UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15 (d) of the
Securities Exchange Act of 1934
For the quarterly period ended September 25, 1998
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)
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
----------- ----------
20,091,027 common shares were outstanding as of October 22, 1998.
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 6-7
Item 2. Management's Discussion and Analysis
of Financial Condition and
Results of Operations 8-11
PART II OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 12
SIGNATURES 13
Credit Agreement dated July 2, 1998, between the Company
and U.S. Bank National Association Exhibit 4
Computation of Net Earnings per Common Share Exhibit 11
Financial Data Schedule (EDGAR filing only) Exhibit 27
2
PART I
GRACO INC. AND SUBSIDIARIES
Item I. CONSOLIDATED STATEMENTS OF EARNINGS
(Unaudited)
Thirteen Weeks Ended Thirty-Nine Weeks Ended
-------------------- -----------------------
Sept 25, 1998 Sept 26, 1997 Sept 25, 1998 Sept 26, 1997
------------- ------------- ------------- -------------
(In thousands except per share amounts)
Net Sales $ 106,202 $ 101,920 $ 327,072 $ 305,740
Cost of products sold 52,221 50,558 163,059 156,446
------------- ------------- ------------- -------------
Gross Profit 53,981 51,362 164,013 149,294
Product development 4,369 4,167 13,867 13,820
Selling 19,725 21,051 63,922 66,448
General and administrative 9,920 8,425 32,339 25,264
------------- ------------- ------------- -------------
Operating Profit 19,967 17,719 53,885 43,762
Interest expense 2,569 216 2,967 663
Other (income) expense, net 675 124 783 371
------------- ------------- ------------- -------------
Earnings Before Income Taxes 16,723 17,379 50,135 42,728
Income taxes 5,650 4,500 17,350 13,250
------------- ------------- ------------- -------------
Net Earnings $ 11,073 $ 12,879 $ 32,785 $ 29,478
============= ============= ============= =============
Basic Net Earnings Per Common Share* $ .54 $ .50 $ 1.38 $ 1.15
============= ============= ============= =============
Diluted Net Earnings Per Common Share* $ .53 $ .49 $ 1.35 $ 1.13
============= ============= ============= =============
*All 1997 per share data has been restated for the three-for-two stock split
paid February 4, 1998.
See notes to consolidated financial statements.
3
GRACO INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands)
September 25, 1998 December 26, 1997
ASSETS (Unaudited)
Current Assets:
Cash and cash equivalents $ 3,642 $ 13,523
Accounts receivable, less allowances
of $4,800 and $4,100 83,677 86,148
Inventories 40,075 43,942
Deferred income taxes 11,238 11,140
Other current assets 1,036 1,539
------------------ -----------------
Total current assets 139,668 156,292
Property, Plant and Equipment:
Cost 200,338 196,940
Accumulated depreciation (102,953) (96,760)
------------------ -----------------
97,385 100,180
Other Assets 7,774 8,060
------------------ -----------------
$ 244,827 $ 264,532
================== =================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Notes payable to banks $ 9,387 $ 2,911
Current portion of long-term debt 2,671 1,796
Trade accounts payable 10,740 12,542
Salaries, wages & commissions 13,632 14,903
Accrued insurance liabilities 11,240 10,227
Income taxes payable 6,988 5,546
Other current liabilities 22,952 21,055
------------------ -----------------
Total current liabilities 77,610 68,980
Long-term Debt, less current portion 140,444 6,163
Retirement Benefits and Deferred Compensation 29,985 31,880
Shareholders' Equity:
Common stock 20,088 25,553
Additional paid-in capital 23,734 26,085
Retained earnings (48,146) 105,030
Other, net 1,112 841
------------------ -----------------
Total shareholders' equity (3,212) 157,509
$ 244,827 $ 264,532
================== =================
See notes to consolidated financial statements.
4
GRACO INC. AND SUBSIDIARIES GRACO INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Thirty-Nine Weeks
-----------------
Sept. 25, 1998 Sept. 26, 1997
-------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES: (In thousands)
Net Earnings $ 32,785 $ 29,478
Adjustments to reconcile net earnings to
net cash provided by operating activities:
Depreciation and amortization 10,975 10,507
Deferred income taxes (1,052) (2,137)
Change in:
Accounts receivable 2,100 (2,665)
Inventories 3,949 (4,972)
Trade accounts payable (1,703) 655
Retirement benefits and deferred
compensation (1,705) 1,036
Other accrued liabilities 3,155 (5,743)
Other 2,117 (240)
------------- -------------
50,621 25,919
------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Property, plant and equipment additions (8,486) (16,793)
Proceeds from sale of property, plant
and equipment 112 1,642
------------- -------------
(8,374) (15,151)
------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowing on notes payable and lines of credit 39,407 40,289
Payments on notes payable and lines of credit (32,591) (41,470)
Borrowings on long-term debt 176,200 -
Payments on long-term debt (41,045) (922)
Common stock issued 4,709 2,926
Retirement of common stock (190,899) (6,971)
Cash dividends paid (8,491) (7,219)
------------- -------------
(52,710) (13,367)
------------- -------------
Effect of exchange rate changes on cash 582 3,446
------------- -------------
Net increase (decrease) in cash and cash equivalents (9,881) 847
Cash and cash equivalents:
Beginning of year 13,523 6,535
------------- -------------
End of period $ 3,642 $ 7,382
============= =============
See notes to consolidated financial statements.
