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 26, 1999 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 ------------ ------------- 20,300,233 common shares were outstanding as of April 29, 1999.
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 1999 Corporate and Business Unit Annual Bonus Plan Exhibit 10 Form of Stock Option Agreement under the Long Term Stock Incentive Plan dated December 12, 1997. Exhibit 10.1 Executive Long Term Incentive Agreement between the Company and one executive officer dated February 22, 1999 Exhibit 10.2 Key Employee Agreement between the Company and one executive officer dated March 1, 1999 Exhibit 10.3 Stock Option Agreement. Form of agreement used for award of non-incentive stock options to one executive officer, dated March 1, 1999. Exhibit 10.4 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 -------------------- March 26, 1999 March 27, 1998 -------------- -------------- (In thousands except per share amounts) Net Sales $ 103,241 $ 105,717 Cost of products sold 50,384 53,772 ----------- ------------ Gross Profit 52,857 51,945 Product development 4,754 4,782 Selling, marketing and distribution 19,305 22,647 General and administrative 9,524 10,165 ----------- ------------ Operating Profit 19,274 14,351 Interest expense 1,953 225 Other (income) expense, net 320 279 ----------- ------------ Earnings Before Income Taxes 17,001 13,847 Income taxes 5,800 4,900 ----------- ------------ Net Earnings $ 11,201 $ 8,947 =========== ============ Basic Net Earnings Per Common Share $ .56 $ .35 =========== ============ Diluted Net Earnings Per Common Share $ .54 $ .34 =========== ============ See notes to consolidated financial statements. 3
GRACO INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands) March 26, 1999 Dec. 25, 1998 -------------- ------------- ASSETS (Unaudited) Current Assets: Cash and cash equivalents $ 4,204 $ 3,555 Accounts receivable, less allowances of $4,400 and $4,400 81,162 80,146 Inventories 34,111 34,018 Deferred income taxes 12,563 12,384 Other current assets 1,135 1,217 -------------- ------------ Total current assets 133,175 131,320 Property, Plant and Equipment: Cost 199,706 199,122 Accumulated depreciation (105,355) (102,756) -------------- ------------ 94,351 96,366 Other Assets 6,046 6,016 -------------- ------------ $ 233,572 $ 233,702 ============== ============ LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities: Notes payable to banks $ 11,056 $ 14,560 Current portion of long-term debt 1,715 3,157 Trade accounts payable 12,489 11,965 Salaries, wages & commissions 9,462 14,025 Accrued insurance liabilities 11,193 10,809 Income taxes payable 10,297 5,134 Other current liabilities 20,898 23,316 -------------- ------------ Total current liabilities 77,110 82,966 Long-term Debt, less current portion 105,353 112,582 Retirement Benefits and Deferred Compensation 29,133 28,841 Shareholders' Equity: Common stock 20,294 20,097 Additional paid-in capital 27,274 23,892 Retained deficit (26,891) (35,878) Other, net 1,299 1,202 -------------- ------------ Total shareholders' equity 21,976 9,313 $ 233,572 $ 233,702 ============== ============ See notes to consolidated financial statements. 4
<TABLE> GRACO INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) Thirteen Weeks ------------------------------------ March 26, 1999 March 27, 1998 -------------- -------------- CASH FLOWS FROM OPERATING ACTIVITIES: (In thousands) <S> <C> <C> Net Earnings $ 11,201 $ 8,947 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization 3,773 3,994 Deferred income taxes (69) 158 Change in: Accounts receivable (2,204) 952 Inventories (731) (2,531) Trade accounts payable 471 1,999 Salaries, wages and commissions (4,396) (4,047) Retirement benefits and deferred compensation 380 (200) Other accrued liabilities 3,573 2,922 Other 183 839 ------------- ------------- 12,181 13,033 ------------- ------------- CASH FLOWS FROM INVESTING ACTIVITIES: Property, plant and equipment additions (2,015) (2,995) Proceeds from sale of property, plant and equipment 220 170 ------------- ------------- (1,795) (2,825) ------------- ------------- CASH FLOWS FROM FINANCING ACTIVITIES: Borrowings on notes payable and lines of credit 38,992 5,037 Payments on notes payable and lines of credit (42,397) (2,772) Borrowings on long-term debt 2,000 - Payments on long-term debt (10,632) (310) Common stock issued 3,579 3,822 Retirement of common stock - (12) Cash dividends paid (2,212) (2,811) ------------- ------------- (10,670) 2,954 ------------- ------------- Effect of exchange rate changes on cash 933 1,698 ------------- ------------- Net increase (decrease) in cash and cash equivalents 649 14,860 Cash and cash equivalents: Beginning of year 3,555 13,523 ------------- ------------- End of period $ 4,204 $ 28,383 ============= ============= </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 March 26, 1999, and the related statements of earnings and cash flows for the thirteen weeks then ended, have been prepared by the Company without being audited. In the opinion of management, these consolidated statements reflect all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the financial position of Graco Inc. and Subsidiaries as of March 26, 1999, 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 1998 Form 10-K. The results of operations for interim periods are not necessarily indicative of results that will be realized for the full fiscal year. 2. Major components of inventories were as follows (in thousands): Mar. 26, 1999 Dec. 25, 1998 ------------- ------------- Finished products and components $ 27,396 $ 27,764 Products and components in various stages of completion 22,757 23,024 Raw materials 19,744 18,970 ------------- ------------- 69,897 69,758 Reduction to LIFO cost (35,786) (35,740) ------------- ------------- $ 34,111 $ 34,018 ============= ============= 6
