amended3qtr10qr.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549

FORM 10-Q/A
Amendment No. 2

Quarterly Report Pursuant to Section 13 or 15 (d) of the
Securities Exchange Act of 1934

For the quarterly period ended September 25, 2009

Commission File Number:  001-09249

 
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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or such shorter period that the registrant was required to submit and post such files).
 
Yes
    
No
    

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer
X
Accelerated Filer
  
Non-accelerated Filer
  
Smaller reporting company
  

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
Yes
    
No
  X
  

59,972,000 shares of the Registrant’s Common Stock, $1.00 par value, were outstanding as of October 15, 2009.


Explanatory Note



The sole purpose of this Amendment No. 2  to our Quarterly Report on Form 10-Q for the period ended September 25, 2009, as originally filed with the Securities and Exchange Commission on October 21, 2009, is to include the certifications required under Rule 13a-14(a) and Section 1350 currently dated and signed by our principal executive officer and principal financial officer.   

 
No other changes have been made to the Form 10-Q other than those described above.  This Amendment No. 2 does not reflect subsequent events occurring after the original filing date of the Form 10-Q or modify or update in any way disclosures made in the Form 10-Q.

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
       
 
Item 2.
Management's Discussion and Analysis
  
   
of Financial Condition and Results of Operations
14
       
 
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
19
       
 
Item 4.
Controls and Procedures
19
       
       
       
PART II
OTHER INFORMATION
  
       
 
Item 1A.
Risk Factors
20
       
 
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
20
       
 
Item 4.
Submission of Matters to a Vote of Security Holders
21
       
 
Item 6.
Exhibits
21
       
SIGNATURES
  
   
EXHIBITS
  
 

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

   
Thirteen Weeks Ended
    
Thirty-nine Weeks Ended
  
   
Sep 25,
    
Sep 26,
    
Sep 25,
    
Sep 26,
  
   
2009
    
2008
    
2009
    
2008
  
                         
Net Sales
   $ 147,308     $ 207,231     $ 432,900     $ 650,581  
                                 
Cost of products sold
     69,167       97,071       217,423       299,805  
 
                                
Gross Profit
     78,141       110,160       215,477       350,776  
                                 
Product development
     8,752       9,626       28,584       26,605  
Selling, marketing and distribution
     26,589       32,420       86,814       102,083  
General and administrative
     16,613       15,585       49,317       50,142  
                                 
Operating Earnings
     26,187       52,529       50,762       171,946  
                                 
Interest expense
     1,148       1,934       3,735       5,443  
Other expense, net
     203       623       889       606  
                                 
Earnings Before Income Taxes
     24,836       49,972       46,138       165,897  
                                 
Income taxes
     7,500       17,200       14,400       55,100  
                                 
Net Earnings
   $ 17,336     $ 32,772     $ 31,738     $ 110,797  
                                 
Basic Net Earnings
                                
per Common Share
   $ 0.29     $ 0.55     $ 0.53     $ 1.83  
                                 
Diluted Net Earnings
                                
per Common Share
   $ 0.29     $ 0.54     $ 0.53     $ 1.81  
                                 
Cash Dividends Declared
                                
per Common Share
   $ 0.19     $ 0.19     $ 0.57     $ 0.55  






See notes to consolidated financial statements.
 
 
 

GRACO INC. AND SUBSIDIARIES
  
CONSOLIDATED BALANCE SHEETS
  
(Unaudited)
  
(In thousands)
  
             
   
Sep 25,
    
Dec 26,
  
   
2009
    
2008
  
ASSETS
            
Current Assets
            
Cash and cash equivalents
   $ 5,064     $ 12,119  
Accounts receivable, less allowances of
                
$6,400 and $6,600
     106,890       127,505  
Inventories
     60,581       91,604  
Deferred income taxes
     19,982       23,007  
Other current assets
     4,532       6,360  
Total current assets
     197,049       260,595  
                 
Property, Plant and Equipment
                
Cost
     333,792       326,729  
Accumulated depreciation
     (191,167 )     (176,975 )
Property, plant and equipment, net
     142,625       149,754  
                 
Goodwill
     91,740       91,740  
Other Intangible Assets, net
     43,010       52,231  
Deferred Income Taxes
     14,425       18,919  
Other Assets
     8,223       6,611  
Total Assets
   $ 497,072     $ 579,850  
                 
