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 26, 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 --------- -------- 16,979,650 common shares were outstanding as of October 23, 1997. 1
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 Stock Option Agreement. Form of agreement used for award of nonstatutory stock options to nonemployee director, dated September 5, 1997 Exhibit 10.1 Trust Agreement dated September 30, 1997, between the Company and Norwest Bank Minnesota, N.A. Exhibit 10.2 Computation of Net Earnings per Common Share Exhibit 11 Financial Data Schedule (EDGAR filing only) Exhibit 27 2
<TABLE> <CAPTION> PART I GRACO INC. AND SUBSIDIARIES Item I. CONSOLIDATED STATEMENTS OF EARNINGS (Unaudited) Thirteen Weeks Ended Thirty-Nine Weeks Ended -------------------- ----------------------- Sept. 26, 1997 Sept. 27, 1996 Sept. 26, 1997 Sept. 27, 1996 -------------- -------------- -------------- -------------- (In thousands except per share amounts) <S> <C> <C> <C> <C> Net sales ................................... $ 101,920 $ 97,680 $ 305,740 $ 284,932 Cost of products sold ................. 50,558 47,704 156,446 140,697 -------------- -------------- -------------- -------------- Gross profit ............................... 51,362 49,976 149,294 144,235 Product development .................. 4,167 4,714 13,820 13,566 Selling .............................. 21,051 21,624 66,448 62,714 General and administrative ........... 8,425 8,316 25,264 29,996 -------------- -------------- -------------- -------------- Operating profit ........................... 17,719 15,322 43,762 37,959 Interest expense ..................... 216 155 663 732 Other expense, net ................... 124 310 371 (447) -------------- -------------- -------------- -------------- Earnings before income taxes ............... 17,379 14,857 42,728 37,674 Income taxes ......................... 4,500 4,700 13,250 11,900 -------------- -------------- -------------- -------------- Net earnings ............................... $ 12,879 $ 10,157 $ 29,478 $ 25,774 ============== ============== ============== =============== Net earnings per common and common equivalent share .............. $ .74 $ .58 $ 1.69 $ 1.47 ============== ============== ============== =============== Cash dividend declared per common share .... $ .14 $ .12 $ .42 $ .36 ============== ============== ============== =============== </TABLE> See notes to consolidated financial statements. 3
<TABLE> <CAPTION> GRACO INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands) September 26, 1997 December 27, 1996 ------------------ ----------------- (Unaudited) <S> <C> <C> ASSETS Current Assets: Cash and cash equivalents ............................... $ 7,382 $ 6,535 Accounts receivable, less allowances of $4,196 and $4,723 ................................. 82,566 83,474 Inventories ............................................. 44,768 41,531 Deferred income taxes ................................... 12,459 11,633 Other current assets .................................... 1,387 1,321 ------------------ ----------------- Total current assets .............................. 148,562 144,494 Property, plant and equipment: Cost .................................................... 194,343 183,085 Less Accumulated Depreciation ........................... (94,310) (88,913) ------------------ ----------------- 100,033 94,172 Other assets .................................................. 9,066 9,148 ------------------ ----------------- $ 257,661 $ 247,814 ================== ================= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Notes payable to banks .................................. $ 2,444 $ 3,813 Current portion of long-term debt ....................... 1,620 1,845 Trade accounts payable .................................. 14,191 13,854 Salaries, wages and commissions ......................... 13,639 14,808 Accrued insurance liabilities ........................... 12,157 10,925 Income taxes payable .................................... 7,453 4,647 Other current liabilities ............................... 20,810 30,718 ------------------ ----------------- Total current liabilities ......................... 72,314 80,610 Long-term debt, less current portion .......................... 7,145 8,075 Retirement benefits and deferred compensation ................. 33,795 33,079 Shareholders' equity: Common stock ............................................ 17,020 17,047 Additional paid-in capital .............................. 19,399 22,254 Retained earnings ....................................... 106,471 85,232 Other, net .............................................. 1,517 1,517 ------------------ ----------------- Total shareholders' equity ........................ 144,407 126,050 ------------------ ----------------- $ 257,661 $ 247,814 ================== ================= </TABLE> See notes to consolidated financial statements 4
