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Graco Inc. Form 10-Q, Third Quarter 2005

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 September 30, 2005

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 an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

  Yes        X          No                 

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

  Yes                  No        X         

68,543,000 common shares were outstanding as of October 24, 2005.

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 6-12
       
  Item 2. Management's Discussion and Analysis of Financial
         Condition and Results of Operations 13-16
       
  Item 4. Controls and Procedures 17
       
       
PART II OTHER INFORMATION  
       
  Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 18
       
  Item 4. Submission of Matters to a Vote of Security Holders 18
       
  Item 6. Exhibits 18
       
SIGNATURES  
       
EXHIBITS  

PART I

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

        Thirteen Weeks Ended         Thirty-nine Weeks Ended  
  Sept 30, 2005   Sept 24, 2004   Sept 30, 2005   Sept 24, 2004  
 
Net Sales     $ 176,934   $ 149,066   $ 546,099   $ 444,213  
 
     Cost of products sold    82,212    66,946    263,219    203,547  
Gross Profit    94,722    82,120    282,880    240,666  
 
     Product development    7,031    5,231    19,890    15,798  
     Selling, marketing and distribution    27,581    24,449    82,260    73,976  
     General and administrative    13,148    9,195    38,257    29,208  
Operating Earnings    46,962    43,245    142,473    121,684  
 
     Interest expense    343    115    1,190    384  
     Other expense, net    121    113    508    277  
Earnings before Income Taxes    46,498    43,017    140,775    121,023  
 
     Income taxes    15,600    14,200    47,200    39,900  
Net Earnings   $ 30,898   $ 28,817   $ 93,575   $ 81,123  
Basic Net Earnings  
     per Common Share   $ .45   $ .42   $ 1.36   $ 1.17  
 
Diluted Net Earnings  
     per Common Share   $ .44   $ .41   $ 1.34   $ 1.15  
 
Cash Dividends Declared  
     per Common Share   $ .13   $ .09   $ .39   $ .28  
 
 
 
See notes to consolidated financial statements.
  GRACO INC. AND SUBSIDIARIES  
  CONSOLIDATED BALANCE SHEETS  
  (Unaudited)  
  (In thousands)  

  Sept 30, 2005   Dec 31, 2004  
ASSETS        
         
Current Assets                
     Cash and cash equivalents   $ 14,278   $ 60,554  
     Accounts receivable, less allowances  
        of $5,900 and $5,600    119,856    109,080  
     Inventories    58,705    40,219  
     Deferred income taxes    15,247    15,631  
     Other current assets    1,113    1,742  
          Total current assets    209,199    227,226  
         
Property, Plant and Equipment  
     Cost    253,404    231,819  
     Accumulated depreciation    (150,095 )  (137,309 )
          Property, plant and equipment, net    103,309    94,510  
         
Prepaid Pension    29,101    27,556  
Goodwill    49,129    9,199  
Other Intangible Assets, net    37,098    8,959  
Other Assets    4,330    4,264  
          Total Assets   $ 432,166   $ 371,714  
LIABILITIES AND SHAREHOLDERS' EQUITY   
         
Current Liabilities  
     Notes payable to banks   $ 16,170   $ 6,021  
     Trade accounts payable    22,531    18,599  
     Salaries, wages and commissions    20,111    19,804  
     Dividends payable    8,914    8,990  
     Other current liabilities    48,410    43,359  
          Total current liabilities    116,136    96,773  
         
Retirement Benefits and Deferred Compensation    32,888    33,092  
         
Deferred Income Taxes    11,050    11,012  
         
Shareholders' Equity  
     Common stock    68,510    68,979  
     Additional paid-in capital    109,720    100,180  
     Retained earnings    96,693    62,773  
     Other, net    (2,831 )  (1,095 )
          Total shareholders' equity    272,092    230,837  
          Total Liabilities and Shareholders' Equity   $ 432,166   $ 371,714  


See notes to consolidated financial statements.

