Graco - 10-Q quarterly report FY

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

For the quarterly period ended September 25, 2009

Commission File Number:  001-09249

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.

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or such shorter period that the registrant was required to submit and post such files).

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

59,972,000 shares of the Registrant’s Common Stock, $1.00 par value, were outstanding as of October 15, 2009.

Item 1.

(Unaudited)

(In thousands except per share amounts)

See notes to consolidated financial statements.

 

 

 

See notes to consolidated financial statements.

 

 

Stock options to purchase 2,834,000 and 2,114,000 shares were not included in the 2009 and 2008 computations of diluted earnings per share, respectively, because they would have been anti-dilutive.

 

 

The aggregate intrinsic value of exercisable option shares was $12.2 million as of September 25, 2009, with a weighted average contractual term of 4.4 years.  There were approximately 4.8 million share options vested and expected to vest as of September 25, 2009, with an aggregate intrinsic value of $20.9 million, a weighted average exercise price of $28.87 and a weighted average contractual term of 6.5 years.

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

 

The Company recognized year-to-date share-based compensation of $7.7 million in 2009 and $7.1 million in 2008.  As of September 25, 2009, there was $8.2 million of unrecognized compensation cost related to unvested options, expected to be recognized over a weighted average period of 2.6 years.

 

 

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions and results:

 

Under the Company’s Employee Stock Purchase Plan, the Company issued 312,000 shares in 2009 and 216,000 shares in 2008.  The fair value of the employees’ purchase rights under this Plan was estimated on the date of grant.  The benefit of the 15 percent discount from the lesser of the fair market value per common share on the first day and the last day of the plan year was added to the fair value of the employees’ purchase rights determined using the Black-Scholes option-pricing model with the following assumptions and results:

 

In the third quarter of 2009, the Company made a voluntary $15 million tax-deductible contribution to its funded defined benefit pension plan.

The Company paid $1.5 million in June 2009 and $1.5 million in June 2008 for contracts insuring the lives of certain employees who are eligible to participate in certain non-qualified pension and deferred compensation plans.  These insurance contracts will be used to fund the non-qualified pension and deferred compensation arrangements.  The insurance contracts are held in a trust and are available to general creditors in the event of the Company’s insolvency.  Cash surrender value of $4.3 million and $2.7 million is included in other assets in the consolidated balance sheet as of September 25, 2009 and December 28, 2008, respectively.

 

 

 

 

 

 

 

 

 

    period.  Amortization of intangibles was $3.4 million in the third quarter of 2009 and $9.2 million year-to-date.  Estimated annual amortization expense is as follows:  $12.1 million in 2009, $11.2 million in 2010, $10.1 million in 2011, $8.3 million in 2012,

    $4.1 million in 2013 and $1.6 million thereafter.

 

 

A liability is established for estimated future warranty and service claims that relate to current and prior period sales.  The Company estimates warranty costs based on historical claim experience and other factors including evaluating specific product warranty issues.  Following is a summary of activity in accrued warranty and service liabilities (in thousands):

 

 

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

In 2007, the Company entered into interest rate swap contracts that effectively fix the rates paid on a total of $80 million of variable rate borrowings.  One contract fixed the rate on $40 million of borrowings at 4.7 percent plus the applicable spread (depending on cash flow leverage ratio) until December 2010.  The second contract fixed an additional $40 million of borrowings at 4.6 percent plus the applicable spread until January 2011.  Both contracts have been designated as cash flow hedges against interest rate volatility.  Consequently, changes in the fair market value are recorded in accumulated other comprehensive income (loss) (AOCI).  Amounts included in AOCI will be reclassified to earnings as interest rates increase and as the swap contracts approach their expiration dates.  Net amounts paid or payable under terms of the contracts were charged to interest expense and totaled $2.2 million in the first nine months of 2009.

The Company uses significant other observable inputs to value the derivative instruments used to hedge interest rate volatility and net monetary positions.  The fair market value and balance sheet classification of such instruments follows (in thousands):  

The Company designs, manufactures and markets systems and equipment to move, measure, control, dispense and spray fluid materials.  Management classifies the Company’s business into three reportable segments:  Industrial, Contractor and Lubrication.  Key strategies include development of new products, expansion of distribution and new market penetration.