5
GRACO INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. The consolidated balance sheet of Graco Inc. and Subsidiaries (the Company)
as of September 25, 1998 and the related statements of earnings for the
thirteen and thirty-nine weeks ended September 25, 1998 and September 26,
1997 and cash flows for the thirty-nine weeks ended September 25, 1998, and
September 26, 1997, 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 September 25, 1998, 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 1997 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):
Sept 25, 1998 Dec 26, 1997
------------- ------------
Finished products and components $ 33,316 $ 38,290
Products and components in various
stages of completion 24,645 25,320
Raw materials 18,522 16,715
------------- -----------
76,483 80,325
Reduction to LIFO cost (36,408) (36,383)
------------- -----------
$ 40,075 $ 43,942
============= ============
6
GRACO INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
3. In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 131, "Disclosures about Segments
of an Enterprise and Related Information", which will be effective for the
Company beginning with the 1998 fiscal year. SFAS No. 131 redefines how
operating segments are determined and requires disclosure of certain
financial and description information about a company's operating segments.
The Company has not yet determined the nature of its segments, nor has it
determined how adoption of SFAS No. 131 will impact its future disclosures.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative
Instruments and Hedging Activities", which will be effective for the
Company beginning with the fiscal year 2000. SFAS No. 133 requires that all
derivatives be recognized in the financial statements as either assets or
liabilities measured at fair value and also specifies new methods of
accounting for hedging transactions. The Company has not yet determined the
impact of FAS 133, if any.
4. To match North American and European fiscal years, Europe's December 1997
operating results were recorded as an adjustment to equity. Those results
included sales of $3,836,000 and net earnings of $300,000. The results of
operations for Graco Inc. for the quarter ended September 25, 1998 include
Europe's operations for July, August and September 1998. Had the Company
included the months of July, August and September in the third quarter of
1997, net sales would have been $100,720,000. Net earnings would have been
$12,379,000 and diluted earnings per share would have been $0.47.
5. On July 2, 1998, the Company repurchased 5,800,000 shares of common stock,
for $190,887,000, from its largest shareholder, the Trust under the Will of
Clarissa L. Gray, pursuant to an agreement executed in May 1998. The stock
repurchase was funded with cash of $32,887,000 and $158,000,000 from the
credit facility discussed below.
On July 2, 1998, the Company entered into a five-year $190,000,000 reducing
revolving credit facility (the Revolver) with a syndicate of ten banks
including the lead bank, U.S. Bank National Association. The Company's
initial borrowing of $158,000,000 financed a portion of the stock
repurchase discussed above. The $137,000,000 outstanding balance bears
interest at the London Interbank Offered Rate ("LIBOR") plus 0.625%. The
Revolver specifies quarterly reductions of the maximum amount of the credit
line, and requires the Company to maintain certain financial covenants as
to net worth, cash flow leverage and fixed charge coverage.
In conjunction with the aforementioned Revolver, the Company entered into a
two-year $75,000,000 interest rate swap agreement on July 2, 1998 with
Wachovia Bank, National Association to manage its exposure to interest rate
changes.
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 $11.1 million for the quarter ended September 25, 1998 decreased
14 percent from third quarter 1997 earnings of $12.9 million. Diluted earnings
per share of $0.53 for the quarter were up 8 percent over diluted earnings per
share of $0.49 in the third quarter of 1997. The quarterly performance was
driven by higher sales, improved gross margins and reduced expenses offset by
increased interest expense and higher income taxes. Diluted earnings per share
were higher due to the repurchase of 5.8 million common shares of stock during
the third quarter of 1998. See Note 5 of the Consolidated Financial Statements
for further discussion. For the nine months ended September 25, 1998, net
earnings of $32.8 million were 11 percent higher than the $29.5 million earned
during the same period a year ago.