LIABILITIES AND SHAREHOLDERS' EQUITY
                
Current Liabilities
                
Notes payable to banks
   $ 13,866     $ 18,311  
Trade accounts payable
     16,663       18,834  
Salaries, wages and commissions
     13,477       17,179  
Dividends payable
     11,398       11,312  
Other current liabilities
     50,070       55,524  
Total current liabilities
     105,474       121,160  
                 
Long-term Debt
     107,364       180,000  
Retirement Benefits and Deferred Compensation
     97,077       108,656  
Uncertain Tax Positions
     2,800       2,400  
                 
Shareholders' Equity
                
Common stock
     59,965       59,516  
Additional paid-in-capital
     187,846       174,161  
Retained earnings
     5,900       8,445  
Accumulated other comprehensive income (loss)
     (69,354 )     (74,488 )
     Total shareholder's equity     184,357        167,634   
     Total Liabilities and Shareholders' Equity    $ 497,072       $ 579,850   
 
 
 
See notes to consolidated financial statements.
 
 

 
GRACO INC. AND SUBSIDIARIES
  
CONSOLIDATED STATEMENTS OF CASH FLOWS
  
(Unaudited) (In thousands)
  
   
Thirty-nine Weeks Ended
  
   
Sep 25,
    
Sep 26,
  
   
2009
    
2008
  
Cash Flows From Operating Activities
            
Net Earnings
   $ 31,738     $ 110,797  
Adjustments to reconcile net earnings to
                
  net cash provided by operating activities
                
Depreciation, amortization and impairment
     26,200       23,310  
Deferred income taxes
     4,671       (3,850 )
Share-based compensation
     7,441       7,072  
Excess tax benefit related to share-based
                
payment arrangements
     (300 )     (2,923 )
Change in
                
Accounts receivable
     22,434       (4,989 )
Inventories
     30,745       (16,466 )
Trade accounts payable
     (2,050 )     (775 )
Salaries, wages and commissions
     (3,853 )     (1,236 )
Retirement benefits and deferred compensation
     (4,741 )     (2,141 )
Other accrued liabilities
     (2,437 )     788  
Other
     313       1,114  
Net cash provided by operating activities
     110,161       110,701  
                 
Cash Flows From Investing Activities
                
Property, plant and equipment additions
     (9,375 )     (20,778 )
Proceeds from sale of property, plant and equipment
     615       1,633  
Investment in life insurance
     (1,499 )     (1,499 )
Capitalized software and other intangible asset additions
     (501 )     (1,130 )
Acquisitions of businesses, net of cash acquired
     -       (39,780 )
Net cash used in investing activities
     (10,760 )     (61,554 )
                 
Cash Flows From Financing Activities
                
Net borrowings (payments) on short-term lines of credit
     (4,700 )     (2,779 )
Borrowings on long-term line of credit
     75,491       188,869  
Payments on long-term line of credit
     (148,127 )     (104,074 )
Excess tax benefit related to share-based
                
payment arrangements
     300       2,923  
Common stock issued
     6,119       13,528  
Common stock retired
     (157 )     (114,341 )
Cash dividends paid
     (34,069 )     (33,693 )
Net cash provided by (used in) financing activities
     (105,143 )     (49,567 )
Effect of exchange rate changes on cash     (1,313  )     748   
Net increase (decrease) in cash and cash equivalents     (7,055  )     328   
Cash and cash equivalents                
    Beginning of year     12,119        4,922   
    End of period    $ 5,064       $ 5,250   

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 25, 2009 and the related statements of earnings for the thirteen and thirty-nine weeks ended September 25, 2009 and September 26, 2008, and cash flows for the thirty-nine weeks ended September 25, 2009 and September 26, 2008 have been prepared by the Company and have not been audited.

 
In the opinion of management, these consolidated financial 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 25, 2009, 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 2008 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
    
Thirty-nine Weeks Ended
  
   
Sep 25,
    
Sep 26,
    
Sep 25,
    
Sep 26,
  
   
2009
    
2008
    
2009
    
2008
  
                         
Net earnings available to
                        
common shareholders
   $ 17,336     $ 32,772     $ 31,738     $ 110,797  
                                 
Weighted average shares
                                
outstanding for basic
                                
earnings per share
     59,940       59,769       59,827       60,521  
                                 
Dilutive effect of stock
                                
options computed using the
                                
treasury stock method and
                                
the average market price
     374       596       306       647  
                                 
Weighted average shares
                                
outstanding for diluted
                                
earnings per share
     60,314       60,365       60,133       61,168  
                                 
Basic earnings per share
   $ 0.29     $ 0.55     $ 0.53     $ 1.83  
                                 
Diluted earnings per share              $ 0.29      $ 0.54     $ 0.53     $ 1.81  


Stock options to purchase 2,834,000 and 2,114,000 shares were not included in the 2009 and 2008 computations of diluted earnings per share, respectively, because they would have been anti-dilutive.
 