The following Management’s Discussion and Analysis reviews significant factors affecting the Company’s results of operations and financial condition.  This discussion should be read in conjunction with the financial statements and the accompanying notes to the financial statements.

Net sales, net earnings and earnings per share were as follows (in millions except per share amounts and percentages):

 

 

Weak economic conditions worldwide continued to affect the Company’s operating results.  Sales and orders decreased in all segments and regions.  Currency translation had an unfavorable effect on sales ($2 million for the quarter and $14 million year-to-date) and net earnings ($1 million for the quarter and $5 million year-to-date).  Year-to-date, the Company has recorded $5 million of cost related to workforce reductions, mostly in the first quarter.  The resulting decrease in cost structure contributed to improvements in second and third quarter net earnings compared to the first quarter.

Consolidated Results

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

 

Sales for the quarter were down 25 percent in the Americas, 39 percent in Europe (36 percent at consistent translation rates) and 25 percent in Asia Pacific.  Year-to-date sales were down 30 percent in the Americas, 44 percent in Europe (38 percent at consistent translation rates) and 26 percent in Asia Pacific.  Consolidated sales were down 29 percent for the quarter and 33 percent year-to-date.

Gross profit margin, expressed as a percentage of sales, was 53 percent for the quarter and 50 percent year-to-date, compared to 53 percent and 54 percent, respectively, for the comparable periods last year.  For the quarter, the favorable effects of pricing, material costs and cost reduction actions were offset by decreases from lower production volume and increased pension cost.  Decreases in the year-to-date rate were due to lower production volumes (approximately 5 percentage points), unfavorable currency translation rates (approximately 1 percentage point) and increased pension cost (approximately 1 percentage point).  Decreases were offset somewhat by the effects of favorable material costs and pricing.

Total operating expenses for the quarter and year-to-date were down 10 percent and 8 percent, respectively.  For both the quarter and year-to-date, the effects of spending reductions and lower volume were partially offset by higher pension expenses.  Year-to-date, a $4 million decrease from translation effects was partially offset by $2 million related to workforce reductions.

Effective income tax rates were 30 percent for the quarter and 31 percent year-to-date, down from last year’s rates of 34 percent for the quarter and 33 percent year-to-date.  A higher-than-expected benefit upon filing of prior year tax returns contributed to lower rates in 2009.  Effective rates were higher in 2008 because the R&D tax credit was not renewed until the fourth quarter and no credit was included in the provisions for the first three quarters.

Segment Results

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

 

For the quarter, Industrial segment sales decreased 32 percent in the Americas, 40 percent in Europe (37 percent at consistent translation rates) and 29 percent in Asia Pacific.  Year-to-date sales decreased 36 percent in the Americas, 46 percent in Europe (41 percent at consistent translation rates) and 28 percent in Asia Pacific.

In the third quarter, the impact of low volume on operating earnings was partially offset by the impacts of lower selling-related expenses and spending reductions initiated in prior quarters.  Low volume, workforce reduction costs and currency translation affected year-to-date operating earnings as a percentage of sales.

For the quarter, Contractor segment sales decreased 13 percent in the Americas and 35 percent in Europe (32 percent at consistent translation rates).  Year-to-date sales decreased 20 percent in the Americas, 39 percent in Europe (33 percent at consistent translation rates) and 12 percent in Asia Pacific.

In the third quarter, the impact of low volume on operating earnings was partially offset by the impacts of lower selling-related expenses and spending reductions initiated in prior quarters.  Low volume, workforce reduction costs, currency translation and sustained product development spending affected year-to-date operating earnings as a percentage of sales.  Contractor year-to-date operating results were also affected by sales, costs and expenses related to the rollout of entry-level paint sprayers to additional paint and home center stores in both 2009 and 2008.

 

 

 

For the quarter, Lubrication segment sales decreased 35 percent in the Americas, 49 percent in Europe (47 percent at consistent translation rates) and 39 percent in Asia Pacific.  Year-to-date sales decreased 37 percent in the Americas, 50 percent in Europe (47 percent at consistent translation rates) and 41 percent in Asia Pacific.