  GRACO INC. AND SUBSIDIARIES  
  CONSOLIDATED STATEMENTS OF CASH FLOWS  
  (Unaudited)  
  (In thousands)  

  Thirty-nine Weeks Ended  
  Sept 30, 2005   Sept 24, 2004  
Cash Flows from Operating Activities            
 
   Net Earnings   $ 93,575   $ 81,123  
     Adjustments to reconcile net earnings to net cash      
      provided by operating activities  
        Depreciation and amortization    17,603    13,333  
        Deferred income taxes    (95 )  (985 )
        Tax benefit related to stock options exercised    1,900    5,500  
        Change in  
          Accounts receivable    (3,762 )  (3,740 )
          Inventories    1,783    (10,112 )
          Trade accounts payable    (1,385 )  2,353  
          Salaries, wages and commissions    (1,187 )  800  
          Retirement benefits and deferred compensation    (788 )  (777 )
          Other accrued liabilities    1,898    7,015  
          Other    660    (152 )
Net cash provided by operating activities     110,202    94,358  
Cash Flows from Investing Activities   
   Property, plant and equipment additions    (12,027 )  (9,184 )
   Proceeds from sale of property, plant and equipment    136    126  
   Capitalized software and other intangible asset additions    (785 )  (856 )
   Acquisitions of businesses, net of cash acquired    (102,797 )  --  
Net cash used in investing activities     (115,473 )  (9,914 )
Cash Flows from Financing Activities   
 
   Borrowings on notes payable and lines of credit    75,346    20,943  
   Payments on notes payable and lines of credit    (64,989 )  (19,186 )
   Common stock issued    9,573    14,075  
   Common stock retired    (35,238 )  (32,773 )
   Cash dividends paid    (26,894 )  (123,460 )
Net cash used in financing activities     (42,202 )  (140,401 )
Effect of exchange rate changes on cash    1,197    112  
Net increase (decrease) in cash and cash equivalents    (46,276 )  (55,845 )
 
Cash and cash equivalents  
 
   Beginning of year    60,554    112,118  
   End of period   $ 14,278   $ 56,273  


See notes to consolidated financial statements.

GRACO INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1.

The consolidated balance sheet of Graco Inc. and Subsidiaries (the Company) as of September 30, 2005, and the related statements of earnings for the thirteen and thirty-nine weeks ended September 30, 2005 and September 24, 2004, and cash flows for the thirty-nine weeks ended September 30, 2005 and September 24, 2004 have been prepared by the Company and have not been 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 30, 2005, 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 2004 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   Thirty-nine Weeks Ended  
  Sept 30, 2005   Sept 24, 2004   Sept 30, 2005   Sept 24, 2004  
Net earnings available to                    
  common shareholders   $ 30,898   $ 28,817   $ 93,575   $ 81,123  
     
Weighted average shares  
  outstanding for basic  
  earnings per share    68,612    69,176    68,881    69,167  
     
Dilutive effect of stock  
  options computed using the  
  treasury stock method and  
  the average market price    1,095    1,067    1,125    1,089  
     
Weighted average shares  
  outstanding for diluted  
  earnings per share    69,707    70,243    70,006    70,256  
     
Basic earnings per share   $ .45   $ .42   $ 1.36   $ 1.17  
Diluted earnings per share   $ .44   $ .41   $ 1.34   $ 1.15  

 

Stock options to purchase 370,300 shares are not included in the 2005 calculation of diluted earnings per share because they would have been anti-dilutive.


3.

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):


  Thirteen Weeks Ended     Thirty-nine Weeks Ended  
Sept 30, 2005   Sept 24, 2004   Sept 30, 2005   Sept 24, 2004  
Net earnings          
           
As reported     $ 30,898   $ 28,817   $ 93,575   $ 81,123  
Stock-based compensation, net of          
  related tax effects    1,279    878    3,583    2,594  
     
 
 		  
 
 		  
 
 		  
 
 		  
   Pro forma   $ 29,619   $ 27,939   $ 89,992   $ 78,529  
     
 
 		  
 
 		  
 
 		  
 
 		  
Net earnings per common share       
           
Basic as reported   $ .45   $ .42   $ 1.36   $ 1.17  
Basic pro forma    .43    .40    1.31    1.14  
Diluted as reported    .44    .41    1.34    1.15  
Diluted pro forma    .42    .40    1.29    1.12  

 

In December 2004, the Financial Accounting Standards Board issued SFAS No. 123 (Revised 2004), “Share-Based Payment” that requires compensation costs related to share-based payment transactions to be recognized in the financial statements. This standard will be effective for the Company starting with the first quarter of 2006. Annual compensation cost, net of tax effects, related to unvested stock compensation as of September 30, 2005 is approximately $4.8 million in 2005, $2.6 million in 2006, $1.8 million in 2007 and $0.7 million in 2008 (as valued and calculated under SFAS 123 pro forma disclosures.) The Company has not yet determined how it will value future grants or whether it will elect to adjust prior periods upon adoption of SFAS No. 123 (Revised 2004).


