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 March 27, 1998 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 25,814,967 common shares were outstanding as of April 30, 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 8-10 PART II OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K 11 SIGNATURES 12 1998 Corporate and Business Unit Annual Bonus Plan Exhibit 10 Stock Option Agreement. Form of agreement used for award of non-incentive stock options to executive officers, dated February 27, 1998 Exhibit 10.1 Computation of Net Earnings per Common Share Exhibit 11 Financial Data Schedule Exhibit 27 2
PART I GRACO INC. AND SUBSIDIARIES Item 1. CONSOLIDATED STATEMENTS OF EARNINGS (Unaudited) Thirteen Weeks Ended -------------------- March 27, 1998 March 28, 1997 -------------- -------------- (In thousands except per share amounts) Net Sales $ 105,717 $ 92,099 Cost of products sold 53,772 47,566 -------------- -------------- Gross Profit 51,945 44,533 Product development 4,782 4,825 Selling 22,647 21,633 General and administrative 10,165 8,555 -------------- -------------- Operating Profit 14,351 9,520 Interest expense 225 207 Other expense, net 279 (368) -------------- -------------- Earnings Before Income Taxes 13,847 9,681 Income taxes 4,900 3,500 -------------- -------------- Net Earnings $ 8,947 $ 6,181 ============== ============== Basic Net Earnings Per Common Share* $ .35 $ .24 ============== ============== Diluted Net Earnings Per Common* $ .34 $ .24 ============== ============== Basic Weighted Average Number of Common Shares* 25,635 25,659 Diluted Weighted Average Number of Common Shares* 26,239 26,248 *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 (Unaudited) March 27, 1998 December 26, 1997 -------------- ----------------- ASSETS (In thousands) Current Assets: Cash and cash equivalents $ 28,383 $ 13,523 Accounts receivable, less allowances of $4,600 and $4,100 83,699 86,148 Inventories 46,170 43,942 Deferred income taxes 10,949 11,140 Prepaid expenses 1,282 1,539 -------------- ----------------- Total current assets 170,483 156,292 Property, Plant and Equipment: Cost 197,284 196,940 Accumulated depreciation (98,176) (96,760) -------------- ----------------- 99,108 100,180 Other Assets 7,586 8,060 -------------- ----------------- $ 277,177 $ 264,532 ============== ================= LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities: Notes payable to banks $ 4,996 $ 2,911 Current portion of long-term debt 1,796 1,796 Trade accounts payable 14,562 12,542 Salaries, wages & commissions 10,753 14,903 Accrued insurance liabilities 10,571 10,227 Income taxes payable 7,399 5,546 Other current liabilities 21,853 21,055 -------------- ----------------- Total current liabilities 71,930 68,980 Long-term debt, less current portion 5,809 6,163 Retirement benefits and deferred compensation 31,594 31,880 Shareholders' equity: Common stock 25,792 25,553 Additional paid-in capital 29,670 26,085 Retained earnings 112,382 105,030 Other, net 0 841 -------------- ----------------- Total Shareholders' Equity 167,844 157,509 -------------- ----------------- $ 277,177 $ 264,532 ============== ================= See notes to consolidated financial statements. 4
GRACO INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) Thirteen Weeks -------------- March 27, 1998 March 28, 1997 -------------- -------------- CASH FLOWS FROM OPERATING ACTIVITIES: (In thousands) Net Earnings $ 8,947 $ 6,181 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation 3,994 3,548 Deferred income taxes 158 (481) Change in: Accounts receivable 952 (61) Inventories (2,531) (6,688) Trade accounts payable 1,999 (419) Retirement benefits and deferred compensation (200) 571 Other accrued liabilities (1,125) (7,029) Other 839 (1,453) -------------- -------------- 13,033 (5,831) -------------- -------------- CASH FLOWS FROM INVESTING ACTIVITIES: Property, plant and equipment additions (2,995) (6,340) Proceeds from sale of property, plant, and equipment 170 1,578 -------------- -------------- (2,825) (4,762) -------------- -------------- CASH FLOWS FROM FINANCING ACTIVITIES: Borrowing on notes payable and lines of credit 5,037 5,335 Payments on notes payable and lines of credit (2,772) (1,528) Payments on long-term debt (310) (326) Common stock issued 3,822 2,790 Repurchase of common stock (12) -- Cash dividends paid (2,811) (2,420) -------------- -------------- 2,954 3,851 -------------- -------------- Effect of exchange rate changes on cash 1,698 1,585 -------------- -------------- Net increase (decrease) in cash and cash equivalents 14,860 (5,157) Cash and cash equivalents: Beginning of year 13,523 6,535 -------------- -------------- End of period $ 28,383 $ 1,378 ============== ============== 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 March 27, 1998 and the related statements of earnings for the thirteen weeks ended March 27, 1998 and March 28, 1997 and cash flows for the thirteen weeks ended March 27, 1998, and March 28, 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 March 27, 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): March 27, 1998 December 26, 1997 -------------- ----------------- Finished products and components $ 39,170 $ 38,290 Products and components in various stages of completion 24,375 25,320 Raw materials 19,171 16,715 -------------- ----------------- 82,716 80,325 Reduction to LIFO cost (36,546) (36,383) -------------- ----------------- $ 46,170 $ 43,942 ============== ================= 6
GRACO INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) ( Continued) 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 at the end of the 1998 fiscal year. SFAS No. 131 redefines how operating segments are determined and requires disclosure of certain financial and descriptive 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. 4. 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., (the Company) for the quarter ended March 27, 1998 include Europe's operations for the months of January, February and March. First quarter 1997 results included the months of December, 1996 and January and February, 1997. Had the company included the months of January, February and March in its operating results for Europe in the first quarter of 1997, net sales would have been $94,099,000, net earnings would have been $6,854,000 and diluted earnings per share would have been $0.26. 