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 24, 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 ---------- ------------- 20,415,979 common shares were outstanding as of October 22, 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 Amendment dated August 31, 1999, to Credit Agreement Dated June 26, 1998 between the Company and Wachovia Bank, N.A. Exhibit 4 Retirement and Release Agreement between Clayton R. Carter and the Company, dated June 26, 1999. Exhibit 10 Separation and Release Agreement between Roger L. King and the Company, dated August 10, 1999. Exhibit 10.1 Computation of Net Earnings per Common Share Exhibit 11 Financial Data Schedule (EDGAR filing only) Exhibit 27
<TABLE> PART I GRACO INC. AND SUBSIDIARIES Item I. CONSOLIDATED STATEMENTS OF EARNINGS (Unaudited) Thirteen Weeks Ended Twenty Six Weeks Ended ----------------------------- ---------------------------- Sept 24, 1999 Sept 25, 1998 Sept 24, 1999 Sept 25,1998 (In thousands except per share amounts) <S> <C> <C> <C> <C> Net Sales $ 110,076 $ 106,202 $ 328,020 $ 327,072 Cost of products sold 52,566 52,221 158,034 163,059 ------------- ------------- ------------- ------------ Gross Profit 57,510 53,981 169,986 164,013 Product development 4,845 4,369 14,370 13,867 Selling, marketing and distribution 19,049 19,725 57,289 63,922 General and administrative 9,599 9,920 28,729 32,339 ------------- ------------- ------------- ------------ Operating Profit 24,017 19,967 69,598 53,885 Interest expense 1,661 2,569 5,472 2,967 Other (income) expense, net (187) 675 (2,579) 783 ------------- ------------- ------------- ------------ Earnings Before Income Taxes 22,543 16,723 66,705 50,135 Income taxes 7,500 5,650 22,500 17,350 ------------- ------------- ------------- ------------ Net Earnings $ 15,043 $ 11,073 $ 44,205 $ 32,785 ============= ============= ============= ============ Basic Net Earnings Per Common Share $ .74 $ .54 $ 2.19 $ 1.38 ============= ============= ============= ============ Diluted Net Earnings Per Common Share $ .72 $ .53 $ 2.12 $ 1.35 ============= ============= ============= ============ See notes to consolidated financial statements. </TABLE>
GRACO INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands) Sept 24, 1999 Dec. 25, 1998 ------------- ------------- ASSETS (Unaudited) Current Assets: Cash and cash equivalents $ 2,082 $ 3,555 Accounts receivable, less allowances of $4,800 and $4,400 79,081 80,146 Inventories 36,293 34,018 Deferred income taxes 12,769 12,384 Other current assets 1,846 1,217 ------------- ------------- Total current assets 132,071 131,320 Property, Plant and Equipment: Cost 189,191 199,122 Accumulated depreciation (102,478) (102,756) ------------- ------------ 86,713 96,366 Other Assets 13,219 6,016 ------------- ------------- $ 232,003 $ 233,702 ============= ============= LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities: Notes payable to banks $ 4,284 $ 14,560 Current portion of long-term debt 1,715 3,157 Trade accounts payable 10,349 11,965 Salaries, wages & commissions 13,137 14,025 Accrued insurance liabilities 11,153 10,809 Income taxes payable 6,391 5,134 Other current liabilities 22,284 23,316 ------------- ------------- Total current liabilities 69,313 82,966 Long-Term Debt, less current portion 82,098 112,582 Retirement Benefits and Deferred Compensation 30,484 28,841 Shareholders' Equity: Common stock 20,415 20,097 Additional paid-in capital 29,480 23,892 Retained deficit (1,639) (35,878) Other, net 1,852 1,202 ------------- ------------- Total shareholders' equity 50,108 9,313 ------------- ------------- $ 232,003 $ 233,702 ============= ============= See notes to consolidated financial statements.
GRACO INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) Thirty-Nine Weeks ------------------------------ Sept 24, 1999 Sept 25, 1998 ------------- ------------- CASH FLOWS FROM OPERATING ACTIVITIES: (In thousands) Net Earnings $ 44,205 $ 32,785 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization 11,451 10,975 Deferred income taxes (88) (1,052) (Gain) loss on sale of fixed assets (3,147) 211 Change in: Accounts receivable 2,534 2,100 Inventories 4,910 3,949 Trade accounts payable (1,554) (1,703) Salaries, wages and commissions (656) (1,352) Retirement benefits and deferred compensation (715) (1,705) Other accrued liabilities 689 4,507 Other 300 1,906 ------------- ------------- 57,929 50,621 ------------- ------------- CASH FLOWS FROM INVESTING ACTIVITIES: Property, plant and equipment additions (5,947) (8,486) Proceeds from sale of property, plant and equipment 9,523 112 Acquisition of business (18,389) - ------------- ------------- (14,813) (8,374) ------------- ------------- CASH FLOWS FROM FINANCING ACTIVITIES: Borrowings on notes payable and lines of credit 90,243 39,407 Payments on notes payable and lines of credit (100,585) (32,591) Borrowings on long-term debt 25,001 176,200 Payments on long-term debt (56,821) (41,045) Common stock issued 6,125 4,709 Retirement of common stock (3,468) (190,899) Cash dividends paid (6,682) (8,491) ------------- ------------- (46,187) (52,710) ------------- ------------- Effect of exchange rate changes on cash 1,598 582 ------------- ------------- Net increase in cash and cash equivalents (1,473) (9,881) Cash and cash equivalents: Beginning of period 3,555 13,523 ------------- ------------- End of period $ 2,082 $ 3,642 ============= ============= See notes to consolidated financial statements.