4.

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


  Thirteen Weeks Ended   Thirty-nine Weeks Ended
  Sept 30, 2005   Sept 24, 2004   Sept 30, 2005   Sept 24, 2004  
Pension Benefits                    
Service cost   $ 1,154   $ 982   $ 3,509   $ 3,067  
Interest cost    2,482    2,193    7,453    6,554  
Expected return on assets    (3,762 )  (3,524 )  (11,662 )  (10,571 )
Amortization and other    250    5    475    263  
Net periodic benefit cost (credit)   $ 124   $ (344 ) $ (225 ) $ (687 )
Postretirement Medical   
Service cost   $ 181   $ 193   $ 631   $ 578  
Interest cost    395    375    1,215    1,126  
Amortization of net loss    164    113    394    339  
Net periodic benefit cost   $ 740   $ 681   $ 2,240   $ 2,043  

5.

Total comprehensive income was as follows (in thousands):


Thirteen Weeks Ended Thirty-nine Weeks Ended
  Sept 30, 2005   Sept 24, 2004   Sept 30, 2005   Sept 24, 2004  
     
Net income     $ 30,898   $ 28,817   $ 93,575   $ 81,123  
Foreign currency  
   translation adjustments    (107 )  --    (1,881 )  --  
Minimum pension liability  
   adjustment, net of tax    1    --    32    (366 )
Comprehensive income   $ 30,792   $ 28,817   $ 91,726   $ 80,757  

 

The functional currency of certain subsidiaries in Great Britain and Spain, each acquired in 2005, is local currency. Accordingly, adjustments resulting from the translation of those subsidiaries’ financial statements into U.S. dollars are charged or credited to accumulated other comprehensive income.


6.

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 30, 2005 and September 24, 2004 were as follows (in thousands):


Thirteen Weeks Ended Thirty-nine Weeks Ended
Sept 30, 2005 Sept 24, 2004 Sept 30, 2005 Sept 24, 2004
Net Sales   
     
Industrial/Automotive     $ 88,052   $ 67,305   $ 269,696   $ 197,027  
Contractor    75,318    68,620    232,665    209,205  
Lubrication    13,564    13,141    43,738    37,981  
Consolidated   $ 176,934   $ 149,066   $ 546,099   $ 444,213  
Operating Earnings   
     
Industrial/Automotive   $ 23,618   $ 22,411   $ 70,282   $ 62,886  
Contractor    19,370    18,578    60,210    53,874  
Lubrication    3,278    3,446    11,524    9,096  
Unallocated Corporate    696    (1,190 )  457    (4,172 )
Consolidated   $ 46,962   $ 43,245   $ 142,473   $ 121,684  

 

Segment operating earnings for 2004 have been restated to conform to 2005, which includes amortization of intangibles formerly classified as unallocated corporate.


7.

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


  Sept 30, 2005   Dec 31, 2004  
                 
Finished products and components     $ 44,137   $ 29,263  
                 
Products and components in various stages  
of completion    21,745    18,656  
                 
Raw materials and purchased components    20,515    19,929  
     86,397    67,848  
                 
Reduction to LIFO cost    (27,692 )  (27,629 )
    $ 58,705   $ 40,219  
8.

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


   
Estimated
Life (Years) 		 
Original 
Cost    		 
Amorti- 
zation  		 Foreign   
Currency  
Translation
Book 
Value 
September 30, 2005          
Customer relationships and          
   distribution network 4 - 8 $20,365 $(3,665) $(340) $16,360
Patents, proprietary technology          
   and product documentation 3 - 15 11,096 (1,666) (139) 9,291
Trademarks, trade names          
   favorable lease and other 3 - 10 1,774 (759) -- 1,015
   
33,235
(6,090)
(479)
26,666
Not Subject to Amortization:          
Brand names   10,550 -- (118) 10,432
Total  
$43,785
$(6,090)
$(597)
$37,098
December 31, 2004          
Customer relationships and          
   distribution network 5 $ 3,765 $(1,543) $     -- $ 2,222
Patents, proprietary technology          
   and product documentation 3 - 15 1,241 (611) -- 630
Trademarks, trade names and          
   other 2 - 10 1,494 (667) -- 827
   
