Graco Inc. Form 10-Q, First Quarter 2006

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 March 31, 2006

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)


88 - 11th Avenue N.E.    
Minneapolis, Minnesota   55413
(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                 

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).

Large Accelerated Filer    X    Accelerated Filer         Non-accelerated Filer        

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

  Yes                  No        X         

68,424,000 of the Registrant's Common Stock, $1.00 par value were outstanding as of April 21, 2006.

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 6-10
         
  Item 2. Management's Discussion and Analysis
      of Financial Condition and  
      Results of Operations 11-13
         
  Item 3. Quantitative and Qualitative Disclosures About Market Risk 14
         
  Item 4. Controls and Procedures 14
         
         
PART II OTHER INFORMATION  
         
  Item 1A. Risk Factors 15
         
  Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 15
         
  Item 4. Submission of Matters to a Vote of Security Holders 15
         
  Item 6. Exhibits 16
         
SIGNATURES    
         
EXHIBITS    

PART I

 
Item 1.		 GRACO INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS		  
  (Unaudited)  
  (In thousands, except per share amounts)  

      Thirteen Weeks Ended
      March 31, 2006   April 1, 2005  
                 
Net Sales     $ 192,216   $ 170,944  
                 
     Cost of products sold    88,989    85,078  
Gross Profit    103,227    85,866  
                 
     Product development    7,212    6,244  
                 
     Selling, marketing and distribution    27,942    26,407  
                 
     General and administrative    13,421    12,048  
Operating Earnings    54,652    41,167  
                 
     Interest expense    125    339  
                 
     Other expense, net    5    189  
Earnings before Income Taxes    54,522    40,639  
                 
     Income taxes    19,100    13,600  
Net Earnings   $ 35,422   $ 27,039  
Basic Net Earnings per Common Share   $ .52   $ .39  
                 
Diluted Net Earnings per Common Share   $ .51   $ .38  
                 
Cash Dividends Declared per Common Share   $ .15   $ .13  
                 
                 
See notes to consolidated financial statements.
  GRACO INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS		  
  (Unaudited)  
  (In thousands)  

  March 31, 2006   Dec. 30, 2005  
ASSETS            
   
Current Assets  
     Cash and cash equivalents   $ 27,183   $ 18,664  
     Accounts receivable, less allowances  
        of $6,100 and $5,900    129,118    122,854  
     Inventories    64,562    56,547  
     Deferred income taxes    15,733    14,038  
     Other current assets    1,841    1,795  
            Total current assets    238,437    213,898  
   
Property, Plant and Equipment  
     Cost    259,411    255,463  
     Accumulated depreciation    (152,840 )  (148,965 )
            Property, plant and equipment, net    106,571    106,498  
   
Prepaid Pension    30,026    29,616  
Goodwill    52,254    52,009  
Other Intangible Assets, net    38,291    39,482  
Other Assets    3,944    4,127  
            Total Assets   $ 469,523   $ 445,630  
LIABILITIES AND SHAREHOLDERS' EQUITY   
   
Current Liabilities  
     Notes payable to banks   $ 4,341   $ 8,321  
     Trade accounts payable    29,640    24,712  
     Salaries, wages and commissions    13,694    23,430  
     Dividends payable    9,918    9,929  
     Other current liabilities    54,314    45,189  
            Total current liabilities    111,907    111,581  
   
Retirement Benefits and Deferred Compensation    36,145    35,507  
   
Deferred Income Taxes    10,819    10,858  
   
Shareholders' Equity  
     Common stock    68,408    68,387  
     Additional paid-in capital    124,049    110,842  
     Retained earnings    121,750    112,506  
     Other, net    (3,555 )  (4,051 )
            Total shareholders' equity    310,652    287,684  
            Total Liabilities and Shareholders' Equity   $ 469,523   $ 445,630  
   
See notes to consolidated financial statements.
  GRACO INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS		  
  (Unaudited)  
  (In thousands)  

        Thirteen Weeks Ended
      March 31, 2006   April 1, 2005  
Cash Flows from Operating Activities            
     
