UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15 (d) of theSecurities Exchange Act of 1934
For the quarterly period ended September 26, 2003
Commission File Number:001-9249
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.
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).
GRACO INC. AND SUBSIDIARIES
INDEX
GRACO INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
The consolidated balance sheet of Graco Inc. and Subsidiaries (the Company) as of September 26, 2003, and the related statements of earnings for the thirteen and thirty-nine weeks ended September 26, 2003 and September 27, 2002, and cash flows for the thirty-nine weeks ended September 26, 2003 and September 27, 2002 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 September 26, 2003, 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 2002 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.
The Company accounts for stock option and purchase plans using the intrinsic value method and has adopted the “disclosure only” provisions of Statement of Financial Accounting Standards (SFAS) No. 123, as amended by SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure.” No compensation cost has been recognized for the Employee Stock Purchase Plan and stock options granted under the various stock incentive plans.
Had compensation cost been determined based upon fair value (using the Black-Scholes option-pricing method) at the grant date for awards under these plans, the Company’s net earnings and earnings per share would have been reduced as follows (in thousands, except per share amounts):
Total comprehensive income in 2003 was $22.7 million in the third quarter and $65.6 million year-to-date. In 2002, comprehensive income was $20.5 million for the third quarter and $57.6 million for the nine-month period. There have been no significant changes to the components of comprehensive income from those noted on the 2002 Form 10-K.
The Company has three reportable segments; Industrial/Automotive, Contractor and Lubrication. The Company does not identify assets by segment. Sales and operating earnings by segment for the thirteen and thirty-nine weeks ended September 26, 2003 and September 27, 2002 were as follows (in thousands):
Major components of inventories were as follows (in thousands):
At the beginning of the second quarter, the Company purchased certain assets and assumed certain liabilities of Sharpe Manufacturing Company for $13.5 million cash. Sharpe manufactures spray guns and related parts and accessories for the automotive refinishing market, where the Company had no previous presence. Sharpe had sales of approximately $11 million in 2002. Results of Sharpe’s operations have been included in the Industrial/Automotive segment since the date of acquisition.
The purchase price was allocated as follows (in thousands):
Included in identifiable intangible assets is $5.3 million assigned to the Sharpe brand name, which has an indefinite useful life. Remaining identifiable intangible assets mainly consist of Sharpe’s distribution network, which is being amortized over an estimated useful life of 5 years. Goodwill is expected to be fully deductible for tax purposes.
Information related to other intangible assets follows (in thousands):
Amortization of intangibles was $.6 million in the third quarter of 2003 and $1.6 million year-to-date. Estimated annual amortization is as follows: $2.2 million in 2003, $1.7 million in 2004, $1.1 million in 2005, $.9 million in 2006 and $.9 million in 2007.
A liability is established for estimated future warranty and service claims that relate to current and prior period sales. The Company estimates warranty costs based on historical claim experience and other factors including evaluating specific customer warranty issues. Following is a summary of 2003 activity in accrued warranty and service liabilities (in thousands):
Subsequent Event: In October 2003, the Company made a voluntary $20 million tax-deductible contribution to its defined benefit pension plan. The contribution will enhance the funded status of the plan, reduce future pension expense and reduce the need for additional cash contributions in the near term.
Results of Operations
Third quarter sales and net earnings increased 6 percent and 11 percent, respectively. Year-to-date sales and net earnings increased 9 percent and 14 percent, respectively. Stronger foreign currencies versus the U.S. dollar helped to increase third quarter and year-to-date results when compared to 2002. Translated at consistent exchange rates, third quarter sales and net earnings each increased by 4 percent and year-to-date sales and net earnings increased by 5 percent and 3 percent, respectively.
The following table sets forth items from the Company's Consolidated Statements of Earnings as percentages of net sales:
Net Sales
Sales by segment and geographic area were as follows (in thousands):
1North and South America, including the U.S.2Europe, Africa and Middle East
Industrial/Automotive segment sales increased 9 percent for the quarter and 12 percent year-to date. The increase came from strong sales in Asia Pacific, currency translation and the Sharpe acquisition. Most of the currency translation effect came from Europe, where sales for the quarter were flat in local currencies but increased by 11 percent when translated to U.S. dollars. Year-to-date sales in Europe for this segment were down 2 percent in local currencies but increased by 14 percent when translated to U.S. dollars.
Contractor segment sales increased 4 percent for the quarter and 8 percent year-to-date. In the Americas, third quarter sales were higher in the paint store channel but decreased in the home center channel due to a change in inventory purchasing practices at a major customer. Management believes the full impact of this change was reflected in third quarter sales. Year-to-date sales increased in both the paint store and in the home center channels. Sales increases in Europe were mostly from currency translation. Sales in Asia Pacific were up 18 percent for the quarter and 32 percent year-to-date.