3.  
Information on option shares outstanding and option activity for the thirty-nine weeks ended September 25, 2009 is shown below (in thousands, except per share amounts):
 

         
Weighted
          
Weighted
  
         
Average
          
Average
  
   
Option
    
Exercise
    
Options
    
Exercise
  
   
Shares
    
Price
    
Exercisable
    
Price
  
                         
 Outstanding, December 26, 2008
     3,955     $ 30.77       2,186     $ 24.98  
 Granted
     1,180       20.74                  
 Exercised
     (131 )     10.41                  
 Canceled
     (127 )     31.69                  
 Outstanding, September 25, 2009
     4,877     $ 28.87       2,465     $ 28.16  

The aggregate intrinsic value of exercisable option shares was $12.2 million as of September 25, 2009, with a weighted average contractual term of 4.4 years.  There were approximately 4.8 million share options vested and expected to vest as of September 25, 2009, with an aggregate intrinsic value of $20.9 million, a weighted average exercise price of $28.87 and a weighted average contractual term of 6.5 years.

Information related to options exercised in the first nine months of 2009 and 2008 follows (in thousands):

   
Thirty-nine Weeks Ended
  
   
Sep 25,
    
Sep 26,
  
   
2009
    
2008
  
Cash received
   $ 1,363     $ 6,864  
Aggregate intrinsic value
     1,595       8,645  
Tax benefit realized
     600       3,100  


The Company recognized year-to-date share-based compensation of $7.7 million in 2009 and $7.1 million in 2008.  As of September 25, 2009, there was $8.2 million of unrecognized compensation cost related to unvested options, expected to be recognized over a weighted average period of 2.6 years.
 

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions and results:
 
   
Thirty-nine Weeks Ended
  
   
Sep 25,
    
Sep 26,
  
   
2009
    
2008
  
Expected life in years
     6.0       6.0  
Interest rate
     2.1 %     3.2 %
Volatility
     30.1 %     25.0 %
Dividend yield
     3.7 %     2.1 %
Weighted average fair value per share
   $ 4.27     $ 8.43  



Under the Company’s Employee Stock Purchase Plan, the Company issued 312,000 shares in 2009 and 216,000 shares in 2008.  The fair value of the employees’ purchase rights under this Plan was estimated on the date of grant.  The benefit of the 15 percent discount from the lesser of the fair market value per common share on the first day and the last day of the plan year was added to the fair value of the employees’ purchase rights determined using the Black-Scholes option-pricing model with the following assumptions and results:
 

 
   
Thirty-nine Weeks Ended
  
   
Sep 25,
    
Sep 26,
  
   
2009
    
2008
  
Expected life in years
     1.0       1.0  
Interest rate
     0.7 %     1.5 %
Volatility
     51.5 %     27.1 %
Dividend yield
     4.5 %     2.1 %
Weighted average fair value per share
   $ 5.60     $ 8.14  


4.  
The components of net periodic benefit cost (credit) for retirement benefit plans were as follows (in thousands):

   
Thirteen Weeks Ended
    
Thirty-nine Weeks Ended
  
   
Sep 25,
    
Sep 26,
    
Sep 25,
    
Sep 26,
  
   
2009
    
2008
    
2009
    
2008
  
Pension Benefits
                        
Service cost
   $ 1,078     $ 920     $ 3,498     $ 3,724  
Interest cost
     2,926       2,896       9,261       9,186  
Expected return on assets
     (2,593 )     (4,536 )     (8,143 )     (14,236 )
Amortization and other
     2,034       233       6,761       528  
Net periodic benefit cost (credit)
   $ 3,445     $ (487 )   $ 11,377     $ (798 )
                                 
Postretirement Medical
                                
Service cost
   $ 174     $ 168     $ 424     $ 418  
Interest cost
     335       286       985       1,036  
Amortization
     (45 )     (13 )     (45 )     (13 )
Net periodic benefit cost (credit)
   $ 464     $ 441     $ 1,364     $ 1,441  

In the third quarter of 2009, the Company made a voluntary $15 million tax-deductible contribution to its funded defined benefit pension plan.