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 24, 1999, and the related statements of earnings for the thirteen and thirty-nine weeks ended September 24, 1999 and September 25, 1998, and cash flows for the thirty-nine weeks ended September 24, 1999 and September 25, 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 September 24, 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): Sept 26, 1999 Dec 25, 1998 ------------- ------------ Finished products and components $ 32,397 $ 27,764 Products and components in various stages of completion 20,865 23,024 Raw materials 18,551 18,970 ------------- ------------ 71,813 69,758 Reduction to LIFO cost (35,520) (35,740) ------------- ------------ $ 36,293 $ 34,018 ============= ============
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 thirty-nine weeks ended September 24, 1999 and September 25, 1998 are as follows (in thousands): <TABLE> Thirteen Weeks Ended Thirty-Nine Weeks Ended --------------------------- ----------------------------- Sept 24,1999 Sept 25,1998 Sept 24, 1999 Sept 25,1998 ------------ ------------ ------------- ------------ Net Sales <S> <C> <C> <C> <C> Industrial/Automotive $ 56,982 $ 55,331 $ 161,677 $ 172,078 Contractor 42,988 39,785 134,402 121,432 Lubrication 10,106 11,086 31,941 33,562 ------------ ------------ ------------- ------------ Total $ 110,076 $ 106,202 $ 328,020 $ 327,072 ============ ============ ============= ============ Operating Profit Industrial/Automotive $ 11,846 $ 10,345 $ 34,533 $ 26,969 Contractor 11,038 9,623 33,081 27,503 Lubrication 2,326 2,222 7,291 6,350 Unallocated Corporate expenses (1,193) (2,223) (5,307) (6,937) ------------ ------------ ------------- ------------ Total $ 24,017 $ 19,967 $ 69,598 $ 53,885 ============ ============ ============= ============ </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. The Company formed Graco Verfahrenstechnik (GV) which on June 1, 1999 purchased certain assets and assumed certain liabilities of Bollhoff Verfahrenstechnik (BV), located in Bielefeld, Germany. BV designed, manufactured and sold fluid application equipment for industrial and automotive markets, primarily in Germany, and had 1998 sales of approximately $20 million.
Item 2. GRACO INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Results of Operations Net earnings of $15.0 million and diluted earnings per share of $0.72 for the quarter ended September 24, 1999 were up 36 percent from the third quarter of 1998. Reduced expenses and improved sales drove the quarterly performance. For the nine months ended September 24, 1999, net earnings of $44.2 million are 35 percent higher than the earnings in the same period a year ago while diluted earning per share of $2.12 are up 57 percent due to improved earnings and the common stock repurchase in 1998. Year to date net earnings include 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 following table sets forth items from the Company's Consolidated Statements of Earnings as percentages of net sales: <TABLE> Third Quarter Nine Months (13 weeks) Ended (39 weeks) Ended -------------------- -------------------- September September September September 24, 1999 25, 1998 24, 1999 25, 1998 --------- --------- --------- --------- <S> <C> <C> <C> <C> Net Sales 100.0% 100.0% 100.0% 100.0% --------- --------- --------- --------- Cost of products sold 47.8 49.2 48.2 49.9 Product development 4.4 4.1 4.4 4.2 Selling, marketing and distribution 17.3 18.6 17.5 19.5 General and administrative 8.7 9.3 8.7 9.9 --------- --------- --------- --------- Operating Profit 21.8 18.8 21.2 16.5 --------- --------- --------- --------- Interest expense 1.5 2.5 1.7 1.0 --------- --------- --------- --------- Other (income) expense, net (0.2) .6 (0.8) .2 --------- --------- --------- --------- Earnings Before Income Taxes 20.5 15.7 20.3 15.3 Income taxes 6.8 5.3 6.9 5.3 --------- --------- --------- --------- Net Earnings 13.7% 10.4% 13.4% 10.0% ========= ========= ========= ========= </TABLE>
Net Sales Net sales in the third quarter of $110.1 million were up 4 percent from the third quarter of 1998. Year-to-date sales of $328.0 million were up slightly when compared to last year. Contractor Equipment segment sales were up 8 percent in the quarter and 11 percent year-to-date as the housing market in the North America has remained strong. Industrial/Automotive segment sales were up slightly for the quarter but remained below 1998 on a year-to-date basis primarily due to the Company's exit from the custom designed systems business. Lubrication Equipment segment sales were below 1998 in the third quarter due in part to a shift in promotional activity from the third quarter last year into the fourth quarter of 1999. Geographically, sales in the America's of $75.0 million were flat for the quarter when compared to the same period last year. Year-to-date sales were up 3 percent from the first nine months of 1998. European sales of $18.4 million were 12 percent higher than last year's third quarter, and would have been 18 percent higher with consistent exchange rates. Third quarter sales growth in Europe was due primarily to Industrial/Automotive sales generated by Graco