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 March 31, 2006
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 a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
68,424,000 of the Registrant's Common Stock, $1.00 par value were outstanding as of April 21, 2006.
GRACO INC. AND SUBSIDIARIES
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GRACO INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)
The consolidated balance sheet of Graco Inc. and Subsidiaries (the Company) as of March 31, 2006 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 31, 2006, 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 2005 Annual Report on 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 following table sets forth the computation of basic and diluted earnings per share (in thousands, except per share amounts):
Stock options to purchase 1,000 and 311,800 shares are not included in the 2006 and 2005 calculations of diluted earnings per share, respectively, because they would have been anti-dilutive.
Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment” (SFAS No. 123(R)) became effective for the Company at the beginning of 2006. This standard requires compensation costs related to share-based payment transactions to be recognized in the financial statements. The Company adopted the standard using the modified prospective transition method, whereby compensation cost related to unvested awards as of the effective date are recognized as calculated for pro forma disclosures under SFAS No. 123, and cost related to new awards are recognized in accordance with SFAS No. 123(R). The Company continues to use the Black-Scholes option-pricing model to value option grants. The Company recognized $2.2 million of share-based compensation cost in the first quarter of 2006, which reduced net income by $1.5 million, or $0.02 per weighted average common share.
Had share-based compensation cost for the Employee Stock Purchase Plan and stock options granted under various stock incentive plans been recognized prior to 2006, the Company’s net earnings and earnings per share for the thirteen weeks ended April 1, 2005 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):
Total comprehensive income was as follows (in thousands):
The Company has three reportable segments: Industrial, Contractor and Lubrication. The Company does not identify assets by segment. Sales and operating earnings by segment for the thirteen weeks ended March 31, 2006 and April 1, 2005 were as follows (in thousands):
Major components of inventories were as follows (in thousands):
Information related to other intangible assets follows (dollars in thousands):
Amortization of intangibles during the first quarter of 2006 was $1.3 million. Estimated annual amortization expense is as follows: $5.2 million in 2006, $5.1 million in 2007, $4.5 million in 2008, $4.0 million in 2009, $3.6 million in 2010 and $6.7 million thereafter.
Components of other current liabilities were (in thousands):
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 product warranty issues. Following is a summary of activity in accrued warranty and service liabilities (in thousands):
In April 2006, the Company announced that it would close its plant and office facilities in Lakewood, New Jersey. The Company intends to move the Lakewood operation to North Canton, Ohio, where it currently has a manufacturing facility. As part of this consolidation, the Company will build a 60,000 square foot expansion of the North Canton facility. The Company is also moving its spray foam production from Villanova, Spain to Minneapolis, Minnesota.
Results of Operations
Increases in sales and gross profit margin rate, along with smaller increases in expenses, resulted in higher net earnings in the first quarter of 2006. As a percentage of sales, net earnings improved to 18.4 percent, compared to 15.8 percent for the first quarter of 2005. 2006 results include $2.2 million of share-based compensation cost and a $1 million contribution to the Company’s charitable foundation. There were no comparable costs included in 2005 first quarter results. Foreign currency translation rates had an adverse impact on first quarter sales and net earnings. Translated at consistent exchange rates, sales increased 14 percent, compared to 12 percent translated at actual rates.
Net Sales
Sales by reportable segment and geographic area were as follows (in thousands):
All reportable segments experienced double-digit percentage growth in sales. Geographically, sales in the Americas and Europe also experienced double-digit percentage growth. Sales in Asia Pacific were 4 percent lower than the first quarter of last year, but bookings and backlog in this region increased.
Industrial sales increased by 14 percent. Translated at consistent exchange rates, sales increased by 17 percent. Demand for this segment’s products remained strong in all major product categories.
Contractor sales increased by 10 percent, with contributions from new product introductions and strong growth in the professional paint stores channel.
Lubrication sales increased by 16 percent, with good demand for its key products, including PBL products, acquired in late 2005.
Gross Profit
Gross profit as a percentage of sales was 53.7 percent compared to 50.2 percent for the first quarter last year. Nearly 2 percentage points of the increase was due to the recognition of higher costs assigned to inventories of acquired operations in 2005. Favorable factory productivity, spending and volume in 2006, along with enhanced pricing, contributed to the improvement in gross margin percentage, more than offsetting the adverse impact of currency translation.
Operating Expenses
Total operating expenses increased by $3.9 million, including $1.8 million of share-based compensation expense and a $1 million charitable foundation contribution. Expenses as a percentage of sales decreased to 25.3 percent from 26.1 percent.
Income Taxes
The effective tax rate is 35 percent for 2006, up from 33.5 percent for 2005, due to reduced available tax credits.
Liquidity and Capital Resources
Significant uses of cash in the first quarter of 2006 included $17 million for purchases and retirement of Company common stock and $10 million for payment of dividends. During the first quarter of 2005, significant uses of cash included $103 million for acquisitions of businesses, $9 million of dividends paid and $7 million for purchases and retirement of Company common stock. The Company used cash on hand and a $40 million advance from a line of credit to fund the acquisitions.
The Company had unused lines of credit available at March 31, 2006 totaling $89 million. Cash balances of $27 million at March 31, 2006, internally generated funds and unused financing sources provide the Company with the financial flexibility to meet liquidity needs, including the costs, estimated at approximately $4 to $6 million, related to the planned move and consolidation of the operations currently located in Lakewood, New Jersey and Villanova, Spain.
Outlook
Results for the first quarter were in line with management’s expectations. While management’s vision is limited due to the short cycle nature of the business, the sales tempo experienced throughout the quarter was good and management continues to expect growth this year.
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, or 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 Item 1A of, and Exhibit 99 to, the Company’s Annual Report on Form 10-K for fiscal year 2005 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.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
There are no material changes related to market risk from the disclosures made in the Company’s 2005 Annual Report on Form 10-K.
Item 4. Controls and Procedures
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 Chairman, President and Chief Executive Officer, Chief Financial Officer 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 OTHER INFORMATION
Item 1A. Risk Factors
There have been no material changes to the Company’s risk factors from those disclosed in the Company’s 2005 Annual Report on Form 10-K.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On February 20, 2004, the Board of Directors authorized the Company to purchase up to a total of 3,000,000 shares of its outstanding common stock, primarily through open-market transactions. This authorization effectively expired February 17, 2006, upon Board approval authorizing the purchase of up to 7,000,000 shares, expiring on February 29, 2008.
In addition to shares purchased under the Board authorization, 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 option exercises.
Information on issuer purchases of equity securities follows:
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 6. Exhibits
Credit agreement dated April 1, 2006, between the Company and Wachovia Bank, N.A. (Promissory Note and Offering Basis Loan Agreement)
Certification of Chairman, President and Chief Executive Officer pursuant to Rule 13a-14(a)
Certification of Chief Financial Officer and Treasurer pursuant to Rule 13a-14(a)
Certification of Chairman, President and Chief Executive Officer and Chief Financial Officer and Treasurer pursuant to Section 1350 of Title 18, U.S.C.
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.