The Company paid $1.5 million in June 2009 and $1.5 million in June 2008 for contracts insuring the lives of certain employees who are eligible to participate in certain non-qualified pension and deferred compensation plans.  These insurance contracts will be used to fund the non-qualified pension and deferred compensation arrangements.  The insurance contracts are held in a trust and are available to general creditors in the event of the Company’s insolvency.  Cash surrender value of $4.3 million and $2.7 million is included in other assets in the consolidated balance sheet as of September 25, 2009 and December 28, 2008, respectively.

5.  
Total comprehensive income was as follows (in thousands):

   
Thirteen Weeks Ended
    
Thirty-nine Weeks Ended
  
   
Sep 25,
    
Sep 26,
    
Sep 25,
    
Sep 26,
  
   
2009
    
2008
    
2009
    
2008
  
                         
Net earnings
   $ 17,336     $ 32,772     $ 31,738     $ 110,797  
Cumulative translation
                                
adjustment
     -       (346 )     234       (377 )
Pension and postretirement
                                
medical liability adjustment
     2,432       164       7,183       353  
Gain (loss) on interest
                                
rate hedge contracts
     303       (211 )     594       (634 )
                                 
Income taxes
     (1,011 )     23       (2,877 )     107  
                                 
Comprehensive income
   $ 19,060     $ 32,402     $ 36,872     $ 110,246  


 
Components of accumulated other comprehensive income (loss) were (in thousands):
 

 
   
Sep 25,
    
Dec 26,
  
   
2009
    
2008
  
             
Pension and postretirement medical liability adjustment
   $ (65,796 )   $ (70,322 )
Gain (loss) on interest rate hedge contracts
     (2,735 )     (3,109 )
Cumulative translation adjustment
     (823 )     (1,057 )
Total
   $ (69,354 )   $ (74,488 )


6.  
The Company has three reportable segments:  Industrial, Contractor and Lubrication.  The Company does not track assets by segment.  Sales and operating earnings by segment for the thirteen and thirty-nine weeks ended September 25, 2009 and September 26, 2008 were as follows (in thousands):

   
Thirteen Weeks Ended
    
Thirty-nine Weeks Ended
  
   
Sep 25,
    
Sep 26,
    
Sep 25,
    
Sep 26,
  
   
2009
    
2008
    
2009
    
2008
  
Net Sales
                        
Industrial
   $ 78,242     $ 117,685     $ 226,808     $ 365,028  
Contractor
     55,379       67,751       163,213       215,992  
Lubrication
     13,687       21,795       42,879       69,561  
Consolidated
   $ 147,308     $ 207,231     $ 432,900     $ 650,581  
                                 
Operating Earnings
                                
Industrial
   $ 20,332     $ 35,874     $ 45,262     $ 117,847  
Contractor
     11,138       15,226       24,420       49,663  
Lubrication
     (167 )     3,409       (3,348 )     12,333  
Unallocated corporate (expense)
     (5,116 )     (1,980 )     (15,572 )     (7,897 )
Consolidated
   $ 26,187     $ 52,529     $ 50,762     $ 171,946  

 
7.  
Major components of inventories were as follows (in thousands):
 
 
   
Sep 25,
    
Dec 26,
  
   
2009
    
2008
  
             
Finished products and components
   $ 38,209     $ 50,703  
Products and components in various
                
stages of completion
     24,359       24,938  
Raw materials and purchased components
     30,952       51,348  
      93,520       126,989  
Reduction to LIFO cost
     (32,939 )     (35,385 )
Total
   $ 60,581     $ 91,604  

 

8.  
Information related to other intangible assets follows (dollars in thousands):

   
Estimated
                
Foreign
        
   
Life
    
Original
    
Accumulated
    
Currency
    
Book
  
   
(years)
    