   Net Earnings   $ 35,422   $ 27,039  
     Adjustments to reconcile net earnings to net  
      cash provided by operating activities  
        Depreciation and amortization    5,781    5,703  
        Deferred income taxes    (1,706 )  (766 )
        Share-based compensation    2,164    --  
        Excess tax benefit related to share-based  
         payment arrangements    (2,000 )  --  
        Change in:  
          Accounts receivable    (6,471 )  (3,107 )
          Inventories    (7,934 )  (2,329 )
          Trade accounts payable    4,906    1,824  
          Salaries, wages and commissions    (9,825 )  (9,472 )
          Retirement benefits and deferred compensation    19    (86 )
          Other accrued liabilities    11,883    6,182  
          Other    50    814  
Net cash provided by operating activities     32,289    25,802  
Cash Flows from Investing Activities   
   
   Property, plant and equipment additions    (4,371 )  (3,735 )
   Proceeds from sale of property, plant and equipment    19    32  
   Acquisitions of businesses, net of cash acquired    --    (102,534 )
Net cash used in investing activities     (4,352 )  (106,237 )
Cash Flows from Financing Activities   
   
   Borrowings on notes payable and lines of credit    4,333    45,816  
   Payments on notes payable and lines of credit    (8,310 )  (6,062 )
   Excess tax benefit related to share-based payment  
      arrangements    2,000    --  
   Common stock issued    10,200    7,946  
   Common stock retired    (17,404 )  (7,017 )
   Cash dividends paid    (9,922 )  (8,969 )
Net cash provided by (used in) financing activities     (19,103 )  31,714  
Effect of exchange rate changes on cash    (315 )  488  
Net increase (decrease) in cash and cash equivalents    8,519    (48,233 )
Cash and cash equivalents  
   Beginning of year    18,664    60,554  
   End of period   $ 27,183   $ 12,321  
               
See notes to consolidated financial statements.

GRACO INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1.

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.


2.

The following table sets forth the computation of basic and diluted earnings per share (in thousands, except per share amounts):


        Thirteen Weeks Ended
        March 31, 2006   April 1, 2005  
               
Net earnings available to common shareholders     $ 35,422   $ 27,039  
               
Weighted average shares outstanding for basic  
earnings per share    68,428    69,074  
               
Dilutive effect of stock options computed based on  
the treasury stock method using the average  
market price    1,121    1,200  
               
Weighted average shares outstanding for  
diluted earnings per share    69,549    70,274  
               
Basic earnings per share   $ .52   $ .39  
               
Diluted earnings per share   $ .51   $ .38  

 

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.


3.

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):


Net earnings        
As reported   $ 27,039  
Stock-based compensation, net of related tax effects    (1,058 )
   Pro forma   $ 25,981  
Net earnings per common share   
Basic as reported   $.39
Basic pro forma    .38
Diluted as reported    .38  
Diluted pro forma    .37  

4.

The components of net periodic benefit cost for retirement benefit plans were as follows (in thousands):


      Thirteen Weeks Ended
      March 31, 2006   April 1, 2005  
                 
Pension Benefits                
Service cost   $ 1,440   $ 1,251  
Interest cost    2,608    2,489  
Expected return on assets    (4,175 )  (3,950 )
Amortization and other    192    157  
Net periodic benefit cost (credit)   $ 65   $ (53 )
                 
Postretirement Medical   
Service cost   $ 250   $ 225  
Interest cost    420    410  
Amortization of net loss    186    115  
Net periodic benefit cost   $ 856   $ 750  

5.

Total comprehensive income was as follows (in thousands):


      Thirteen Weeks Ended
      March 31, 2006   April 1, 2005  
Net income     $ 35,422   $ 27,039  
Foreign currency translation adjustments    515    (117 )
Minimum pension liability adjustment, net of tax    (19 )  14  
Comprehensive income   $ 35,918   $ 26,936  

6.

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):


      Thirteen Weeks Ended
      March 31, 2006   April 1, 2005  
Net Sales            
Industrial   $ 100,160   $ 87,869  
Contractor    74,352    67,780  
Lubrication    17,704    15,295  
Consolidated   $ 192,216   $ 170,944  
Operating Earnings   
Industrial   $ 32,083   $ 21,964  
Contractor    21,042    15,086  
Lubrication    4,755    4,199  
Unallocated corporate expenses    (3,228 )  (82 )
Consolidated   $ 54,652   $ 41,167  

7.

Major components of inventories were as follows (in thousands):


      March 31, 2006   Dec. 30, 2005  
Finished products and components     $ 44,643   $ 40,444  
Products and components in various stages  
   of completion    22,322    21,788  
Raw materials and purchased components    25,660    22,690  
        92,625     84,922  
Reduction to LIFO cost    (28,063 )  (28,375 )
Total   $ 64,562   $ 56,547  

8.