6,500
(2,821)
--
3,679
Not Subject to Amortization:          
Brand names   5,280 -- -- 5,280
Total  
$11,780
$(2,821)
$     --
$ 8,959

 

Amortization of intangibles was $1.2 million in the third quarter of 2005 and $3.4 million year-to-date. Estimated annual amortization is as follows: $4.5 million in 2005, $4.6 million in 2006, $4.6 million in 2007, $4.0 million in 2008, $3.5 million in 2009 and $9.3 million thereafter.


9.

Components of other current liabilities were (in thousands):


    Sept 30, 2005 Dec 31, 2004
  Accrued insurance liabilities $ 9,033 $ 9,139
  Accrued warranty and service liabilities 8,803 9,409
  Accrued trade promotions 5,830 6,574
  Payable for employee stock purchases 4,222 4,913
  Income taxes payable 5,642 2,188
  Other   14,880   11,136
    $48,410 $43,359

 

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):


    Thirty-nine    
Weeks Ended 
Sept 30, 2005 
Year Ended  
Dec 31, 2004 
       
  Balance, beginning of year $9,409  $  9,227 
  Charged to expense 5,334  8,066 
  Margin on parts sales reversed 1,226  2,516 
  Reductions for claims settled (7,166) (10,400)
  Balance, end of period $8,803  $  9,409 

10.

Effective January 1, 2005, the Company purchased the stock of Liquid Control Corporation and its affiliated company Profill Corp. for approximately $35 million cash. Liquid Control designs and manufactures highly engineered precision resin dispensing equipment, which will expand and complement the Company’s Industrial/Automotive business. Liquid Control had sales of approximately $26 million in 2004. Results of Liquid Control’s operations have been included in the Industrial/Automotive segment since the date of acquisition.


 

The purchase price was allocated based on estimated fair values as follows (in thousands):


  Accounts receivable and prepaid expenses $ 2,900   
  Inventories 4,900   
  Property, plant and equipment 7,800   
  Identifiable intangible assets 16,100   
  Goodwill 8,600   
  Total purchase price 40,300   
  Liabilities assumed (4,900)  
  Net assets acquired $35,400   

 

Identifiable intangible assets and weighted average estimated useful life are as follows (dollars in thousands):


  Customer relationships (8 years) $10,100   
  Proprietary technology (8 years) 3,500   
  Total (8 years) 13,600   
  Brand names (indefinite useful life) 2,500   
  Total identifiable intangible assets $16,100   

 

For tax purposes, the transaction will be treated as a purchase of assets and goodwill is expected to be fully deductible.


 

Effective February 4, 2005, the Company purchased the stock of Gusmer Corporation and Gusmer Europe, S.L. for approximately $68 million cash. Gusmer designs and manufactures specialized two-component dispense equipment systems, which will expand and complement the Company’s Industrial/Automotive business. Gusmer had sales of approximately $43 million in 2004. Results of Gusmer’s operations have been included in the Industrial/Automotive segment since the date of acquisition.


 

The purchase price was allocated based on estimated fair values as follows (in thousands):


  Cash and cash equivalents $     500   
  Accounts receivable 7,400   
  Inventories 15,600   
  Property, plant and equipment 2,900   
  Identifiable intangible assets 15,800   
  Goodwill 32,200   
  Total purchase price 74,400   
  Liabilities assumed (6,500)  
  Net assets acquired $67,900   

 

Identifiable intangible assets and weighted average estimated useful life are as follows (dollars in thousands):


  Customer relationships (7 years) $ 6,500   
  Proprietary technology (8 years) 4,400   
  Product documentation (5 years) 1,800   
  Favorable lease (3 years) 400   
  Total (7 years) 13,100   
  Brand names (indefinite useful life) 2,700   
  Total identifiable intangible assets $15,800   

 

For tax purposes, the transaction will be treated as a purchase of assets and goodwill is expected to be fully deductible.


 

The following pro forma information assumes the acquisitions of Liquid Control and Gusmer occurred as of the beginning of each year presented. The pro forma information is not necessarily indicative of what would have actually occurred or of future results (in thousands, except per share amounts).