<TABLE> <CAPTION> GRACO INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) Thirty-Nine Weeks ----------------- Sept. 26, 1997 Sept. 27, 1996 -------------- -------------- (In thousands) <S> <C> <C> CASH FLOWS FROM OPERATING ACTIVITIES: Net Earnings ...................................................... $ 29,478 $ 25,774 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization ............................... 10,507 9,633 Deferred income taxes ....................................... (2,137) 2,318 Change in: Accounts receivable ....................................... (2,665) (3,182) Inventories ............................................... (4,972) (7,147) Trade accounts payable .................................... 655 (380) Retirement benefits and deferred compensation ............................................. 1,036 564 Other accrued liabilities ................................. (5,743) 6,813 Other ..................................................... (240) 350 -------------- -------------- 25,919 34,743 -------------- -------------- CASH FLOWS FROM INVESTING ACTIVITIES: Property, plant and equipment additions ........................ (16,793) (18,681) Proceeds from sale of property, plant, and equipment ............................................. 1,642 62 -------------- -------------- (15,151) (18,619) -------------- -------------- CASH FLOWS FROM FINANCING ACTIVITIES: Borrowing on notes payable and lines of credit ............. 40,289 13,932 Payments on notes payable and lines of credit .............. (41,470) (13,957) Borrowing on long-term debt ................................ -- 198 Payments on long-term debt ................................. (922) (1,347) Common stock issued ........................................ 2,926 2,352 Retirement of common and preferred stock ................... (6,971) (6,819) Cash dividends paid ........................................ (7,219) (6,293) -------------- -------------- (13,367) (11,934) -------------- -------------- Effect of exchange rate changes on cash ....................... 3,446 1,568 -------------- -------------- Net increase in cash and cash equivalents ..................... 847 5,758 Cash and cash equivalents: Beginning of year .......................................... 6,535 1,643 -------------- -------------- End of period .............................................. $ 7,382 $ 7,401 ============== ============== </TABLE> 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 26, 1997 and the related statements of earnings for the thirteen and thirty-nine weeks ended September 26, 1997 and September 27, 1996 and cash flows for the thirty-nine weeks ended September 26, 1997, and September 27, 1996, have been prepared by the Company without being audited. In the opinion of management, these consolidated statements reflect all adjustments necessary (consisting of only normal recurring adjustments) to present fairly the financial position of Graco Inc. and Subsidiaries as of September 26, 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): Sept. 26, 1997 Dec. 27, 1996 -------------- ------------- Finished products and components $43,148 $38,707 Products and components in various stages of completion 26,943 24,691 Raw materials 12,387 15,192 -------------- ------------- 82,478 78,590 Reduction to LIFO cost (37,710) (37,059) -------------- ------------- $44,768 $41,531 ============== ============= 6
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. 4. 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. 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 $12.9 million for the quarter ended September 26, 1997 increased 27 percent over the third quarter of 1996 earnings of $10.2 million. For the nine months ended September 26, 1997, net earnings of $29.5 million were 14 percent over 1996 earnings of $25.8 million. The quarterly earnings improvement results primarily from a 4 percent increase in sales, coupled with a 3 percent decline in operating expenses. A lower effective tax rate and income of approximately $450,000, net of tax, related to the settlement of a lawsuit, also contributed to the net earnings improvement. Partially offsetting the improvements were a lower gross profit margin on product sales and losses resulting from unfavorable exchange rate changes. The following table sets forth items from the Company's Consolidated Statements of Earnings as percentages of net sales: <TABLE> <CAPTION> Third Quarter Nine Months (13 weeks) Ended (39 weeks) Ended ---------------- ---------------- September September September September 26, 1997 27, 1996 26, 1997 27, 1996 --------- --------- --------- --------- <S> <C> <C> <C> <C> Net Sales ................................... 100.0% 100.0% 100.0% 100.0% --------- --------- --------- --------- Cost of Products Sold ....................... 49.6 48.8 51.2 49.4 Product Development ......................... 4.1 4.8 4.5 4.8 Selling ..................................... 20.7 22.1 21.7 22.0 General and Administrative .................. 8.2 8.6 8.3 10.5 --------- --------- --------- --------- Operating Profit ............................ 17.4 15.7 14.3 13.3 --------- --------- --------- --------- Interest Expense ............................ .2 .2 .2 .3 --------- --------- --------- --------- Other Income(Expense), Net .................. (.1) (.3) (.1) .2 --------- --------- --------- --------- Earnings Before Income Taxes ................ 17.1 15.2 14.0 13.2 Income Taxes ................................ 4.5 4.8 4.4 4.2 --------- --------- --------- --------- Net Earnings ................................ 12.6% 10.4% 9.6% 9.0% ========= ========= ========= ========= </TABLE> 8
