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Article by DailyStocks_admin    (11-18-08 09:58 AM)

The Daily Magic Formula Stock for 11/15/2008 is Graco Inc. According to the Magic Formula Investing Web Site, the ebit yield is 14% and the EBIT ROIC is 50-75 %.

Dailystocks.com only deals with facts, not biased journalism. What is a better way than to go to the SEC Filings? It's not exciting reading, but it makes you money. We cut and paste the important information from SEC filings for you to get started on your research on a specific company.


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BUSINESS OVERVIEW

BUSINESS

Our Company was originally incorporated in the state of South Dakota in 1926 as Gray Company, Inc. and in the state of Minnesota in 1947. It began business as a Minneapolis, Minnesota-based manufacturer of grease guns and lubricating pumps primarily for servicing vehicles. Our Company changed its name to Graco Inc. and first offered its common stock to the public in 1969. Today we provide fluid handling solutions to organizations involved in manufacturing, processing, construction and maintenance throughout the world.

Graco Inc. and its subsidiaries (which we refer to in this Form 10-K as us, we, our Company or the Company) sell a full line of products in each of the following geographic markets: the Americas (North and South America), Europe (including the Middle East and Africa), and Asia Pacific. Sales in the Americas represent approximately 60 percent of our Company’s total sales; sales in Europe approximately 25 percent; and sales in Asia Pacific approximately 15 percent. Part II, Item 7, Results of Operations and Note B to the Consolidated Financial Statements of this Form 10-K contain financial information about these geographic areas. Our Company provides marketing, product design and application assistance to, and employs sales personnel in, each of these geographic markets. Subsidiaries located in Belgium, the People’s Republic of China (“P.R.C.”), Japan, and Korea distribute our Company’s products in their local geographies. The majority of our manufacturing occurs in the United States, but limited lines of products are assembled in the P.R.C., the United Kingdom (“U.K.”) and Belgium.

For more information about our Company, our products, services and solutions, visit our website at www.graco.com. The information on the website is not part of this report nor any other report filed or furnished to the Securities and Exchange Commission (SEC).

Business Segments

Our Company classifies its business into three reportable segments, each with a world-wide focus: Industrial, Contractor and Lubrication. Financial information concerning these segments is set forth in Part II, Item 7, Results of Operations and Note B to the Consolidated Financial Statements of this Form 10-K.

The equipment developed and distributed by our Company’s segments is broadly described as fluid handling equipment. It is used to spray, dispense, measure and move a wide variety of fluids and semi-solids in a wide variety of applications in manufacturing, processing, construction and maintenance industries. Our Company’s products enable customers to reduce their use of labor, material and energy, improve quality and achieve environmental compliance.

The development of technologically superior, multiple-featured, reliable products is a key strategy of our Company. Our Company strives to generate 30 percent of its annual sales from products introduced in the prior three years. In 2007, we generated 21 percent of our sales from new products. In 2006 and 2005, the percentage of sales represented by new products was 21 and 29 percent, respectively. Major product development efforts are carried out in facilities located in Minneapolis and Rogers, Minnesota, North Canton, Ohio and on Lubrication equipment in Suzhou, P.R.C. The product development and engineering group in each segment focuses on new product design, product improvements, applied engineering and strategic technologies for its specific customer base. Total product development expenditures for all segments were $30 million, $30 million and $27 million in 2007, 2006 and 2005 respectively.

Manufacturing is a key competency of Graco. Our Company invests significant resources in maximizing the quality, responsiveness and cost-effectiveness of our production operations by purchasing state-of-the-art equipment and doing most machining, assembly and testing in-house. Principal products are manufactured in vertically integrated focused factories and product cells. Raw materials and purchased components are sourced from suppliers around the world. The segments manage operations devoted to the manufacture of their product lines. Oversight and direction of manufacturing strategy is provided by our vice president of manufacturing and distribution operations. He also manages those factories not fully aligned with a single segment, the warehouses, customer service, and other shared corporate manufacturing functions.

