Item 2.
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GRACO INC. AND SUBSIDIARIES
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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Results of Operations
Net earnings of $39 million for the quarter were 5 percent higher than
net earnings in the third quarter last year. Sales of $207 million were 3 percent higher
than the same period last year. Year-to-date net earnings of $117 million were 3 percent
higher than last year and sales of $636 million were up 4 percent. Higher sales in Europe
and Asia were offset to a great extent by lower sales in the Americas.
Foreign currency translation rates had a favorable impact on sales and
net earnings. Translated at consistent exchange rates, net earnings and sales for the
quarter were each up 1 percent. Year-to-date net earnings were down 1 percent and sales
increased 2 percent.
Results include the operations of Lubriquip, which was acquired in July
2006. Sales of Lubriquip products contributed approximately 2 percentage points of
year-to-date sales growth. Year-to-date costs and expenses related to moving and
consolidation activities (including the consolidation of Gusmer operations completed in
the first quarter) totaled approximately $2 million.
Net Sales
Sales by reportable segment and geographic area were as follows (in
thousands):
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Thirteen Weeks Ended
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Thirty-nine Weeks Ended
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Sep 28,
2007
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Sep 29,
2006
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Sep 28,
2007
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Sep 29,
2006
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Net Sales
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Industrial
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$107,791
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$101,149
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$327,137
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$305,864
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Contractor
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76,649
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78,659
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240,631
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249,518
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Lubrication
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22,830
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22,391
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68,381
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57,665
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Consolidated
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$207,270
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$202,199
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$636,149
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$613,047
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By Geographic Area
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Americas
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$124,373
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$133,339
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$386,400
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$409,923
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Europe
2
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53,109
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43,334
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161,154
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128,234
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Asia Pacific
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29,788
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25,526
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88,595
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74,890
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Consolidated
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$207,270
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$202,199
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$636,149
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$613,047
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1
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North
and South America, including the U.S.
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2
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Europe,
Africa and Middle East
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Industrial segment sales increased 7 percent for both the quarter and
year-to-date. Double-digit percentage growth in Europe and Asia more than offset the 5
percent decrease in the Americas for both the quarter and year-to-date.
Contractor segment sales decreased 3 percent for the quarter and 4
percent year-to-date. Strong increases in Europe and Asia were not enough to offset the
decrease in the Americas, where sales were down in both the home center and the professional paint store channels.
Lubrication segment sales increased 2 percent for the quarter and 19
percent year-to-date. The year-to-date increase is due to sales of Lubriquip products,
acquired in mid-2006. Year-to-date sales in this segment increased in all geographic
areas.
Gross Profit
Gross profit as a percentage of sales was 53.4 percent for the quarter
compared to 52.7 percent for the third quarter last year. Translated at consistent
exchange rates, gross profit percentage for the quarter is virtually the same as last
year.
Year-to-date gross profit percentage was 53.1 percent in 2007 compared
to 53.3 percent in 2006. The decrease was due mainly to lower margin rates on Lubriquip
products, consolidation costs and higher material costs, offset somewhat by the favorable
impacts of currency translation and pricing.
Operating Expenses
Total operating expenses for the quarter increased 1 percent. Product
development and general and administrative expenses were down slightly while higher
selling, marketing and distribution spending was in line with the sales increase.
Year-to-date operating expenses increased 4 percent, mostly due to
expenses related to Lubriquip. Operating expenses as a percentage of sales are about the
same as last year.
Income Taxes
The effective income tax rate of 32 percent for the quarter was 2
percentage points lower than the year-to-date rate. The lower rate in the quarter resulted
from expiring statutes of limitations and a higher than expected benefit upon filing
of prior year tax returns.
Effective tax rates were about the same as last year for both the
quarter and year-to-date.
Liquidity and Capital Resources
In the first nine months of 2007, the Company used cash from operations
and borrowings to purchase and retire $165 million of Company common stock. Other
significant uses of cash in the first nine months of 2007 included $33 million for payment
of dividends and $28 million for capital additions.
In the first nine months of 2006, the Company used primarily cash from
operations to purchase and retire $70 million of Company common stock. Other significant
uses of cash in the first nine months of 2006 included $31 million for the acquisition of
Lubriquip, $30 million for payment of dividends and $22 million for capital additions.
In July 2007, the Company entered into an agreement with a syndicate of
lenders providing $250 million of unsecured committed credit with an option for an
additional $150 million. The new credit facility will be used for general corporate
purposes including acquisitions and share repurchases. Upon securing the new facility,
certain committed lines of credit totaling $50 million were terminated. Additional
uncommitted lines totaling $55 million expired at the end of July 2007.
At September 28, 2007, the Companys various lines of credit,
including the new facility, totaled $295 million, of which $193 million was unused.
Internally generated funds and unused financing sources provide the Company with the
financial flexibility to meet liquidity needs.
Outlook
Management is optimistic about continued strength in the Companys
international businesses and remains cautious in its outlook for the
Americas. Portions of the Companys business that have ties to the housing sector in
the Americas are expected to be soft until market conditions improve.
In September 2007, the Company announced the launch of new paint
sprayers in the home center channel. The new sprayers are expected to generate higher
per-store net sales; however sales to home centers in 2008 are estimated to be approximately $7
to $8 million lower than 2007 due to a reduction in the number of stores carrying the
sprayers. Incremental expenses totaling approximately $5 million related to the launch and
production of new units will be incurred over the next 15 months, including $0.5 million
in 2007.
The integration of Lubriquip is on track for completion by the end of
the year and the consolidation of Gusmer operations was completed in the first quarter.
These integration activities will improve the contribution of the acquired products.
Management believes it can continue to guide the business to higher
sales and earnings by making long-term investments in key growth strategies including new
product development, expanding distribution, entering new markets and pursuing 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, or in press or earnings releases, analyst briefings and conference calls,
which reflects the Companys current thinking on market trends and the Companys
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
Companys Annual Report on Form 10-K for fiscal year 2006 for a more comprehensive
discussion of these and other risk factors.
Investors should realize that factors other than those identified above
and in Item 1A and Exhibit 99 might prove important to the Companys future results.
It is not possible for management to identify each and every factor that may have an
impact on the Companys 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 Companys 2006 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 Companys President and Chief Executive Officer, the
Chief Financial Officer and Treasurer, the Vice President and Controller, and the Vice
President, General Counsel and Secretary. Based upon that evaluation, they concluded that
the Companys disclosure controls and procedures are effective in gathering,
analyzing and disclosing information needed to satisfy the Companys disclosure
obligations under the Exchange Act.
Changes in internal controls
During the quarter, there was no change in the Companys internal
control over financial reporting that has materially affected or is reasonably likely to
materially affect the Companys internal control over financial reporting.