UNITED STATESSECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15 (d) of the SecuritiesExchange Act of 1934
For the quarterly period ended September 24, 2004
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).
69,132,000 common shares were outstanding as of October 19, 2004.
INDEX
See notes to consolidated financial statements.
See notes to consolidated financial statements
The consolidated balance sheet of Graco Inc. and Subsidiaries (the Company) as of September 24, 2004, and the related statements of earnings for the thirteen and thirty-nine weeks ended September 24, 2004 and September 26, 2003, and cash flows for the thirty-nine weeks ended September 24, 2004 and September 26, 2003 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 24, 2004, 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 2003 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.
On February 20, 2004, the Board of Directors declared a three-for-two split of the Company’s common stock. The split was distributed on March 30, 2004 to shareholders of record on March 16, 2004. Share and per share amounts for all periods presented reflect the stock split.
The following table sets forth the computation of basic and diluted earnings per share (in thousands, except per share amounts):
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):
The components of net periodic benefit cost for retirement benefit plans were as follows (in thousands):
In December 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the Act) was signed into law. The Company’s retirement medical plan is not eligible for the Medicare subsidy under the Act.
Total comprehensive income in 2004 was $28.8 million in the third quarter and $80.8 million year-to-date. In 2003, comprehensive income was $22.7 million for the third quarter and $65.6 million for the nine-month period. There have been no significant changes to the components of comprehensive income from those noted on the 2003 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 24, 2004 and September 26, 2003 were as follows (in thousands):
Major components of inventories were as follows (in thousands):
Information related to other intangible assets follows (in thousands):
Amortization of intangibles was $0.3 million in the third quarter of 2004 and $1.4 million year-to-date. Estimated annual amortization is as follows: $1.7 million in 2004, $1.1 million in 2005, $0.9 million in 2006, $0.9 million in 2007, $0.4 million in 2008 and $0.3 million thereafter.
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 warranty issues. Following is a summary of activity in accrued warranty and service liabilities (in thousands):
The Company has been named as a defendant in a number of lawsuits alleging bodily injury as a result of exposure to asbestos or silica. None of the suits make any allegations specifically regarding the Company or any of its products. Management does not know why the Company was included in the suits along with hundreds of other defendants. Management does not expect that resolution of these matters will have a material adverse effect on the Company, although the ultimate outcome cannot be determined based on available information.
Results of Operations
Increased sales and higher gross margin rates resulted in a 27 percent increase in net earnings for the quarter and a 24 percent increase year-to-date. Factors contributing to the improved results include better economic conditions, controlled spending increases, and favorable foreign currency translation rates. Translated at consistent exchange rates, third quarter and year-to-date net earnings increased by 21 percent and 17 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):
North and South America, including the U.S.
Europe, Africa and Middle East
Industrial/Automotive segment sales increased 18 percent for the both the quarter and year-to date. Translated at consistent exchange rates, sales increased 14 percent for the quarter and 13 percent year-to-date. Sales in this segment grew in all three geographic regions and across all major product categories. New product introductions contributed to sales growth, including the ProMix™ II and ProMix Easy units, which were launched in the second quarter.
Contractor segment sales increased 5 percent for the quarter and 6 percent year-to-date. Translated at consistent exchange rates, sales were up 4 percent for the quarter and 5 percent year-to-date. Sales increased in all geographic regions, with strong volume increases in Europe and Asia Pacific. In the Americas, sales were higher in both the professional paint store channel and in the home center channel. Sales were aided by demand for new products, including the new Ultra® Max II sprayers and a new texture unit.
Lubrication segment sales were up 17 percent for the quarter and 7 percent year-to-date. Translated at consistent exchange rates, sales were up 16 percent for the quarter and 6 percent year-to-date. Sales increased in all geographic regions, with most of the increase from the Americas. New product introductions include the Mini Fire-Ball oil pump released for sale in August.
Gross Profit
Gross margin rate was higher for the quarter and year-to-date. The effect of higher material costs on margin rate was more than offset by the favorable effects of production volume, productivity, favorable foreign currency translation rates and pension costs.