Verfahrenstechnik, acquired in June of 1999. Year-to-date sales in Europe were down 7 percent. Asia Pacific quarterly sales of $11.1 million increased 21 percent from last year (up 11 percent with consistent exchange rates) as business improved throughout the Asia Pacific region, except in Japan. Sales in Asia Pacific for the first nine months were up 13 percent from last year and were up 5 percent with consistent exchange rates. Gross Profit Gross profit as a percentage of quarterly and year-to-date sales has risen to 52.2 and 51.8 percent, up 1.4 and 1.7 percentage points from the same periods in 1998. The increases were due primarily to the change in approach to serving the automotive industry by providing pre-engineered packages rather than custom designed systems, pricing and cost containment. Operating Expenses Third quarter operating expenses of $33.5 million decreased 2 percent from the third quarter of 1999, despite the addition of GV. Selling, marketing and distribution expenditures are down 10 percent in the first nine months of 1999, when compared to the same period last year due primarily to restructuring of the Company's industrial and automotive businesses in 1998. Year-to-date general and administrative expenses were 11 percent lower than 1998 due largely to the results of restructuring the Company's Asia Pacific operations last year and due to decreased Year 2000 related expenditures. Interest Expense Interest expense was $1.6 and $5.5 million for the quarter and first nine months of 1999, down significantly from the third quarter of 1998 as the Company continues to pay down the debt related to the repurchase of 5.8 million shares of the Company's common stock for $190.9 million in July of 1998.
Other Income (Expense) Other income was $0.2 million in the third quarter of 1999, compared to $0.7 million expense in 1998. The third quarter of 1998 was unfavorably impacted by the settlement of a lawsuit. Other income for the nine months ended September 24, 1999 included gains on the sale of real estate totaling $3.2 million. Income Taxes The third quarter and year-to-date income tax rates were 33 and 34 percent in 1999 versus 34 and 35 percent for the same periods in 1998. Liquidity and Capital Resources - ------------------------------- The Company generated $57.9 million of cash from operating activities in the first nine months of 1999, compared to $50.6 million for the same period last year. Cash flow from operating activities and $9.5 million received from the sale of real estate was used to pay $18.6 million for a business acquisition. In addition, the company made net payments on borrowings (short and long-term debt) of $42.2 million in the first nine months of 1999. The company had unused lines of credit available at September 24, 1999 totaling $83.1 million. 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 has nearly completed 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 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, was substantially complete in September 1999. The Company has incurred costs totaling approximately $6.2 million, including $1.4 million in 1999, and estimates an additional $0.3 million will 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. Existing resources were redeployed and other projects 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 have been 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 300 non-IT applications were identified at the Company. Non-IT applications are primarily microprocessors and other electronic controls embedded in non-computer equipment used by the Company. All business critical, and substantially all non-business critical non-IT applications were compliant as of September 1999. Conversion of the remaining non-IT applications 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 had discussions with, and sent questionnaires to, its suppliers to assess their Year 2000 readiness. The Company is not aware of any Year 2000 issues with its suppliers that would have a material impact on the Company's results. 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 were successfully converted 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 optimistic that sales growth will continue for the remainder of the year while maintaining gross profit percentages. 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.
PART II Item 6. Exhibits and Reports on Form 8-K (a) Exhibits Amendment dated August 31, 1999, to Credit Agreement dated June 26, 1998 between the Company and Wachovia Bank, N.A. Exhibit 4 Retirement and Release Agreement between Clayton R. Carter and the Company dated June 26, 1999. Exhibit 10 Separation and Release Agreement between Roger L. King and the Company, dated August 10, 1999. Exhibit 10.1 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.
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: October 27, 1999 By: /s/James A. Earnshaw ---------------- ----------------------------------------- James A. Earnshaw President & Chief Executive Officer Date: October 27, 1999 By: /s/James A. Graner ---------------- ----------------------------------------- James A. Graner Vice President & Controller (duly authorized officer)