Other primary objectives of our Company include the expansion of distribution, the penetration of new markets and the completion of acquisitions. These subjects are discussed below in the context of each segment’s business operations.

Our Company’s headquarters are located in a 142,000 sq. ft. facility in Minneapolis, Minnesota. In 2007, the visitors’ entrance area was renovated and general office space was added. The facility is also occupied by the management, marketing and product development personnel for the Industrial segment. Information systems, accounting services and purchasing for our Company are housed in a 42,000 sq. ft. office building nearby.

A large percentage of our Company’s facilities are devoted to manufacturing and distribution of the various products offered for sale by the business segments.

Products marketed by the Industrial segment are manufactured in owned facilities in Minneapolis, Minnesota (405,000 sq. ft. manufacturing/warehouse/o ffice), Sioux Falls, South Dakota (149,000 sq. ft. manufacturing/office), and North Canton, Ohio (132,000 sq. ft. manufacturing/office), and leased facilities in Mississauga, Ontario (11,760 sq. ft. assembly/office) and Vilanova, Spain (29,000 sq. ft. manufacturing/warehouse/o ffice). Limited lines of products are assembled in owned facilities in Suzhou, P.R.C. (79,000 sq. ft. assembly/warehouse/office ), Wellingborough, U.K. (12,500 sq. ft. manufacturing/office) and Maasmechelen, Belgium (75,000 sq. ft. assembly/warehouse/office ). During the first half of 2007, our Company ceased manufacturing in Vilanova, Spain. Products formerly manufactured there are now manufactured in Minneapolis. The lease on the Vilanova facility will terminate at the end of February 2008 and operations will move to a new facility (7,280 sq. ft. office/warehouse). The new facility will continue to warehouse and distribute products to Spanish customers. At the end of 2007, we announced that the mobile spray rig manufacturing and customer service functions would move from Mississauga, Ontario to North Canton, Ohio. The move was completed in January 2008. The lease for the Mississauga facility will expire at the end of June 2008. The lease for the Lakewood, New Jersey, facilities where Gusmer and Decker foam and polyurethane equipment was formerly manufactured terminated in April 2007. A 50,000 sq. ft. addition to the facility in North Canton was completed in March 2007. Some Industrial segment products are assembled for the European market in an owned facility located in Maasmechelen, Belgium, the site of our Company’s European headquarters (75,000 sq. ft. assembly/warehouse/ office). A 50,000 sq. ft. warehouse addition to the Maasmechelen facility is expected to be completed in July 2008.

Products marketed by the Contractor segment are manufactured in owned facilities in Rogers, Minnesota (333,000 sq. ft. manufacturing/warehouse/o ffice). Segment management, marketing, engineering, customer service, warehouse, shipping, sales and training are also located at the Rogers facility. The Sioux Falls, South Dakota, plant also manufactures spray guns and accessories for the Contractor segment.

During 2007, the Lubrication segment moved its manufacturing operations in Madison, Wisconsin, Cleveland, Ohio and Minneapolis, Minnesota and its segment management, marketing, engineering, customer service, warehouse, shipping, sales and training functions to an owned facility in Anoka, Minnesota (207,000 sq. ft. manufacturing/office). The lease for the facility in Madison terminated at the end of January 2008 and the sale of the owned facility in Cleveland is pending. A limited line of Lubrication products are being assembled in our owned facility in Suzhou, P.R.C. The output of the Suzhou plant is shipped to Minneapolis, Minnesota, for subsequent worldwide distribution. The plant is expected to produce products designed specifically for the Asia Pacific market sometime in the future.

Industrial Segment

The Industrial segment is the largest part of our Company’s businesses and represents approximately 53 percent of our total sales. This segment includes the Industrial Products and the Applied Fluid Technologies divisions. These divisions were created in 2005. While both divisions market their equipment and services to customers who manufacture, assemble, repair and refinish products such as appliances, vehicles, airplanes, electronics, cabinets and furniture and other articles, the divisions focus on different fluids and application methods in these industries.