Cost
    
Amortization
    
Translation
    
Value
  
September 25, 2009
                              
Customer relationships
     3 - 8     $ 41,075     $ (17,109 )   $ (181 )   $ 23,785  
Patents, proprietary technology
                                        
and product documentation
     3 - 15       22,737       (12,899 )     (87 )     9,751  
Trademarks, trade names
                                        
and other
     3 - 10       6,554       (1,860 )     -       4,694  
                                         
              70,366       (31,868 )     (268 )     38,230  
Not Subject to Amortization:
                                        
Brand names
             4,780       -       -       4,780  
                                         
Total
           $ 75,146     $ (31,868 )   $ (268 )   $ 43,010  
                                         
December 26, 2008
                                        
Customer relationships
     3 - 8     $ 41,075     $ (12,470 )   $ (181 )   $ 28,424  
Patents, proprietary technology
                                        
and product documentation
     3 - 15       23,780       (11,290 )     (87 )     12,403  
Trademarks, trade names
                                        
and other
     3 - 10       5,514       (3,908 )     (12 )     1,594  
                                         
              70,369       (27,668 )     (280 )     42,421  
Not Subject to Amortization:
                                        
Brand names
             9,810       -       -       9,810  
                                         
Total
           $ 80,179     $ (27,668 )   $ (280 )   $ 52,231  
 

 
 
In 2009, the useful life of certain brand names was determined to be no longer indefinite.  The cost of such brand names, totaling $4.5 million (after an impairment charge of $0.5 million in the third quarter), is being amortized over a three-year period.  Amortization of intangibles was $3.4 million in the third quarter of 2009 and $9.2 million year-to-date.  Estimated annual amortization expense is as follows:  $12.1 million in 2009, $11.2 million in 2010, $10.1 million in 2011, $8.3 million in 2012, $4.1 million in 2013 and $1.6 million thereafter.


9.  
Components of other current liabilities were (in thousands):

   
Sep 25,
    
Dec 26,
  
   
2009
    
2008
  
             
Accrued self-insurance retentions
   $ 7,901     $ 7,896  
Accrued warranty and service liabilities
     7,644       8,033  
Accrued trade promotions
     3,625       9,001  
Payable for employee stock purchases
     3,659       5,473  
Income taxes payable
     3,549       904  
Other
     23,692       24,217  
Total
   $ 50,070     $ 55,524  

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):

   
Thirty-nine
        
   
Weeks Ended
    
Year Ended
  
   
Sep 25,
    
Dec 26,
  
   
2009
    
2008
  
             
Balance, beginning of year
   $ 8,033     $ 7,084  
Charged to expense
     3,519       6,793  
Margin on parts sales reversed
     2,235       3,698  
Reductions for claims settled
     (6,143 )     (9,542 )
Balance, end of period
   $ 7,644     $ 8,033  
 
 
10.  
The Company accounts for all derivatives, including those embedded in other contracts, as either assets or liabilities and measures those financial instruments at fair value.  The accounting for changes in the fair value of derivatives depends on their intended use and designation.
 
As part of its risk management program, the Company may periodically use forward exchange contracts and interest rate swaps to manage known market exposures.  Terms of derivative instruments are structured to match the terms of the risk being managed and are generally held to maturity.  The Company does not hold or issue derivative financial instruments for trading purposes.  All other contracts that contain provisions meeting the definition of a derivative also meet the requirements of, and have been designated as, normal purchases or sales.  The Company’s policy is to not enter into contracts with terms that cannot be designated as normal purchases or sales.

In 2007, the Company entered into interest rate swap contracts that effectively fix the rates paid on a total of $80 million of variable rate borrowings.  One contract fixed the rate on $40 million of borrowings at 4.7 percent plus the applicable spread (depending on cash flow leverage ratio) until December 2010.  The second contract fixed an additional $40 million of borrowings at 4.6 percent plus the applicable spread until January 2011.  Both contracts have been designated as cash flow hedges against interest rate volatility.  Consequently, changes in the fair market value are recorded in accumulated other comprehensive income (loss) (AOCI).  Amounts included in AOCI will be reclassified to earnings as interest rates increase and as the swap contracts approach their expiration dates.  Net amounts paid or payable under terms of the contracts were charged to interest expense and totaled $2.2 million in the first nine months of 2009.

