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 June 25, 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 ---------- ------------ 20,337,102 common shares were outstanding as of July 23, 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 Non-employee Director Stock Plan, as amended June 18, 1999 Exhibit 10 Computation of Net Earnings per Common Share Exhibit 11 Financial Data Schedule (EDGAR filing only) Exhibit 27 2
<TABLE> PART I GRACO INC. AND SUBSIDIARIES Item I. CONSOLIDATED STATEMENTS OF EARNINGS (Unaudited) Thirteen Weeks Ended Twenty Six Weeks Ended ----------------------------- --------------------------- June 25, 1999 June 26, 1998 June 25, 1999 June 26,1998 ------------- ------------- ------------- ------------ (In thousands except per share amounts) <S> <C> <C> <C> <C> Net Sales $ 114,703 $ 115,153 $ 217,944 $ 220,870 Cost of products sold 55,084 57,066 105,468 110,838 ------------- ------------- ------------- ------------ Gross Profit 59,619 58,087 112,476 110,032 Product development 4,771 4,716 9,525 9,498 Selling, marketing and distribution 18,935 21,550 38,240 44,197 General and administrative 9,606 12,254 19,130 22,419 ------------- ------------- ------------- ------------ Operating Profit 26,307 19,567 45,581 33,918 Interest expense 1,858 173 3,811 398 Other (income) expense, net (2,712) (171) (2,392) 108 ------------- ------------- ------------- ------------ Earnings Before Income Taxes 27,161 19,565 44,162 33,412 Income taxes 9,200 6,800 15,000 11,700 ------------- ------------- ------------- ------------ Net Earnings $ 17,961 $ 12,765 $ 29,162 $ 21,712 ============= ============= ============= ============ Basic Net Earnings Per Common Share $ .89 $ .49 $ 1.45 $ .84 ============= ============= ============= ============ Diluted Net Earnings Per Common Share $ .86 $ .48 $ 1.41 $ .82 ============= ============= ============= ============ See notes to consolidated financial statements. </TABLE> 3
GRACO INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands) June 25, 1999 Dec. 25, 1998 ------------- ------------- ASSETS (Unaudited) Current Assets: Cash and cash equivalents $ 5,575 $ 3,555 Accounts receivable, less allowances of $4,716 and $4,400 80,998 80,146 Inventories 37,409 34,018 Deferred income taxes 12,353 12,384 Other current assets 1,629 1,217 ------------- ------------- Total current assets 137,964 131,320 Property, Plant and Equipment: Cost 192,062 199,122 Accumulated depreciation (104,201) (102,756) ------------- ------------- 87,861 96,366 Other Assets 14,516 6,016 ------------- ------------- $ 240,341 $ 233,702 ============= ============= LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities: Notes payable to banks $ 5,664 $ 14,560 Current portion of long-term debt 1,715 3,157 Trade accounts payable 10,744 11,965 Salaries, wages & commissions 12,324 14,025 Accrued insurance liabilities 10,946 10,809 Income taxes payable 5,366 5,134 Other current liabilities 20,371 23,316 ------------- ------------- Total current liabilities 67,130 82,966 Long-term Debt, less current portion 104,032 112,582 Retirement Benefits and Deferred Compensation 30,897 28,841 Shareholders' Equity: Common stock 20,332 20,097 Additional paid-in capital 27,589 23,892 Retained deficit (11,187) (35,878) Other, net 1,548 1,202 ------------- ------------- Total shareholders' equity 38,282 9,313 ------------- ------------- $ 240,341 $ 233,702 ============= ============= See notes to consolidated financial statements. 4
GRACO INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) Twenty-six Weeks ------------------------------ June 25, 1999 June 26, 1998 ------------- ------------- CASH FLOWS FROM OPERATING ACTIVITIES: (In thousands) Net Earnings $ 29,162 $ 21,712 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization 7,615 7,864 Deferred income taxes 123 (436) (Gain) loss on sale of fixed assets (3,209) (172) Change in: Accounts receivable (2) (2,063) Inventories 4,041 45 Trade accounts payable (997) 236 Salaries, wages and commissions (1,940) (2,197) Retirement benefits and deferred compensation (546) (348) Other accrued liabilities (2,288) 381 Other 139 710 ------------- ------------- 32,098 25,732 ------------- ------------- CASH FLOWS FROM INVESTING ACTIVITIES: Property, plant and equipment additions (3,844) (6,492) Proceeds from sale of property, plant and equipment 9,473 386 Acquisition of business (18,389) - ------------- ------------- (12,760) (6,106) ------------- ------------- CASH FLOWS FROM FINANCING ACTIVITIES: Borrowings on notes payable and lines of credit 58,688 5,789 Payments on notes payable and lines of credit (67,382) (3,960) Borrowings on long-term debt 25,082 - Payments on long-term debt (34,988) (722) Common stock issued 3,933 4,164 Retirement of common stock - (12) Cash dividends paid (4,445) (5,649) ------------- ------------- (19,112) (390) ------------- ------------- Effect of exchange rate changes on cash 1,794 1,467 ------------- ------------- Net increase in cash and