GRACO INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 3. The Company has three reportable segments, Industrial/Automotive, Contractor and Lubrication. Assets of the Company are not tracked along reportable segment lines. Sales and operating profit by segment for the thirteen weeks ended March 26, 1999 and March 25, 1998 are as follows (in thousands): Mar. 26, 1999 Mar. 27, 1998 ------------- ------------- Net Sales Industrial/Automotive $ 50,748 $ 57,428 Contractor 41,694 37,392 Lubrication 10,799 10,897 ------------- ------------- Total $ 103,241 $ 105,717 ============= ============= Operating Profit Industrial/Automotive $ 9,745 $ 7,225 Contractor 8,899 7,039 Lubrication 2,288 1,750 Unallocated Corporate expenses (1,658) (1,663) ------------- ------------- Consolidated Operating Profit $ 19,274 $ 14,351 ============= ============= 4. 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 in fiscal year 2000. SFAS No. 133 requires that all derivatives are 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. 5. On April 28, 1999 the Company agreed to purchase the assets of Bollhoff Verfahrenstechnik (BV), located in Bielefeld, Germany. BV designs, manufactures and sells fluid application equipment for industrial and automotive markets primarily in Germany, and had 1998 sales of approximately $20 million. 7
Item 2. GRACO INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Results of Operations - --------------------- Graco's net earnings of $11.2 million for the quarter ended March 26, 1999 increased 25 percent from first quarter 1998 earnings of $8.9 million. Diluted earnings per share of $0.54 for the quarter were up 59 percent over diluted earnings per share of $0.34 in the first quarter of 1998. The quarterly performance was driven by reduced expenses and improved gross profit margins, offset by increased interest expense and reduced sales. Diluted earnings per share were higher due to higher earnings and the repurchase of 5.8 million common shares of the Company's common stock during the third quarter of 1998. The following table sets forth items from the Company's Consolidated Statements of Earnings as percentages of net sales: Three Months (13 weeks) Ended -------------------- March March 26, 1999 27, 1998 -------- -------- Net Sales 100.0% 100.0% -------- -------- Cost of products sold 48.8 50.9 Product development 4.6 4.5 Selling, marketing and distribution 18.7 21.4 General and administrative 9.2 9.6 -------- -------- Operating Profit 18.7 13.6 -------- -------- Interest expense 2.0 0.2 -------- -------- Other (income) expense, net 0.3 0.3 -------- -------- Earnings Before Income Taxes 16.4 13.1 Income taxes 5.6 4.6 -------- -------- Net Earnings 10.8% 8.5% ======== ======== Net Sales Net sales in the first quarter of $103.2 million were down 2 percent from the first quarter of 1998. Industrial/Automotive Equipment segment sales of $50.7 million are down 12 percent, due to slow sales in the Americas and Europe in 1999 and strong sales to automotive companies and automotive feeder plants in Europe in 1998. First quarter Contractor Equipment segment sales of $41.7 million were 12 percent higher than last year due to strong demand in North America. Lubrication Equipment segment sales decreased 1 percent from the first quarter 1998 to $10.8 million as improved sales in the Americas were offset by lower demand in Europe and in Asia. 8
Geographically, sales in the Americas increased 4 percent to $74.7 million for the quarter primarily due to strong Contractor sales. European quarterly sales of $19.1 million were 18 percent lower than last year due to weak demand in all segments. Asia Pacific sales of $9.3 million were 11 percent lower than last year's first quarter due to the weak economy's in Japan. Gross Profit Gross profit as a percentage of net sales improved to 51.2 percent in the first quarter, up 2.1 percentage points from the same period last year. The increase was due to higher margins on automotive products resulting from the switch from custom designed systems to pre-engineered packages, disciplined cost controls, enhanced pricing, and more favorable exchange rates. The weakening of the US dollar has improved 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 First quarter operating expenses of $33.6 million decreased 11 percent from the first quarter of 1998. Selling, marketing and distribution expenses were down 15 percent due