The following table sets forth items from the Company's Consolidated Statements
of Earnings as percentages of net sales:
Third Quarter Nine Months
(13 weeks) Ended (39 weeks) Ended
--------------------- ---------------------
September September September September
25, 1998 26, 1997 25, 1998 26, 1997
--------- --------- --------- ---------
Net Sales 100.0% 100.0% 100.0% 100.0%
--------- --------- --------- ---------
Cost of Products Sold
49.2 49.6 49.9 51.2
Product Development
4.1 4.1 4.2 4.5
Selling
18.6 20.7 19.5 21.7
General and Administrative
9.3 8.2 9.9 8.3
--------- --------- --------- ---------
Operating Profit
18.8 17.4 16.5 14.3
--------- --------- --------- ---------
Interest Expense
2.5 .2 1.0 .2
--------- --------- --------- ---------
Other Income(Expense), Net .6 (.1) .2 (.1)
--------- --------- --------- ---------
Earnings Before Income Taxes 15.7 17.1 15.3 14.0
Income Taxes 5.3 4.5 5.3 4.4
--------- --------- --------- ---------
Net Earnings 10.4% 12.6% 10.0% 9.6%
========= ========= ========= =========
Net Sales
Net sales in the third quarter of $106.2 million were 4 percent higher than the
same period last year. Year-to-date sales of $327.1 million were 7 percent
higher than the first nine months of 1997. The improved sales level was achieved
despite a negative currency impact, which reduced the sales increase by 3
percent for the quarter and 3 percent for the nine month period.
8
Industrial/Automotive Equipment Division sales improved 3 percent to $55.3
million, driven by strong demand for industrial products in the Americas and
Europe as well as automotive system sales in Europe. Sales for the nine month
period ended September 25, 1998 in Industrial/Automotive of $172.1 million were
7 percent higher than 1997. Third quarter Contractor Equipment Division sales of
$39.8 million were 7 percent higher than last year due primarily to strong
demand in North America and Europe. Year-to-date sales in the Contractor
Division were up 9 percent to $121.4 million. Lubrication Equipment Division
quarterly sales decreased 1 percent to $11.1 million. Sales of $33.6 million for
the first nine months in the Lubrication Division were down 2 percent over the
same period last year.
Geographically, sales in the Americas (North, South and Central) increased 9
percent to $75.6 million for the quarter primarily due to strong Contractor and
Industrial/Automotive sales. Year-to-date sales in the Americas of $228.7
million are up 10 percent over the same period last year. European quarterly
sales of $21.4 million were 16 percent higher than last year. Year to date
European sales of $69.2 million improved 21 percent from the same period last
year, and would have been 26 percent higher with consistent exchange rates. The
growth in Europe was attributable primarily to strong Industrial/Automotive and
Contractor Division sales. Asia Pacific sales of $9.2 million were 35 percent
lower than last year's third quarter, including an 11 percent decline due to
exchange rates, due to the instability of the economies in Japan, Korea, and
Southeast Asia.
Gross Profit
Gross profit as a percentage of net sales improved to 50.8 percent in the third
quarter, compared to 50.4 percent for the same period last year. The gross
profit margin for nine months of 50.1 percent increased 1.3 percentage points
from the same period a year ago. The increases are primarily the result of
improvements in manufacturing, disciplined purchasing, increased sales volumes,
and price increases. The strengthening of the US dollar has reduced gross
margins as a greater proportion of the Company's sales are denominated in
currencies other than the US dollar than are costs.
Operating Expenses
Third quarter operating expenses of $34.0 million decreased 1 percent from the
third quarter of 1997. Operating expenses of $110.1 million for the first nine
months were 4 percent above the 1997 level. Third quarter general and
administrative expenses increased $1.5 million due primarily to information
systems' expenses related to the Year 2000 conversion and non-recurring charges
for restructuring Graco's operations in North America and Europe. Selling
expenses were 6 percent lower than the same quarter last year. Current year
restructuring initiatives have resulted in the lower expenses. Product
development costs increased 5 percent in comparison to the third quarter of
1997.
Other Income (Expense)
Other expense was $0.7 million in the third quarter, compared to $0.1 million of
expense for the same period last year. The third quarter of 1998 was unfavorably
affected by the settlement of a lawsuit. Other expense for the nine months ended
September 25, 1998 was $0.8 million, compared to $0.4 million in the same period
of 1997.
9
Income Taxes
The quarterly and nine month effective income tax rates increased to 33.8
percent and 34.6 percent respectively, compared to 25.9 percent and 31.0 percent
for the same periods last year. The lower rates in 1997 were principally due to
foreign earnings being taxed at lower effective rates than the U.S. rate as
foreign subsidiary earnings permitted recognition of previously reserved
deferred tax benefits and previous tax filings were validated.
Liquidity and Capital Resources
The Company generated $50.6 million of cash flow from operating activities in
the first nine months of 1998, compared to $25.9 million for the same period
last year. Significant uses of operating cash flow in 1998 included a decrease
in trade accounts payable balances and a reduction in deferred compensation
liabilities. On July 2, 1998 the company repurchased 5.8 million shares of its
stock and entered into a $190 million reducing revolving credit facility to fund
a portion of the repurchase. See Note 5 of the Consolidated Financial Statements
for further discussion. Available cash and net borrowing on lines of credit of
$6.8 million were used to fund short-term operating needs, finance capital
expenditures of $8.5 million, pay dividends of $8.5 million and pay interest of
$2.0 million. The Company had unused lines of credit available at September 25,
1998 totaling $59.5 million. The available credit facilities and
internally-generated funds provide the Company with the financial flexibility to
meet liquidity needs.