Information related to other intangible assets follows (dollars in thousands):


   
Estimated
Life (Years) 		 
Original 
Cost    		 
Amorti- 
zation  		 Foreign   
Currency  
Translation
Book 
Value 
March 31, 2006          
Customer relationships and          
   distribution network 4 - 8 $22,402 $(4,673) $(348) $17,381
Patents, proprietary technology          
   and product documentation 5 - 15 12,143 (2,380) (143) 9,620
Trademarks, trade names          
   other 3 - 10 1,624 (764) -- 860
   
36,169
(7,817)
(491)
27,861
Not Subject to Amortization:          
Brand names   10,550 -- (120) 10,430
Total  
$46,719
$(7,817)
$(611)
$38,291
December 30, 2005          
Customer relationships and          
   distribution network 4 - 8 $22,965 $(4,419) $(427) $18,119
Patents, proprietary technology          
   and product documentation 3 - 15 12,266 (2,065) (174) 10,027
Trademarks, trade names and          
   other 3 - 10 1,774 (837) -- 937
   
37,005
(7,321)
(601)
29,083
Not Subject to Amortization:          
Brand names   10,550 -- (151) 10,399
Total  
$47,555
$(7,321)
$(752)
$39,482

 

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.


9.

Components of other current liabilities were (in thousands):


      March 31, 2006   Dec. 30, 2005  
                 
Accrued insurance liabilities     $ 8,048   $ 7,848  
Accrued warranty and service liabilities    7,418    7,649  
Accrued trade promotions    4,909    6,584  
Payable for employee stock purchases    996    5,710  
Income taxes payable    20,124    4,075  
Other    12,819    13,323  
    $ 54,314   $ 45,189  

 

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):


      Thirteen Weeks
Ended      
March 31, 2006 		  Year Ended  
Dec. 30, 2005 		 
                 
Balance, beginning of year     $ 7,649   $ 9,409  
Charged to expense       1,106     6,045  
Margin on parts sales reversed       333     1,201  
Reductions for claims settled       (1,670 )   (9,006 )
Balance, end of period     $ 7,418   $ 7,649  

10.

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.


Item 2. GRACO INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS		  

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):

           Thirteen Weeks Ended  
      March 31, 2006   April 1, 2005  
                 
By Segment            
Industrial   $ 100,160   $ 87,869  
Contractor    74,352    67,780  
Lubrication    17,704    15,295  
Consolidated   $ 192,216   $ 170,944  
By Geographic Area   
Americas1    $ 132,212   $ 114,019  
Europe2     39,546    35,709  
Asia Pacific    20,458    21,216  
Consolidated   $ 192,216   $ 170,944  
1    North and South America, including the U.S.
2    Europe, Africa and Middle East

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:

Period                                     (a)
Total Number
of Shares
Purchased 		(b)
Average
Price Paid
per Share 		(c)
Total Number
of Shares
Purchased as
Part of Publicly
Announced
Plans or
Programs 		(d)
Maximum
Number of
Shares that
May Yet Be
Purchased
Under the
Plans or
Programs (at
end of period)
                    
Dec 31, 2005 - Jan 27, 2006 969       $38.97    --       786,600          
                    
Jan 28, 2006 - Feb 24, 2006 143,051       $39.65    142,100       7,000,000          
                    
Feb 25, 2006 - Mar 31, 2006 275,970        $42.38    255,100       6,774,900          


Item 4.   Submission of Matters to a Vote of Security Holders

 

None


Item 6.   Exhibits

  4.1

Credit agreement dated April 1, 2006, between the Company and Wachovia Bank, N.A. (Promissory Note and Offering Basis Loan Agreement)

  31.1

Certification of Chairman, President and Chief Executive Officer pursuant to Rule 13a-14(a)


  31.2

Certification of Chief Financial Officer and Treasurer pursuant to Rule 13a-14(a)


  32

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.

      GRACO INC.
       
       
       
Date:    April 26, 2006    By:    /s/David A. Roberts              
      David A. Roberts
      Chairman, President and Chief Executive Officer
      (Principal Executive Officer)
       
       
       
Date:    April 26, 2006    By:    /s/James A. Graner              
      James A. Graner
      Chief Financial Officer and Treasurer
      (Principal Financial Officer)