Lubrication segment sales were up 10 percent for the quarter and 3 percent year-to-date. The timing of promotions in the second quarter of 2002 and in the third quarter of 2003 influenced the increase in the third quarter.
Gross Profit
For the quarter, gross margin rate was higher due to favorable exchange rates, pricing, material cost reductions and factory efficiencies. Year-to-date, gross margin rate was flat when translated at consistent exchange rates.
Operating Expenses
Increased warranty and extended service costs, Sharpe operations and changes in exchange rates drove operating expenses higher in both the third quarter and year-to-date. Year-to-date operating expenses were also affected by increased payroll related costs including salaries (normal rate increases), incentives (higher sales and earnings) and benefits (pension and medical).
Year-to-date operations include $1.3 million of pension expense related to the Company’s U.S. defined benefit pension plan, compared to a $.8 million credit in the same period last year. This change resulted from the decrease in pension plan assets due to recognition of investment losses. Pension expense/income is allocated to cost of products sold and operating expenses based on salaries and wages.
Operating Earnings
Higher sales and gross profit rates in the quarter resulted in increased operating earnings in the Industrial/Automotive and Contractor segments. Lubrication segment operating earnings decreased due to re-work costs and warranty expenses of approximately $1 million resulting from design problems associated with the Matrix fluid management system, a product launched in late 2002.
Liquidity and Capital Resources
In March 2003, the Company repurchased 2.2 million shares of its common stock for $54.8 million from David A. Koch, a former Chairman and Chief Executive Officer of the Company, his wife, a family trust and a family foundation. The repurchase is expected to be accretive to earnings per share and yield a rate of return to remaining shareholders that will exceed the Company’s equity cost of capital. The per share purchase price represented a discount of 5.5 percent from the ten-day average closing price of the Company’s stock immediately prior to the date of the transaction. The Company used available cash balances to fund the repurchase.
In the second quarter of 2003, the Company acquired the operations of Sharpe Manufacturing Company, utilizing available cash of $13.5 million and assuming liabilities totaling $1.6 million.
In October 2003, the Company made a $20 million tax-deductible contribution to its defined benefit pension plan. The contribution was made to increase pension assets at a time when values have declined due to weak short-term asset performance. The contribution will enhance the funded status of the plan, reduce future pension expense and reduce the need for additional cash contributions in the near term.
The Company had unused lines of credit available at September 26, 2003 totaling $47 million. Cash balances of $96 million at September 26, 2003, internally generated funds and unused financing sources provide the Company with the financial flexibility to meet liquidity needs.
Outlook
Despite ongoing soft conditions in its two largest geographic markets, the Company remains on track to make 2003 a year of sales and earnings growth. Management has yet to see any material signs of an increase in underlying demand for its Industrial/Automotive products in the Americas, and economic conditions throughout Europe remain weak. Management expects this to continue for at least the balance of this year. Asia, except for Japan, remains strong with higher demand for the Company’s products as companies continue to invest in infrastructure and increased durable goods output.
SAFE HARBOR CAUTIONARY STATEMENT
A forward-looking statement is any statement made in this report and other reports that the Company files periodically with the Securities and Exchange Commission, as well as in press or earnings releases, analyst briefings and conference calls, which reflects the Company’s current thinking on market trends and the Company’s future financial performance at the time they are made. All forecasts and projections are forward-looking statements.
The Company desires to take advantage of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995 by making cautionary statements concerning any forward-looking statements made by or on behalf of the Company. The Company cannot give any assurance that the results forecasted in any forward-looking statement will actually be achieved. Future results could differ materially from those expressed, due to the impact of changes in various factors. These risk factors include, but are not limited to: economic conditions in the United States and other major world economies, currency fluctuations, political instability, changes in laws and regulations, and changes in product demand. Please refer to Exhibit 99 to the Company’s Annual Report on Form 10-K for fiscal year 2002 for a more comprehensive discussion of these and other risk factors.
Evaluation of disclosure controls and procedures
As of the end of the fiscal quarter covered by this report, the Company carried out an evaluation of the effectiveness of the design and operation of its disclosure controls and procedures. This evaluation was done under the supervision and with the participation of the Company’s President and Chief Executive Officer, Vice President and Controller, Vice President and Treasurer, and Vice President, General Counsel and Secretary. Based upon that evaluation, they concluded that the Company’s disclosure controls and procedures are effective in gathering, analyzing and disclosing information needed to satisfy the Company’s disclosure obligations under the Exchange Act.
Changes in internal controls
During the quarter, there was no change in the Company’s internal control over financial reporting that has materially affected or is reasonably likely to materially affect the Company’s internal control over financial reporting.
PART II
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.