Most Industrial segment equipment is sold worldwide through general and specialized distributors, integrators and original equipment manufacturers. Distributors promote and sell the equipment, provide product application expertise and offer on-site service, technical support and integration capabilities. Integrators implement large individual installations in manufacturing plants where products and services from a number of different vendors are aggregated into a single system. Original equipment manufacturers incorporate our Company’s Industrial segment products into the systems and assemblies that they supply to customers. In-plant polyurethane and Liquid Control™ equipment is sold through distribution and directly to manufacturers.

Industrial Products

The Industrial Products division focuses its development and sales efforts on three main product families: equipment to apply paint and other coatings to products such as motor vehicles, appliances, furniture and other industrial and consumer products; equipment to move and dispense chemicals and liquid and semi-solid foods; and equipment to refinish and repair automobiles.

Finishing equipment for applying paints, varnishes and other coatings includes paint circulating and paint supply pumps, plural component coating proportioners, various accessories to filter, transport, agitate and regulate the fluid, spare parts such as spray tips, seals and filter screens, and a variety of applicators that use different methods of atomizing and spraying the paint or other coating depending on the viscosity of the fluid, the type of finish desired, and the need to maximize transfer efficiency, minimize overspray and prevent the release of volatile organic compounds (VOCs) into the air.

We offer double diaphragm and piston transfer pumps to the chemical, petroleum, general manufacturing and food processing industries, pumps for sanitary applications including FDA-compliant 3-A sanitary pumps for use in dairies, diaphragm pumps, transfer pumps and drum and bin unloaders. Our sanitary pumps are used in pharmaceutical, cosmetic, beverage and food processing applications. Sharpe® spray guns are used in the refinishing of automobiles.

Applied Fluid Technologies

The Applied Fluid Technologies division directs its engineering, sales and marketing efforts toward three broad product families: equipment to apply high performance coatings and foam (protective coatings); equipment to apply sealants and adhesives; and equipment to create reaction injection molded polyurethane parts.

Our Company offers a full line of plural component proportioning equipment to apply foam and protective coatings to a wide variety of surfaces. The Reactor® line of plural component pumps is used to apply foam to insulate walls and roofs as well as apply polyurea to coat tanks, pipes, roofs, truck beds and foundations where accurate temperatures and pressures are required to achieve optimal results. The XtremeMix™ plural component sprayers provide on-demand mixing, ratio assurance and job site portability to spray high solid epoxies, urethanes and protective coatings with a short pot life. These pumps are incorporated into systems with our Company’s heated hose, diaphragm supply pumps and Fusion® spray guns with accurate mix capability. The Reactor systems are also available installed in trailer rigs for mobility and flexibility at remote job sites.

Our Company offers pumps, applicators and accessories, to supply and precisely dispense sealants and adhesives in automotive assembly, furniture assembly, insulated glass and window manufacturing, bookbinding and other industrial assembly operations. The Therm-O-Flow® bulk hot melt drum unloader system was introduced during 2006 and among other uses, supplies adhesive to roll coaters used in the manufacture of tapes and labels. The line was expanded with a pail version in 2007 for use in the manufacture of insulating glass, carrying the CE mark to permit distribution in Europe. The Therm-O-Flow offers a new generation air motor called the NXT® with an embedded control structure (provides runaway protection, diagnostics and material usage data), modular air valve, and integrated air controls. The Liquid Control line of equipment meters, mixes and dispenses precision beads of sealants and adhesives and is customized for use in the electronics and automotive industries and in bonding, molding, sealing, doming and gasketing other products. In 2007, we introduced the Liquid Control™ PR70, the first meter, mix and dispense plural components system with Graco Control Architecture™ for quick troubleshooting and a compact modular design that is broadly configurable. In-plant polyurethane equipment and systems are used to reduce road noise and vibration in motor vehicles and to produce a wide variety of injection molded parts for automobiles, trucks, consumer products and general industrial use. Material suppliers and end-user customers play a significant role in the development of in-plant polyurethane systems for specific applications.