Net Sales Net sales during the third quarter of $101.9 million were 4 percent higher than 1996's third quarter. Year-to-date sales of $305.7 million were 7 percent higher than the first nine months of 1996. Improved sales levels were achieved despite a negative currency impact, which reduced sales by 4 percent for the quarter and 3 percent for the nine month period. Industrial/Automotive Equipment sales worldwide fell 5 percent to $53.5 million from last year's third quarter, 4 percent due to exchange and most of the remainder due to a decline in automotive systems demand in Europe. Sales for the nine month period ended September 26, 1997 in Industrial/Automotive of $160.9 million were 3 percent higher than 1996. Third quarter Contractor Equipment sales of $37.2 million were 22 percent higher than last year due primarily to new products and price repositioning. Year-to-date Contractor Equipment sales were up 15 percent to $110.7 million. Lubrication Equipment quarterly sales increased 3 percent to $11.2 million. Sales of $34.1 million for the first nine months in Lubrication were up 6 percent over the same period last year reflecting a healthy North American economy and an increased key distributor base. Sales in the Americas (North, South and Central) increased 12 percent to $69.3 million for the quarter primarily due to strong sales performance in Contractor Equipment, partially offset by a decline in North American automotive systems sales. Year-to-date sales in the Americas of $207.8 million were up 11 percent compared to the same period last year. Quarterly sales in Europe of $18.5 million were 15 percent lower than last year. Much of the decline (9 percent) can be attributed to changes in exchange rates. The remainder is due primarily to a shift in timing of automotive systems sales between quarters. Year-to-date automotive system sales remain ahead of last year. Sales in Europe for the nine months ended September 26, 1997 of $57.3 million improved 5 percent from the same period last year (a 13 percent volume increase, and an 8 percent decline due to exchange rates). Asia Pacific sales of $14.1 million were 2 percent higher than last year's third quarter (a 7 percent volume increase, and a 5 percent decline due to exchange rates). Sales in Asia Pacific for nine months of $40.7 million were 4 percent lower than last year (a 3 percent volume increase, and a 7 percent decline due to exchange rates). Gross Profit Gross profit as a percentage of quarterly and year-to-date net sales has risen to 50.4 and 48.8 percent respectively from the second quarter of 1997. These rates, however, are .8 and 1.8 percentage points lower than the 1996 third quarter and year-to-date rates, respectively. The decreases for the quarter and nine months were primarily the result of a shift in the product mix within Contractor Equipment to an upgraded product line which generates a lower margin than other products. The strengthening of the U.S. dollar also reduced the gross margin as a greater proportion of the Company's sales, relative to costs, are denominated in currencies other than the U.S. dollar. 9
Operating Expenses Operating expenses for the quarter ended September 26, 1997 of $33.6 million decreased 3 percent from the same quarter of 1996. Operating expenses of $105.5 million for the first nine months were 1 percent below the 1996 level. Quarterly product development expense decreased 12 percent from 1996 and selling expense decreased 3 percent. The decline in both product development and selling can be attributed to lower employee benefit costs. General and administrative costs remained relatively flat in comparison to the third quarter of 1996. Other Income (Expense) Other expense was $.1 million in the third quarter, compared to expense of $.3 million for the same period last year. The third quarter of 1997 includes proceeds from the settlement of a lawsuit. This income was partially offset by losses due to exchange rate fluctuations. Other expense for the nine months ended September 26, 1997 was $.4 million, compared to income of $.4 million in the same period of 1996. Income Taxes The quarterly and year-to-date effective income tax rates decreased to 25.9 percent and 31.0 percent, respectively compared to 31.6 percent for both periods last year. The lower rates in 1997 were principally due to previously unrecognized foreign tax benefits. Liquidity and Capital Resources - ------------------------------- The Company generated $25.9 million of cash flow from operating activities in the first nine months of 1997 compared to $34.7 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 from 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 was also used to fund an increase in inventory levels which was driven by higher engineered systems activity in the foreign operations. Available cash, borrowing on lines of credit of $40.3 million, and proceeds from issuances of common stock were used to fund short-term operating needs, finance capital expenditures of $16.8 million, repurchase $7.0 million in common stock and pay dividends of $7.2 million. The Company had unused lines of credit available at September 26, 1997 totaling $68.7 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 performance for the remainder of the year. With the exception of North American Automotive, the Company is experiencing strong demand for its products. Sales backlog has grown by $11 million since the beginning of the year to $30 million. Also, despite continuing unfavorable exchange rate changes, the Company's profitability has improved. 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 6. Exhibits and Reports on Form 8-K (a) Exhibits Stock Option Agreement. Form of agreement used for award of nonstatutory stock options to nonemployee director, dated September 5, 1997 Exhibit 10.1 Trust agreement dated September 30, 1997, between the Company and Norwest Bank, Minnesota N.A. Exhibit 10.2 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: 11/6/97 By:/s/George Aristides George Aristides Chief Executive Officer Date: 11/6/97 By:/s/Mark W. Sheahan Mark W. Sheahan Treasurer (Principal Financial Officer) 13