Americas of $138.5 million are up 10 percent over the same period last year. European quarterly sales of $21.9 million were 29 percent higher than last year (including a 10 percent decline due to exchange rates). European sales for the six months ended June 27, 1997 of $38.8 million improved 18 percent from the same period last year (including an 8 percent decline due to exchange rates). The growth in Europe was attributable primarily to strong automotive systems activity and improved results in the Contractor Division. Asia Pacific sales of $13.9 million were 13 percent lower than last year's second quarter (including an 8 percent decline due to exchange rates). Poor sales performance in Japan contributed to the decline. Sales in Asia Pacific for six months of $26.5 million were 7 percent lower than last year (a 1 percent volume increase, offset by an 8 percent decline due to exchange rates). Gross Profit Gross profit as a percentage of net sales declined to 47.8 percent in the second quarter, compared to 50.9 percent for the same period last year. Gross profit margin for six months of 48.0 percent dropped 2.3 percentage points from the 1996 rate. The decreases for the quarter and six months were primarily the result of a shift in the product mix within the Contractor Division to an upgraded product line which generates a lower margin than other products and an increase in automotive systems activity. The strengthening of the U.S. dollar also reduced the gross margin as a greater proportion of the Company's sales are denominated in currencies other than the U.S. dollar than are costs. Operating Expenses Second quarter operating expenses of $36.9 million increased 3 percent from the second quarter of 1996. Operating expenses of $71.9 million for the first six months were at the 1996 level. Quarterly product development expense increased 4 percent over 1996, reflecting the Company's commitment to expanding sales through the development of new products. Selling expenses were 12 percent higher than the same quarter last year, largely due to increased sales levels, distributor training programs and sales force automation costs. General and administrative costs declined 17 percent from the second quarter of 1996 as a result of lower compensation and benefit accruals and reduced information system development costs. 9 Other Income (Expense) Other expense was $.6 million in the second quarter, compared to $1.3 million of income for the same period last year. The second quarter of 1997 was unfavorably affected by foreign exchange rate changes, while 1996 was favorably impacted by the receipt of a $1.5 million pretax lawsuit settlement. Other expense for the six months ended June 27, 1997 was $.2 million, compared to $.8 million of income in the same period of 1996. Income Taxes The quarterly and six month effective income tax rates increased to 33.5 percent and 34.5 percent, respectively compared to 31.0 percent and 31.5 percent for the same periods last year. The higher rates in 1997 were principally due to higher effective rates on foreign earnings. Liquidity and Capital Resources - ------------------------------- The Company generated $3.8 million of cash flow from operating activities in the first six months of 1997, compared to $14.5 million for the same period last year. Significant uses of operating cash flow in 1997 resulted from an increase in accounts receivable balances, attributable to higher sales levels, and a reduction in other accrued liabilities, most significantly the reserve established in the prior year for the relocation of the Company's Franklin Park, Illinois operations. Operating cash flow was also used to fund an increase in inventory levels which was driven by higher engineered systems activity in the foreign operations and anticipated demand for the upgraded product line in the Contractor Division. Available cash and borrowing on lines of credit of $37.4 million were used to fund short-term operating needs, finance capital expenditures of $12.9 million and pay dividends of $4.8 million. The Company had unused lines of credit available at June 27, 1997 totaling $65.0 million. The available credit facilities and internally-generated funds provide the Company with the financial flexibility to meet liquidity needs. Outlook The Company is optimistic about the balance of the year, but does not expect to record double digit sales increases in the third and fourth quarters. Backlog at June 27, 1997 stands at $25.3 million, up $6.1 million since the beginning of the year. The Company has introduced a number of new products in 1997 and believes that its marketing strategies and continued investments in product development and manufacturing should have a positive impact on the Company in 1997 and its long-term ability to grow profitably. 10 SAFE HARBOR CAUTIONARY STATEMENT The information in this 10Q contains "forward-looking statements" about the Company's expectations of the future, which are subject to certain risk factors that could cause actual results to differ materially from those expectations. These factors include economic conditions in the United States and other major world economies, currency exchange fluctuations, and additional factors identified in Exhibit 99 to the Company's Report on Form 10-K for fiscal year 1996. 11 PART II Item 4. Submission of Matters to a Vote of Security Holders. At the Annual Meeting of Shareholders held on May 6, 1997, George Aristides and Ronald O. Baukol were elected to the Office of Director with the following votes: FOR WITHHELD ---------- -------- George Aristides 15,872,873 35,497 Ronald O. Baukol 15,885,568 22,802 At the same meeting, the following matters were also voted upon with the votes as indicated: An amendment to the Long Term Stock Incentive Plan to include an annual per person aggregate limit was approved, with the following votes: For Against Abstentions Broker Non-Vote - ---------- ------- ----------- --------------- 15,697,160 152,531 58,679 0 The selection of Deloitte & Touche as independent auditors for the current year was approved and ratified, with the following votes: For Against Abstentions Broker Non-Vote - ---------- ------- ----------- --------------- 15,838,196 25,831 44,343 0 No other matters were voted on at the meeting. 12 PART II (cont.) Item 6. Exhibits and Reports on Form 8-K (a) Exhibits Restated Bylaws Exhibit 3 Seventh Amendment to Credit Agreement dated May 27, Exhibit 4 1997 between the Company and First Bank National Association. Key Employee Agreement. Form of agreement with Exhibit 10.1 officers and other key employees, dated April 2, 1997. First Amendment of Graco Inc. Deferred Compensation Exhibit 10.2 Plan Restated, effective September 1, 1996. Long Term Stock Incentive Plan as amended May 6, 1997. Exhibit 10.3 Nonemployee Director Stock Plan as amended May 6, 1997. Exhibit 10.4 Nonemployee Director Stock Option Plan as amended May 6, 1997. Exhibit 10.5 Stock Option Agreement Amendment. Form of amendment, Exhibit 10.6 dated April 14, 1997, used to add change of control provision to non-incentive stock options to executive officers dated May 2, 1994, March 1, 1995 and March 1, 1996. Stock Option Agreement Amendment. Form of amendment, Exhibit 10.7 dated April 14, 1997, used to add change of control provision to non-incentive stock options to selected officers dated December 15, 1994. Stock Option Agreement Amendment. Form of amendment, Exhibit 10.8 dated April 14, 1997, used to add change of control provision to non-incentive stock options to one executive officer dated December 15, 1995. Stock Option Agreement. Form of agreement used for Exhibit 10.9 award of non-incentive stock option to one executive officer, dated April 23, 1997. Stock Option Agreement. Form of agreement used for Exhibit 10.10 award of nonstatutory stock options to nonemployee directors, dated May 6, 1997. Executive Long Term Incentive Agreement. Form of Exhibit 10.11 restricted stock award agreement used for award to one executive officer, dated May 6, 1997. Stock Option Agreement. Form of agreement used for Exhibit 10.12 award of non-incentive stock option to two executive officers, dated May 6, 1997 Statement of Computation of Per Share Earnings Exhibit 11 Financial Data Schedule Exhibit 27 (b) No reports on Form 8-K have been filed during the quarter for which this report is filed. 13 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: August 7, 1997 By:/s/George Aristides George Aristides Chief Executive Officer Date: August 7, 1997 By:/s/James A. Graner James A. Graner Vice President & Controller ("duly authorized officer")