Year 2000 Disclosures
The Company is continuing its program, begun in 1996, to ensure that all
information technology systems and non-information technology (non-IT) systems
will be Year 2000 compliant. The assessment phase of the Year 2000 project has
been completed. It was determined the Company needed to modify or upgrade most
of its mainframe applications, operating systems, network hardware and software,
and desktop hardware and software. In addition, many non-IT systems needed to be
upgraded or replaced in order insure proper functioning beyond the year 1999.
The mainframe modification phase involving the conversion of core business
applications was completed in July 1998 and it is anticipated the operating
system upgrades will be successfully completed in November 1998. The network and
desktop upgrades involving the replacement of certain hardware and software is
scheduled to be completed by April of 1999. Further testing of all mainframe
applications and databases is scheduled to continue through July 1999.
Approximately 200 non-IT applications were identified at the Company with
approximately 45 percent being Year 2000 compliant as of October 1998. Non-IT
applications are primarily microprocessors and other electronic controls
embedded in equipment, other than computers, used by the Company. Additional
teams have been assembled to ensure the successful conversion of the remaining
systems. These conversions will continue into 1999.
The Company has incurred costs totaling $3.5 million, including $2.5 million in
the first nine months of 1998, and estimates a total of an additional $3 million
to be spent in the remainder of 1998 and 1999 to resolve year 2000 issues. These
costs are charged to expense as incurred and include software license fees and
cost of all persons assigned to the project. Incremental costs associated with
Year 2000 compliance are not anticipated to result in significant increases in
future operating expenses and are not expected to have a material adverse effect
on the results of operations, liquidity and capital resources. Existing
resources are being redeployed and other projects are being delayed to
accommodate Year 2000 related projects. These delays are not expected to have a
material adverse impact on future results of operations.
10
Business continuation plans for critical business applications are being
developed. These plans include adequate staffing on site during the year 2000
date change to quickly repair any errant applications. In addition, in the event
of any problems the Company would follow its current computer outage business
continuation plans until such problems are corrected.
The Company is having discussions with, and has sent questionnaires to, its
suppliers to assess their Year 2000 readiness. Information will continue to be
gathered until January 1999. Alternative suppliers will be identified for those
suppliers it appears will not be able to supply materials due to Year 2000
issues. The Company has very few customers whose loss of business would be
material to the Company. It is not aware of any Year 2000 issues at these
customers that would have a material adverse impact on the Company's results.
Management believes that sufficient resources have been allocated and project
plans are in place to avoid any adverse material impact on operations or
operating results. However, there can be no guarantee that the Company's systems
will be timely converted and Year 2000 problems would not have an adverse effect
on the Company. The Year 2000 efforts of third parties are not within the
Company's control and their failure to respond to Year 2000 issues successfully
could result in business disruption and increased operating cost to the Company.
At the present time, it is not possible to determine whether any such events are
likely to occur, or to quantify any potential impact they may have on the
Company's future results of operations and financial condition.
Readers are cautioned that forward-looking statements contained in the Year 2000
Update should be read in conjunction with the company's disclosures under the
heading: "SAFE HARBOR CAUTIONARY STATEMENT" below.
Outlook
The Company expects its business in North America to remain strong for the
balance of the year. Management expects continued weak sales in the Asia Pacific
region. The Company has undertaken a number of restructuring efforts to improve
its effectiveness and profitability in the markets it serves. Management
believes these restructuring efforts will help Graco withstand the uncertainty
of the global economies while reducing costs by approximately $10 million
dollars on an annualized basis.
SAFE HARBOR CAUTIONARY STATEMENT
The information in this 10-Q 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, the results of the efforts of
the Company, its suppliers and customers, to avoid any adverse effect as a
result of the Year 2000 issue, and additional factors identified in Exhibit 99
to the Company's Report on Form 10-K for fiscal year 1997.
11
PART II
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Credit Agreement dated July 2, 1998, between the
Company and U.S. Bank National Association Exhibit 4
Statement on Computation Exhibit 11
of Per Share Earnings
Financial Data Schedule (EDGAR filing only) Exhibit 27
(b) No reports on Form 8-K have been filed during the quarter for which
this report is filed.
12
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: November 6, 1998 By:/s/George Aristides
George Aristides
Chief Executive Officer
Date: November 5, 1998 By:/s/James A. Graner
James A. Graner
Vice President & Controller
("duly authorized officer")
13