primarily to restructuring of the Company's industrial and automotive businesses in 1998. General and administrative expenses were down 6 percent, which included the results of the restructuring of the Company's Asia Pacific operations in 1998. Product development costs were $4.8 million in both the first quarters of 1999 and 1998. Other Income (Expense) Other expense was $0.3 million in the first quarter of 1999 and 1998. Income Taxes The effective tax rate decreased to 34 percent in the first quarter compared to 35 percent for the same period last year. Liquidity and Capital Resources The Company generated $12.1 million of cash flow from operating activities in the first three months of 1999, compared to $13.0 million for the same period last year. Significant uses of operating cash flow in 1999 included the payment of 1998 sales incentives and bonuses and an increase in accounts receivable balances. Available cash was used to fund short-term operating needs and pay $12.0 million on net borrowings (notes payable and long-term debt). The Company had unused lines of credit available at March 26, 1999 totaling $63.3 million. The available credit facilities and internally generated funds provide the Company with the financial flexibility to meet liquidity needs. 9
Year 2000 The Year 2000 issue is the result of computer programs that were written using two digits rather than four to define the applicable year, which could cause potential failure or miscalculation in date-sensitive software that recognizes "00" as 1900 rather than 2000. 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 that 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 required upgrading or replacement in order to ensure proper functioning beyond the year 1999. The mainframe modification phase involving the conversion of core business applications was completed in July 1998 and the operating systems' upgrades were completed in November 1998. The network and desktop upgrades involving the replacement of certain hardware and software is scheduled to be completed by July 1999. Further testing of all mainframe applications and databases is scheduled to continue through July 1999. The Company has incurred costs totaling $5.1 million, including $0.6 million in 1999, and estimates a total of an additional $1.7 million to be spent in the remainder of 1999 to resolve Year 2000 issues. These costs are charged to expense as incurred and include software license fees and cost of 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 or financial condition. Business continuation plans for critical business processes and 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 will follow its current computer outage business continuation plans until such problems are corrected. Approximately 240 non-IT applications were identified at the Company with approximately 64 percent being Year 2000-compliant as of March 1999. Non-IT applications are primarily microprocessors and other electronic controls embedded in non-computer equipment used by the Company. Teams have been assembled to ensure the successful conversion of the remaining systems. These conversions are continuing in 1999. The Company has a very limited number of products with embedded controls and does not believe there are any Year 2000 compatibility issues with these products. 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 with these customers that would have a material adverse impact on the Company's results. 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 from key suppliers until July 1999. At that time, the Company will identify alternative suppliers for those key suppliers unable to supply materials due to Year 2000 issues. 10
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 converted in a timely fashion and Year 2000 problems will 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 costs 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 While the Company expects 1999 to be a difficult year for sales growth, it continues to plan for higher sales and strong earnings per share. Management believes the strategic changes made in 1998 and prior years will allow the Company to deliver higher profits in the turbulent international environment. 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 1998. 11
PART II Item 6. Exhibits and Reports on Form 8-K (a) Exhibits 1999 Corporate and Business Unit Annual Bonus Plan Exhibit 10 Form of Stock Option Agreement under the Long Term Stock Incentive Plan Dated December 12, 1997. Exhibit 10.1 Executive Long Term Incentive Agreement between the Company and one executive officer dated February 22, 1999 Exhibit 10.2 Key Employee Agreement between the Company and one executive officer dated March 1, 1999 Exhibit 10.3 Stock Option Agreement. Form of agreement used for award of non-incentive stock options to one executive officer, dated March 1, 1999. Exhibit 10.4 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: May 7, 1999 By: /s/James A. Earnshaw James A. Earnshaw Chief Executive Officer Date: May 7, 1999 By: /s/James A. Graner James A. Graner Vice President & Controller ("duly authorized officer") 13