Operating Expenses
Operating expenses for the quarter were 4 percent higher than the third quarter last year and 5 percent higher year-to-date. Operating expenses for both the quarter and year-to-date decreased as a percentage of sales. The Company increased spending on product development to meet its stated objective of creating sales growth from new products. Changes in currency translation rates contributed significantly to the increase in selling, marketing and distribution expenses. Year-to-date contributions to the Company’s charitable foundation (included in general and administrative expenses) were $2.7 million in 2004 compared to $1.1 million last year.
Year-to-date operations include a pension benefit credit of $.7 million compared to $2 million of expense in the same period last year. This change resulted from the increase in pension plan assets due to investment gains and the $20 million voluntary contribution made in the fourth quarter of 2003. Pension income / expense is allocated based on related salaries and wages, approximately 45 percent to cost of products sold and 55 percent to operating expenses.
Liquidity and Capital Resources
Significant uses of cash in the first nine months of 2004 included $123 million of dividends paid (including $104 million for a one-time special dividend) and $33 million for purchases and retirement of Company common stock. Inventories have increased to support higher sales and from actions taken to improve customer service.
The Company has announced that it intends to open a manufacturing facility in the Shanghai region of China sometime in the second half of 2005. The facility will be approximately 50,000 square feet and will require approximately $4 million in capital investment.
The Company had unused lines of credit available at September 24, 2004 totaling $48 million. Subsequent to the end of the quarter, the Company obtained an additional $20 million uncommitted line of credit. Cash balances of $56 million at September 24, 2004, internally generated funds and unused financing sources provide the Company with the financial flexibility to meet liquidity needs, including its capital expenditure plan.
Outlook
Management has not been able to identify economic indicators that predict future Company results. The Company has experienced sales growth from favorable economic conditions and has leveraged fixed costs to improve profitability. Management is encouraged by these results, especially given the substantial price increases the Company has experienced for raw materials like steel. Management will attempt to protect the Company’s margins by increasing prices in 2005 and continuing to reduce manufacturing costs and improve efficiencies. While management is uncertain as to the duration of the economic recovery, it is cautiously optimistic that favorable conditions will remain for the balance of 2004 and into early 2005. Management is looking forward to the prospects for further growth as it pursues its strategies of developing new product, entering new markets, expanding distribution and making strategic acquisitions.
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 2003 for a more comprehensive discussion of these and other risk factors.
Investors should realize that factors other than those identified above and in Exhibit 99 might prove important to the Company’s future results. It is not possible for management to identify each and every factor that may have an impact on the Company’s operations in the future as new factors can develop from time to time.
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
Item 1. Legal Proceedings
The Company is engaged in routine litigation incident to its business, which management believes will not have a material adverse effect on its operations or consolidated financial position. The Company has also been named as a defendant in a number of lawsuits alleging bodily injury as a result of exposure to asbestos, and a number of lawsuits alleging bodily injury as a result of exposure to silica. All of these lawsuits have multiple (most in excess of 100) defendants, and several have multiple plaintiffs. None of the suits make any allegations specifically regarding the Company or any of its products. A substantial portion of the cost and potential liability for these cases is covered by insurance, although the exact extent of insurance coverage cannot be determined at this time because the cases are in the early stages of the litigation process and the allegations are so indefinite. Management does not expect that resolution of these matters will have a material adverse effect on the Company, although the ultimate outcome cannot be determined based on available information.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities 1
On February 22, 2002, the Board of Directors authorized a plan for the Company to purchase up to a total of 2,700,000 shares of its outstanding common stock, primarily through open-market transactions. This plan effectively expired upon approval of a new plan on February 20, 2004, authorizing the purchase of up to 3,000,000 shares and expiring on February 28, 2006.
In addition to shares purchased under the plan, the Company purchases shares of common stock held by employees who wish to tender owned shares to satisfy the exercise price or tax withholding on stock option exercises.
Information on issuer purchases of equity securities follows:
All share and per share data reflects the three-for-two stock splits distributed on June 6, 2002 and March 30, 2004.
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.