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 $8.9 million for the quarter ended March 27, 1998 increased 45 percent over the first quarter of 1997 earnings of $6.2 million. The quarterly earnings improvement was driven by higher sales and improved gross margin rates. First quarter operating earnings include charges related to restructuring Graco's Automotive operation in Plymouth, Michigan. Many of the functions that were performed in Plymouth will be relocated to Graco's Minneapolis facilities. Most of the restructuring charges have been recognized, and it is expected that the transition will be completed by the end of the second quarter of 1998. First quarter operating results also include charges for restructuring operations in Asia Pacific. The following table sets forth items from the Company's Consolidated Statements of Earnings as percentages of net sales: First Quarter (13 weeks) Ended ---------------- March 27, 1998 March 28, 1997 -------------- -------------- Net Sales 100.0% 100.0% -------------- -------------- Cost of Products Sold 50.9 51.6 Product Development 4.5 5.2 Selling 21.4 23.6 General and Administrative 9.6 9.3 -------------- -------------- Operating Profit 13.6 10.3 -------------- -------------- Interest Expense (.2) (.2) -------------- -------------- Other Income(Expense), Net (.3) .4 -------------- -------------- Earnings Before Income Taxes 13.1 10.5 -------------- -------------- Income Taxes 4.6 3.8 -------------- -------------- Net Earnings 8.5% 6.7% ============== ============== 8
GRACO INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Net Sales Net sales in the first quarter of $105.7 million were 15 percent higher than the same period last year. The improved sales level was achieved despite a negative currency impact, which had a 3 percent impact on sales for the quarter. The Contractor Equipment Division sales of $37.4 million increased from last year's first quarter due to new product introductions and stronger demand for existing products. Industrial Equipment Division sales of $40.5 million improved 10 percent, driven by strong demand for industrial products in Europe and the Americas. Automotive sales of $17.0 million increased 26 percent due to strong sales in North America, improved system sales in Europe and the change in calendar months reported in Europe. Lubrication Equipment Division quarterly sales increased 2 percent to $10.9 million. Geographically, sales in the Americas (North, South and Central) increased 15 percent to $71.9 million for the quarter primarily due to strong Contractor and Industrial activity. European sales, on a comparable basis, of $20.4 million were 21 percent higher than last year, and would have been 29% higher with constant exchange rates The growth in Europe was attributable primarily to strong Industrial and Automotive sales. Asia Pacific sales of $10.5 million were 17 percent lower than last year's first quarter (including an 11 percent decline due to exchange rates) due to the instability in the economies of Japan, Korea and Southeast Asia. Gross Profit Gross profit as a percentage of net sales increased to 49.1 percent in the first quarter, compared to 48.4 percent for the same period last year. The increases were primarily due to manufacturing efficiencies and price increases. Operating Expenses Operating expenses in the first quarter of $37.6 million increased 7 percent from the first quarter of 1997, but decreased from 38.1% to 35.5% of net sales. General and administrative expenses were 19 percent higher than the same quarter last year, largely due to restructuring charges related to operations in Plymouth, Michigan and South East Asia. Selling expenses increased 5 percent compared to the first quarter last year due to increased sales levels and increased warranty costs. Product development costs remained relatively flat in comparison to the first quarter of 1997. 9
GRACO INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Other Income (Expense) Other expense was $0.3 million in the first quarter, compared to $0.4 million of income for the same period last year. The first quarter of 1998 was affected more unfavorably by foreign exchange rate changes, while 1997 was favorably impacted by a gain on the sale of the Company's Franklin Park, Illinois facility. Income Taxes The effective tax rate decreased to 35 percent in the quarter compared to 36 percent last year. Liquidity and Capital Resources The Company generated $13.0 million of cash flow from operating activities in the first three months of 1998 compared to using cash of $5.8 million for the same period last year. Significant uses of operating cash flow in 1998 resulted from a planned increase in inventory levels primarily in Europe. Available cash and borrowing on lines of credit of $5.0 million were used to fund short-term operating needs, finance capital expenditures of $3.0 million and pay dividends of $2.8 million. The Company had unused lines of credit available at March 27, 1998 totaling $70.1 million. The available credit facilities and internally-generated funds provide the Company with the financial flexibility to meet liquidity needs. Outlook The Company is cautiously optimistic about the outlook for 1998 based on the level of activity during the first quarter. Overall we expect improved financial results in 1998. We anticipate higher sales, driven by continued new product introductions, an improved and expanding worldwide distribution network and good economic conditions in North America and Europe, despite weakness in Asia Pacific, including Japan, South Korea and Southeast Asia. Graco has undertaken a number of restructuring efforts recently to improve its effectiveness in the markets it serves, and have increased the Company's operating margins and net profits. These efforts will continue to favorably impact margins and profits in 1998. We are implementing additional measures to improve operating efficiency. We anticipate that the strength of the U.S. dollar relative to other major currency will negatively impact operating margins in 1998. We also anticipate a higher tax rate in 1998. 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 1997. 11
PART II Item 6. Exhibits and Reports on Form 8-K (a) Exhibits 1998 Corporate and Business Unit Annual Bonus Plan Exhibit 10 Stock Option Agreement. Form of agreement used for award of non-incentive stock options to executive officers, dated February 28, 1998. Exhibit 10.1 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: May 8, 1998 By:/s/George Aristides George Aristides Chief Executive Officer Date: May 8, 1998 By:/s/Mark W. Sheahan Mark W. Sheahan Treasurer (Principal Financial Officer) 13