       Thirteen Weeks Ended        Thirty-nine Weeks Ended
  Sept 30, 2005 Sept 24, 2004 Sept 30, 2005 Sept 24, 2004
Net sales $176,934 $166,626 $550,718 $496,892
Net earnings 30,898 29,177 92,992 78,790
Basic earnings per share .45 .42 1.35 1.14
Diluted earnings per share .44 .42 1.33 1.12
  GRACO INC. AND SUBSIDIARIES  
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS 		 

Results of Operations

Sales and net earnings increased for the quarter and year-to-date. The rate of sales growth exceeded the rate of net earnings growth as a result of acquired operations having lower gross profit rates and higher operating expense rates. During the quarter, acquired operations attained break-even operating results. Year-to-date, acquired operations contributed approximately half of the increase in sales and more than three-fourths of the increase in operating expenses.

The following table sets forth items from the Company’s Consolidated Statements of Earnings as percentages of net sales:


      Thirteen Weeks Ended     Thirty-nine Weeks Ended    
      Sept 30,
2005   		  Sept 24,
2004   		  Sept 30,
2005   		  Sept 24,
2004   		 
Net Sales       100.0 %   100.0 %   100.0 %   100.0 %
   Cost of products sold     46.5     44.9     48.2     45.8
Gross Profit     53.5     55.1     51.8     54.2  
   Product development       4.0     3.5     3.6     3.5  
   Selling, marketing and distribution     15.6     16.4     15.1     16.7  
   General and administrative     7.4     6.2     7.0     6.6  
Operating Earnings     26.5     29.0     26.1     27.4  
   Interest expense     0.2     0.1     0.2     0.1  
   Other (income) expense, net     --     0.1     0.1     --  
Earnings Before Income Taxes     26.3     28.8     25.8     27.3  
   Income taxes     8.8     9.5     8.7     9.0  
Net Earnings     17.5 %   19.3 %   17.1 %   18.3 %

Net Sales

Sales by segment and geographic area were as follows (in thousands):

            Thirteen Weeks Ended           Thirty-nine Weeks Ended
  Sept 30, 2005 Sept 24, 2004 Sept 30, 2005 Sept 24, 2004
 
By Segment
 
Industrial/Automotive $  88,052 $  67,305 $269,696 $197,027
Contractor 75,318 68,620 232,665 209,205
Lubrication 13,564 13,141 43,738 37,981
Consolidated $176,934 $149,066 $546,099 $444,213
By Geographic Area
 
Americas1 $117,598 $100,621 $364,188 $297,663
Europe2 36,390 29,533 112,416 90,525
Asia Pacific 22,946 18,912 69,495 56,025
Consolidated $176,934 $149,066 $546,099 $444,213
 

1 North and South America, including the U.S.
2 Europe, Africa and Middle East


Compared to last year, consolidated sales increased by 19 percent for the quarter and 23 percent year-to-date. Sales from acquired businesses contributed 11 percentage points to both the quarter increase and the year-to-date increase. The impact of currency translations was negligible for the quarter and contributed 1 percentage point to the year-to-date increase. All operating segments and geographic regions experienced growth in sales for both the quarter and year-to-date.

Industrial / Automotive segment sales increased 31 percent for the quarter and 37 percent year-to-date. Acquired businesses contributed 24 and 25 percentage points to the quarterly and year-to date increases, respectively. Favorable currency translations contributed 2 percentage points to the year-to-date increase. Sales were higher in all three regions for both the quarter and year-to-date.

Contractor segment sales increased 10 percent for the quarter and 11 percent year-to-date. In the Americas, sales for the quarter were higher in the professional paint store channel due to new products and strong underlying demand. In the home center channel, sales for the quarter were slightly lower as a result of changes in inventory stocking practices by a major customer. Both channels still show strong increases in sales on a year-to-date basis. In Europe, demand for the segment’s products remained strong, resulting in double-digit percentage sales growth for both the quarter and year-to-date.

Lubrication segment sales increased 3 percent for the quarter and 15 percent year-to-date. Sales were higher in all major products and all geographic regions.