cash equivalents 2,020 20,703 Cash and cash equivalents: Beginning of period 3,555 13,523 ------------- ------------- End of period $ 5,575 $ 34,226 ============= ============= 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 June 25, 1999, and the related statements of earnings and cash flows for the thirteen and twenty-six weeks ended June 25, 1999 and June 26, 1998 , and cash flows for the twenty-six weeks ended June 25, 1999 and June 26, 1998 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 the Company as of June 25, 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): June 26, 1999 Dec. 25, 1998 ------------- ------------- Finished products and components $ 33,320 $ 27,764 Products and components in various stages of completion 21,332 23,024 Raw materials 18,400 18,970 ------------- ------------- 73,052 69,758 Reduction to LIFO cost (35,643) (35,740) ------------- ------------- $ 37,409 $ 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 identified along reportable segment lines. Sales and operating profit by segment for the thirteen and twenty-six weeks ended June 25, 1999 and June 26, 1998 are as follows (in thousands): <TABLE> Thirteen Weeks Ended Twenty-Six Weeks Ended ---------------------------- ---------------------------- June 25, 1999 June 26, 1998 June 25, 1999 June 26, 1998 ------------- ------------- ------------- ------------- Net Sales <S> <C> <C> <C> <C> Industrial/Automotive $ 53,948 $ 59,313 $ 104,695 $ 116,748 Contractor 49,719 44,255 91,414 81,646 Lubrication 11,036 11,579 21,835 22,476 ------------- ------------- ------------- ------------- Total $ 114,703 $ 115,147 $ 217,944 $ 220,870 ============= ============= ============= ============= Operating Profit Industrial/Automotive $ 12,942 $ 9,399 $ 22,687 $ 16,624 Contractor 13,144 10,841 22,044 17,880 Lubrication 2,676 2,378 4,964 4,128 Unallocated Corporate expenses (2,455) (3,053) (4,114) (4,714) ------------- ------------- ------------- ------------- Consolidated Operating Profit $ 26,307 $ 19,565 $ 45,581 $ 33,918 ============= ============= ============= ============= </TABLE> 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 2001. 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 SFAS 133, if any. 5. On June 1, 1999 the Company purchased certain assets and assumed certain liabilities 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 - --------------------- Net earnings of $18.0 million for the quarter ended June 25, 1999 increased 41 percent from second quarter 1998 earnings of $12.8 million. Diluted earnings per share of $0.86 for the quarter were up 79 percent over diluted earnings per share of $0.48 in the second quarter of 1998. Net earnings included a non-recurring after-tax gain of $2.1 million, or $0.10 per diluted share, from the sale of the Company's Plymouth, Michigan and Los Angeles facilities. The quarterly performance was driven by reduced expenses and improved gross margins. For the six months ended June 25, 1999, net earnings of $29.2 million were 35 percent higher than the $21.7 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: <TABLE> Second Quarter Six Months (13 weeks) Ended (26 weeks) Ended -------------------- ------------------- June June June June 25, 1999 26, 1998 25, 1999 26, 1998 -------- -------- -------- -------- <S> <C> <C> <C> <C> Net Sales 100.0% 100.0% 100.0% 100.0% -------- -------- -------- -------- Cost of products sold 48.0 49.6 48.4 50.2 Product development 4.2 4.1 4.4 4.3 Selling, marketing and distribution 16.5 18.7 17.5 20.0 General and administrative 8.4 10.6 8.8 10.2 -------- -------- -------- -------- Operating Profit 22.9 17.0 20.9 15.4 -------- -------- -------- -------- Interest expense 1.6 .2 1.7 .2 -------- -------- -------- -------- Other (income) expense, net (2.4) (.2) (1.1) .1 -------- -------- -------- -------- Earnings Before Income Taxes 23.7 17.0 20.3 15.1 Income taxes 8.0 5.9 6.9 5.3 -------- -------- -------- -------- Net Earnings 15.7% 11.1% 13.4% 9.8% ======== ======== ======== ======== </TABLE> Net Sales Net sales in the second quarter of $114.7 million were flat compared to net sales in the second quarter of 1998. Year-to-date sales of $217.9 million were down 1 percent and would have been 2 percent lower than last year with consistent exchange rates. 8