The Company periodically evaluates its monetary asset and liability positions denominated in foreign currencies. The Company enters into forward contracts or options, or borrows in various currencies, in order to hedge its net monetary positions. These instruments are recorded at current market values and the gains and losses are included in other expense (income), net. There were eight contracts outstanding as of September 25, 2009, with notional amounts totaling $16 million.  There were 50 contracts outstanding during all or part of the first nine months of 2009, with net losses of $1.4 million offsetting $0.8 million of exchange gains on net monetary positions, included in other expense (income), net.  The Company believes it uses strong financial counterparts in these transactions and that the resulting credit risk under these hedging strategies is not significant. 

The Company uses significant other observable inputs to value the derivative instruments used to hedge interest rate volatility and net monetary positions.  The fair market value and balance sheet classification of such instruments follows (in thousands):  
 
 
Balance Sheet
  
Sep 25,
    
Dec 26,
  
 
Classification
  
2009
    
2008
  
Gain (loss) on interest
              
rate hedge contracts
 Other current liabilities
   $ (4,342 )   $ (4,936 )
Gain (loss) on foreign
                  
currency forward contracts
                  
 Gains
     $ 113     $ 1,868  
 Losses
       (282 )     (670 )
 Net
 Accounts receivable
           $ 1,198  
 Other current liabilites
   $ (169 )        

11.  
In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements.”  This accounting standard establishes a consistent framework for measuring fair value and expands disclosures on fair market value measurements.  It was effective for the Company starting in fiscal 2008 for financial assets and liabilities.  With respect to non-financial assets and liabilities, it was effective for the Company starting in fiscal 2009.  The adoption of this standard as it pertains to non-financial assets and liabilities had no significant impact on the consolidated financial statements.

12.  
The Company has evaluated subsequent events through the time the financial statements were approved for issuance on October 21, 2009.



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

Overview

The Company designs, manufactures and markets systems and equipment to move, measure, control, dispense and spray fluid materials.  Management classifies the Company’s business into three reportable segments:  Industrial, Contractor and Lubrication.  Key strategies include development of new products, expansion of distribution and new market penetration.

The following Management’s Discussion and Analysis reviews significant factors affecting the Company’s results of operations and financial condition.  This discussion should be read in conjunction with the financial statements and the accompanying notes to the financial statements.

Results of Operations

Net sales, net earnings and earnings per share were as follows (in millions except per share amounts and percentages):

   
Thirteen Weeks Ended
    
Thirty-nine Weeks Ended
  
   
Sep 25,
    
Sep 26,
    
%
    
Sep 25,
    
Sep 26,
    
%
  
   
2009
    
2008
    
Change
    
2009
    
2008
    
Change
  
                                     
Net Sales
   $ 147.3     $ 207.2       (29 )%   $ 432.9     $ 650.6       (33 )%
Net Earnings
   $ 17.3     $ 32.8       (47 )%   $ 31.7     $ 110.8       (71 )%
Diluted Net Earnings
                                                
   per Common Share
   $ 0.29     $ 0.54       (46 )%   $ 0.53     $ 1.81       (71 )%

Weak economic conditions worldwide continued to affect the Company’s operating results.  Sales and orders decreased in all segments and regions.  Currency translation had an unfavorable effect on sales ($2 million for the quarter and $14 million year-to-date) and net earnings ($1 million for the quarter and $5 million year-to-date).  Year-to-date, the Company has recorded $5 million of cost related to workforce reductions, mostly in the first quarter.  The resulting decrease in cost structure contributed to improvements in second and third quarter net earnings compared to the first quarter.


Consolidated Results

Sales by geographic area were as follows (in millions):

   
Thirteen Weeks Ended
    
Thirty-nine Weeks Ended
  
   
Sep 25,
    
Sep 26,
    
Sep 25,
    
Sep 26,
  
   
2009
    
2008
    
2009
    
2008
  
                         
Americas 1
   $ 84.1     $ 112.8     $ 252.6     $ 360.5  
Europe 2
     35.6       57.8       105.9       189.4  
Asia Pacific
     27.6       36.6       74.4       100.7  
Consolidated
   $ 147.3     $ 207.2     $ 432.9     $ 650.6  
                                 
1 North and South America, including the U.S.
                          
2 Europe, Africa and Middle East
                          


Sales for the quarter were down 25 percent in the Americas, 39 percent in Europe (36 percent at consistent translation rates) and 25 percent in Asia Pacific.  Year-to-date sales were down 30 percent in the Americas, 44 percent in Europe (38 percent at consistent translation rates) and 26 percent in Asia Pacific.  Consolidated sales were down 29 percent for the quarter and 33 percent year-to-date.