In the third quarter, the impact of low volume on operating earnings was partially offset by the impacts of lower selling-related expenses and spending reductions initiated in prior quarters.  Low volume, workforce reduction costs and increased product development expense affected year-to-date operating earnings as a percentage of sales.  Mix of products sold and costs related to discontinued products contributed to lower margin rates in the Lubrication segment.

In the first nine months of 2009, the Company used cash to reduce the borrowings under its long-term line of credit by $73 million and paid dividends of $34 million.  The Company also made a $15 million voluntary contribution to a funded defined benefit pension plan.  Significant uses of cash and borrowings in the first nine months of 2008 included $114 million for purchases and retirement of Company common stock, $40 million for business acquisitions and $34 million for payment of dividends.  

Since the end of 2008, inventories have been reduced by $31 million.  Accounts receivable decreased by $21 million from continuing collections and lower sales levels.

At September 25, 2009, the Company had various lines of credit totaling $282 million, of which $162 million was unused.  Internally generated funds and unused financing sources are expected to provide the Company with the flexibility to meet its liquidity needs in 2009.

Outlook

While economic conditions continue to create headwinds for the business, management is encouraged by improved profitablility in each of the last two quarters, resulting from efforts to improve production costs and control expenses.  While management is cautious about predicting stronger sales and further improvement in profitability in the near-term, it expects to continue investing in growth initiatives including product development, international expansion and entering new markets.  Management remains confident that the Company will emerge from the recession with strong, profitable growth.

SAFE HARBOR CAUTIONARY STATEMENT

A forward-looking statement is any statement made in this report and other reports that the Company files periodically with the Securities and Exchange Commission, or in press or earnings releases, analyst briefings and conference calls, which reflects the Company’s current thinking on market trends and the Company’s future financial performance at the time they are made.  All forecasts and projections are forward-looking statements.

The Company desires to take advantage of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995 by making cautionary statements concerning any forward-looking statements made by or on behalf of the Company.  The Company cannot give any assurance that the results forecasted in any forward-looking statement will actually be achieved.  Future results could differ materially from those expressed, due to the impact of changes in various factors.  These risk factors include, but are not limited to: economic conditions in the United States and other major world economies, currency fluctuations, political instability, changes in laws and regulations, and changes in product demand.  Please refer to Item 1A of, and Exhibit 99 to, the Company’s Annual Report on Form 10-K for fiscal year 2008 for a more comprehensive discussion of these and other risk factors.

Investors should realize that factors other than those identified above and in Item 1A and Exhibit 99 might prove important to the Company’s future results.  It is not possible for management to identify each and every factor that may have an impact on the Company’s operations in the future as new factors can develop from time to time.

There have been no material changes related to market risk from the disclosures made in the Company’s 2008 Annual Report on Form 10-K.

 

As of the end of the fiscal quarter covered by this report, the Company carried out an evaluation of the effectiveness of the design and operation of its disclosure controls and procedures.  This evaluation was done under the supervision and with the participation of the Company's President and Chief Executive Officer, the Chief Financial Officer and Treasurer, the Vice President and Controller, and the Vice President, General Counsel and Secretary.  Based upon that evaluation, they concluded that the Company's disclosure controls and procedures are effective in gathering, analyzing and disclosing information needed to satisfy the Company's disclosure obligations under the Exchange Act.

 

 

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.

There have been no material changes to the Company’s risk factors from those disclosed in the Company’s 2008 Annual Report on Form 10-K.

On September 28, 2007, the Board of Directors authorized the Company to purchase up to 7,000,000 shares of its outstanding common stock, primarily through open-market transactions.  This authorization expired on September 30, 2009.  

On September 18, 2009, the Board of Directors authorized the Company to purchase up to an additional 6,000,000 shares.  The new authorization expires on September 30, 2012.

In addition to shares purchased under the Board authorizations, the Company purchases shares of common stock held by employees who wish to tender owned shares to satisfy the exercise price or tax withholding on option exercises.  

Information on issuer purchases of equity securities follows:

 

 

None

                          GRACO INC.