Gross Profit

Gross profit as a percentage of sales was 53.5 percent for the third quarter and 51.8 percent year-to-date, down from 55.1 percent and 54.2 percent, respectively, last year. Most of the decrease was due to the impact of acquisitions, including lower margins on acquired products and the recognition of costs assigned to inventories as part of the valuation of assets acquired. Gross profit rate improved in the third quarter compared to the second quarter as most of the value of acquired inventory was reflected in the cost of goods sold in the first half of the year.

Operating Expenses

Total operating expenses increased due mostly to the expenses of acquired operations.

The Company also continued to increase product development spending to meet its stated objective of creating sales growth from new products.

In addition to the expenses of acquired operations (including approximately $3 million of intangible assets amortization), higher payroll costs including incentives, and information systems spending contributed to the year-to-date increase in general and administrative expenses.


Liquidity and Capital Resources

Significant uses of cash in the first nine months of 2005 included $103 million for acquisitions of businesses, $35 million for purchases and retirement of Company common stock and $27 million of dividends paid. The Company used cash on hand and a $40 million advance from a line of credit to fund the acquisitions. Most of the increases in accounts receivable and inventory balances since year-end 2004 are due to acquisitions.

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.

The Company had unused lines of credit available at September 30, 2005 totaling $108 million. Cash balances of $14 million at September 30, 2005, internally generated funds and unused financing sources provide the Company with the financial flexibility to meet liquidity needs, including the planned purchase of assets of PBL Industries announced by the Company in the third quarter.

Outlook

Management is working to bring profitability of businesses acquired in 2005 closer to the levels generated by the rest of the Company. The Florida operations of Liquid Control will be consolidated with similar businesses in New Jersey and Ohio by the end of 2005. The Company is also moving production of spray equipment from acquired Gusmer factories to existing Minnesota and South Dakota factories beginning in the third quarter of 2005 and continuing into 2006. These actions are not expected to have a material impact on 2005 earnings. Management will be evaluating further actions as it continues to integrate the operations of acquired businesses.

Management continues to be optimistic about the remainder of 2005 and the prospects for 2006.

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 2004 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 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 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

     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds  

Issuer Purchases of Equity Securities

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:

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)
                    
Jul 2, 2005 - Jul 29, 2005 --        --    --       1,265,700            
                    
Jul 30, 2005 - Aug 27, 2005 120,000       $37.51    120,000       1,145,700            
                    
Aug 27, 2005 - Sep 30, 2005 155,700        $36.35    155,700       990,000            


     
Item 4. Submission of Matters to a Vote of Security Holders  
     
  None  

     
Item 6. Exhibits  

31.1

Certification of 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 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:    October 31, 2005    By:    /s/David A. Roberts              
      David A. Roberts
      President and Chief Executive Officer
       
       
       
Date:    October 31, 2005    By:    /s/James A. Graner              
      James A. Graner
      Chief Financial Officer and Treasurer

Exhibit 31.1

CERTIFICATION

I, David A. Roberts, certify that:

1.

I have reviewed this quarterly report on Form 10-Q of Graco Inc.;


2.

Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;


3.

Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;


4.

The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act rules 13a-15(f) and 15d-15(f)) for the registrant and have:


  a)

Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;


  b)

Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;


  c)

Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and


  d)

Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and


5.

The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors:


  a)

All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and


  b)

Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.





Date:     October 31, 2005          /s/David A. Roberts             
    David A. Roberts
    President and Chief Executive Officer

Exhibit 31.2

CERTIFICATION

I, James A. Graner, certify that:

1.

I have reviewed this quarterly report on Form 10-Q of Graco Inc.;


2.

Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;


3.

Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;


4.

The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act rules 13a-15(f) and 15d-15(f)) for the registrant and have:


  a)

Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;


  b)

Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;


  c)

Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and


  d)

Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and


5.

The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors:


  a)

All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and


  b)

Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.


Date:     October 31, 2005          /s/James A. Graner             
    James A. Graner
    Chief Financial Officer and Treasurer

Exhibit 32

CERTIFICATION UNDER SECTION 1350

Pursuant to Section 1350 of Title 18 of the United States Code, each of the undersigned certifies that this periodic report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in this periodic report fairly presents, in all material respects, the financial condition and results of operations of Graco Inc.


       
       
       
Date:    October 31, 2005    By:    /s/David A. Roberts              
      David A. Roberts
      President and Chief Executive Officer
       
       
       
Date:    October 31, 2005    By:    /s/James A. Graner              
      James A. Graner
      Chief Financial Officer and Treasurer