Gross profit margin, expressed as a percentage of sales, was 53 percent for the quarter and 50 percent year-to-date, compared to 53 percent and 54 percent, respectively, for the comparable periods last year.  For the quarter, the favorable effects of pricing, material costs and cost reduction actions were offset by decreases from lower production volume and increased pension cost.  Decreases in the year-to-date rate were due to lower production volumes (approximately 5 percentage points), unfavorable currency translation rates (approximately 1 percentage point) and increased pension cost (approximately 1 percentage point).  Decreases were offset somewhat by the effects of favorable material costs and pricing.

Total operating expenses for the quarter and year-to-date were down 10 percent and 8 percent, respectively.  For both the quarter and year-to-date, the effects of spending reductions and lower volume were partially offset by higher pension expenses.  Year-to-date, a $4 million decrease from translation effects was partially offset by $2 million related to workforce reductions.

Effective income tax rates were 30 percent for the quarter and 31 percent year-to-date, down from last year’s rates of 34 percent for the quarter and 33 percent year-to-date.  A higher-than-expected benefit upon filing of prior year tax returns contributed to lower rates in 2009.  Effective rates were higher in 2008 because the R&D tax credit was not renewed until the fourth quarter and no credit was included in the provisions for the first three quarters.


Segment Results

Certain measurements of segment operations compared to last year are summarized below:

Industrial
                        
   
Thirteen Weeks Ended
    
Thirty-nine Weeks Ended
  
   
Sep 25,
    
Sep 26,
    
Sep 25,
    
Sep 26,
  
   
2009
    
2008
    
2009
    
2008
  
                         
Net sales (in millions)
                        
Americas
   $ 37.0     $ 54.1     $ 108.3     $ 169.0  
Europe
     22.0       36.4       65.7       122.2  
Asia Pacific
     19.2       27.2       52.8       73.8  
Total
   $ 78.2     $ 117.7     $ 226.8     $ 365.0  
                                 
Operating earnings as a
                                
percentage of net sales
     26 %     30 %     20 %     32 %

 
For the quarter, Industrial segment sales decreased 32 percent in the Americas, 40 percent in Europe (37 percent at consistent translation rates) and 29 percent in Asia Pacific.  Year-to-date sales decreased 36 percent in the Americas, 46 percent in Europe (41 percent at consistent translation rates) and 28 percent in Asia Pacific.

In the third quarter, the impact of low volume on operating earnings was partially offset by the impacts of lower selling-related expenses and spending reductions initiated in prior quarters.  Low volume, workforce reduction costs and currency translation affected year-to-date operating earnings as a percentage of sales.
 
Contractor
                        
   
Thirteen Weeks Ended
    
Thirty-nine Weeks Ended
  
   
Sep 25,
    
Sep 26,
    
Sep 25,
    
Sep 26,
  
   
2009
    
2008
    
2009
    
2008
  
                         
Net sales (in millions)
                        
Americas
   $ 36.2     $ 41.7     $ 109.0     $ 135.5  
Europe
     12.5       19.4       37.3       61.3  
Asia Pacific
     6.7       6.7       16.9       19.2  
Total
   $ 55.4     $ 67.8     $ 163.2     $ 216.0  
                                 
Operating earnings as a
                                
percentage of net sales
     20 %     22 %     15 %     23 %

 
For the quarter, Contractor segment sales decreased 13 percent in the Americas and 35 percent in Europe (32 percent at consistent translation rates).  Year-to-date sales decreased 20 percent in the Americas, 39 percent in Europe (33 percent at consistent translation rates) and 12 percent in Asia Pacific.

In the third quarter, the impact of low volume on operating earnings was partially offset by the impacts of lower selling-related expenses and spending reductions initiated in prior quarters.  Low volume, workforce reduction costs, currency translation and sustained product development spending affected year-to-date operating earnings as a percentage of sales.  Contractor year-to-date operating results were also affected by sales, costs and expenses related to the rollout of entry-level paint sprayers to additional paint and home center stores in both 2009 and 2008.