Increased sales in the Contractor Equipment segment for the quarter and year-to- date reflect the strong housing market in North America and acceptance of new products. Industrial/Automotive Equipment segment sales for the quarter and first six months of 1999 decreased, due primarily to the Company's exit from the custom designed systems business. Geographically, sales in the Americas increased 2 percent to $79.9 million for the quarter primarily due to strong Contractor sales. Year-to-date sales were up 4 percent compared to the same period last year. European quarterly sales of $20.9 million declined 14 percent from last year, impacted by the exit from the custom designed systems business, and would have been 12 percent lower with consistent exchange rates. Year-to-date sales in Europe were down 16 percent to $40.1 million. Asia Pacific sales of $12.5 million were 31 percent higher than last year's second quarter and 25 percent higher after the positive impact of exchange rates as business is improving throughout the region, except in Japan. Sales in Asia Pacific for the first six months are up 9 percent from the same period last year and up 2 percent after the positive impact of exchange rates. Gross Profit Gross profit as a percentage of quarterly and year-to-date net sales has risen to 52.0 and 51.6 percent respectively, up 1.6 and 1.8 percentage points from the same periods in 1998. The increase was due primarily to the change in approach to serving the automotive industry by providing pre-engineered packages rather than custom designed systems, pricing and production cost containment. Operating Expenses Second quarter operating expenses of $33.3 million decreased 14 percent from the second quarter of 1998. Selling, marketing and distribution expenses were down 12 percent due primarily to restructuring of the Company's industrial and automotive businesses in 1998. General and administrative expenses were down 22 percent, due in part to the results of the restructuring of the Company's Asia Pacific operations in 1998. Product development costs were $4.8 million in the first quarter of 1999 and $4.7 million for the same period in 1998. Year-to-date operating expenses of $66.9 were 12 percent lower than 1998. Interest Expense Interest expense was $1.9 million and $3.8 million for the quarter and first six months of 1999 compared to $0.2 million and $0.4 million for the same periods in 1998. The increase is due to debt related to the repurchase of 5.8 million shares of the Company's common stock for $190.9 million in the third quarter of 1998. Other Income (Expense) Other income was $2.7 million in the second quarter of 1999, compared to $0.2 million in 1998. The second quarter of 1999 included gains on the sale of real estate totaling $3.2 million partially offset by $0.4 million net exchange loss. Other income for the six months ended June 25, 1999 was $2.4 million compared to other expense of $0.1 million in the same period of 1998. 9
Income Taxes The second quarter and year-to-date tax rate was 34 percent in 1999 versus 35 percent for the same periods in 1998. Liquidity and Capital Resources - ------------------------------- The Company generated $32.1 million of cash from operating activities in the first six months of 1999, compared to $25.8 million for the same period last year. Available cash, including $9.5 million received from the sale of real estate, was used to pay $18.4 million for a business acquisition. In addition, cash flow from operating activities allowed the Company to make net payments on borrowings (short and long-term debt) of $18.6 million in the first six months of 1999. The Company had unused lines of credit available at June 25, 1999 totaling $60.3 million. The available credit facilities and internally generated funds provide the Company with the financial flexibility to meet its liquidity needs. 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. Testing of all mission critical mainframe applications and databases was completed in June 1999. The network and desktop upgrades involving the replacement of certain hardware and software is scheduled to be completed by September 1999. The Company has incurred costs totaling $6.0 million, including $1.2 million in 1999, and estimates a total of an additional $0.5 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. 10
Approximately 288 non-IT applications were identified at the Company with approximately 76 percent being Year 2000-compliant as of June 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 will continue through the remainder of 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. The Company will identify alternative suppliers for those key suppliers, if any, unable to supply materials due to Year 2000 issues. 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 that 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 The Company is encouraged by a pick-up in recent order trends in Europe and Asia Pacific (except in Japan). While remaining cautious about the volatility of economies outside of North America, management expects improved earnings performance for the remainder of the year when compared to last year. 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 Non-employee Director Stock Plan, as amended June 18, 1999 Exhibit 10 Computation of Net Earnings per Common Share Exhibit 11 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: July 27, 1999 By: /s/James A. Earnshaw ----------------------------------- James A. Earnshaw President & Chief Executive Officer Date: July 27, 1999 By: /s/James A. Graner ----------------------------------- James A. Graner Vice President & Controller ("duly authorized officer") 13