Lubrication
                        
   
Thirteen Weeks Ended
    
Thirty-nine Weeks Ended
  
   
Sep 25,
    
Sep 26,
    
Sep 25,
    
Sep 26,
  
   
2009
    
2008
    
2009
    
2008
  
                         
Net sales (in millions)
                        
Americas
   $ 10.9     $ 17.0     $ 35.4     $ 56.1  
Europe
     1.1       2.1       2.9       5.8  
Asia Pacific
     1.7       2.7       4.6       7.7  
Total
   $ 13.7     $ 21.8     $ 42.9     $ 69.6  
                                 
Operating earnings as a
                                
percentage of net sales
     (1 )%     16 %     (8 )%     18 %

 
For the quarter, Lubrication segment sales decreased 35 percent in the Americas, 49 percent in Europe (47 percent at consistent translation rates) and 39 percent in Asia Pacific.  Year-to-date sales decreased 37 percent in the Americas, 50 percent in Europe (47 percent at consistent translation rates) and 41 percent in Asia Pacific.

In the third quarter, the impact of low volume on operating earnings was partially offset by the impacts of lower selling-related expenses and spending reductions initiated in prior quarters.  Low volume, workforce reduction costs and increased product development expense affected year-to-date operating earnings as a percentage of sales.  Mix of products sold and costs related to discontinued products contributed to lower margin rates in the Lubrication segment.

Liquidity and Capital Resources

In the first nine months of 2009, the Company used cash to reduce the borrowings under its long-term line of credit by $73 million and paid dividends of $34 million.  The Company also made a $15 million voluntary contribution to a funded defined benefit pension plan.  Significant uses of cash and borrowings in the first nine months of 2008 included $114 million for purchases and retirement of Company common stock, $40 million for business acquisitions and $34 million for payment of dividends.  

Since the end of 2008, inventories have been reduced by $31 million.  Accounts receivable decreased by $21 million from continuing collections and lower sales levels.

At September 25, 2009, the Company had various lines of credit totaling $282 million, of which $162 million was unused.  Internally generated funds and unused financing sources are expected to provide the Company with the flexibility to meet its liquidity needs in 2009.


Outlook

While economic conditions continue to create headwinds for the business, management is encouraged by improved profitablility in each of the last two quarters, resulting from efforts to improve production costs and control expenses.  While management is cautious about predicting stronger sales and further improvement in profitability in the near-term, it expects to continue investing in growth initiatives including product development, international expansion and entering new markets.  Management remains confident that the Company will emerge from the recession with strong, profitable growth.

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 2008 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 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 have been no material changes related to market risk from the disclosures made in the Company’s 2008 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 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 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 2008 Annual Report on Form 10-K.

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

Issuer Purchases of Equity Securities

On September 28, 2007, the Board of Directors authorized the Company to purchase up to 7,000,000 shares of its outstanding common stock, primarily through open-market transactions.  This authorization expired on September 30, 2009.  

On September 18, 2009, the Board of Directors authorized the Company to purchase up to an additional 6,000,000 shares.  The new authorization expires on September 30, 2012.

In addition to shares purchased under the Board authorizations, 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:

                     
Maximum
    
               
Total
    
Number of
    
               
Number
    
Shares that
    
               
of Shares
    
May Yet Be
    
               
Purchased
    
Purchased
    
               
as Part of
    
Under the
    
   
Total
    
Average
    
Publicly
    
Plans or
    
   
Number
    
Price
    
Announced
    
Programs
    
   
of Shares
    
Paid per
    
Plans or
    
(at end of
    
Period
  
Purchased
    
Share
    
Programs
    
period)
    
                           
Jun 27, 2009 – Jul 24, 2009
     -     $ -       -       3,068,234    
                                   
Jul 25, 2009 – Aug 21, 2009
     -     $ -       -       3,068,234    
                                   
Aug 22, 2009 – Sep 25, 2009
     577     $ 25.28       -       9,068,234  
1
                                   
1 Authorization for purchases of up to 3,068,234 shares expired on September 30, 2009.
    


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 the President and Chief Executive Officer and the 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:
 December 22, 2009 
 By:
 /s/Patrick J. McHale
     
Patrick J. McHale
     
President and Chief Executive Officer
     
(Principal Executive Officer)
       
       
       
Date:
 December 22, 2009 
 By:
 /s/James A. Graner
     
James A. Graner
     
Chief Financial Officer and Treasurer
     
(Principal Financial Officer)
       
       
       
Date:
 December 22, 2009 
 By:
 /s/Caroline M. Chambers
     
Caroline M. Chambers
     
Vice President and Controller
     
(Principal Accounting Officer)