We work closely with major material manufacturers to identify and configure Graco equipment suitable for the handling of their materials. For example, our equipment is used to supply a catalyzed plastic resin for the formation of the blades used on turbines for generating electricity from wind and adhesive for cementing parts of the blades together.

Contractor Segment

The Contractor segment generated approximately 36 percent of our Company’s 2007 total sales. This segment markets a complete line of airless paint and texture sprayers (air, gas, hydraulically- and electrically-powered), accessories such as spray guns, hoses and filters and spare parts such as tips and seals, to professional and semi-professional painters in the construction and maintenance industries. The products are distributed primarily through stores whose main products are paint and other coatings. Contractor products are also sold through general equipment distributors. A limited line of sprayers are distributed through the home center channel.

Contractor equipment includes a wide variety of sprayers, including sprayers that apply markings on roads, parking lots, fields and floors; texture to walls and ceilings; highly viscous coatings to roofs; and paint to walls and structures. Many of these sprayers and their accessories contain one or more advanced technological features such as micro-processor based controls for consistent spray and protective shut-down, a pump that may be removed and re-installed without tools, an easy clean feature, gas/electric convertibility, and an extremely durable pump finish. Continual technological innovation and broad product families with multiple offerings are characteristic of our Company’s Contractor equipment business. Painters are encouraged to upgrade their equipment regularly to take advantage of the new and/or more advanced features. A new line of sprayers for the application of fine finishes to cabinets and other wood surfaces was introduced in 2007. The FinishPro™ air-assisted airless sprayer provides a finish quality comparable to high volume low pressure (HVLP) sprayers, the production speed of an airless sprayer and the ability to switch from airless to air-assisted airless with the flip of a switch. These sprayers are equipped with one of the first air-assisted airless spray guns that uses a reversible spray tip.

A large percentage of our Contractor sales come from the North American market, although Contractor products are marketed and sold in all major geographic areas. In recent years, the segment has increased its effort to appeal to customers outside of North America by developing products specifically for these markets, like the Mark X™ texture sprayer, a 240 volt, 2.4 gallons per minute electric sprayer used to fill in rough areas on plaster and concrete walls and designed to be sold in Europe and Asia Pacific where less drywall is used.

In Europe and Asia Pacific, we are pursuing a broad strategy of converting contractors accustomed to the manual application of paint and other coatings by brush and roller to spray technology. This requires extensive in-person demonstration of the productivity advantages, cost savings and finish quality of our spray equipment. This also requires the conversion of local paint distributors who may have a different method of selling their product. For example, in the P.R.C. some paint companies include spray application in the price they charge for their paint.

Lubrication Segment

The Lubrication segment represented approximately 11 percent of our Company’s sales during 2007. Traditionally, the Lubrication segment has focused on pumps, applicators and accessories, such as meters and hose reels, for the motor vehicle lubrication market. In this market, our Company’s customers include fast oil change facilities, service garages, fleet service centers, automobile dealerships, and auto parts stores. Recent acquisitions have expanded the segment’s product offering, providing access to new markets. Small electric fuel and oil transfer pumps for use in remote locations to supply fuel and oil to ranch, farm and construction machinery and off-road vehicles and automatic lubrication systems are examples.

The Lubriquip® product line consists of systems for the automatic lubrication of factory machine tools, compressors and pumps used in petrochemical and gas transmissions plants; bearings and gears on equipment in metal, pulp and paper mills; conveyors and material handling equipment; and off-road and over-the-road trucks. Lubriquip products are primarily sold through distribution. During 2007, the manufacture of Lubriquip products was transferred from facilities in Madison, Wisconsin and Cleveland, Ohio to the facility in Anoka, Minnesota.

Although the bulk of the Lubrication segment’s sales come from North America, the segment is responsible for world-wide marketing and sales of our lubrication equipment. Products are distributed in each of our Company’s major geographic markets, primarily through independent distributors serviced by independent sales representatives, a dedicated sales force in the automatic lubrication systems market and direct sales generalists in foreign markets. Some automatic lubrication systems are marketed to original equipment manufacturers (OEMs). Fuel and oil transfer pumps are marketed through OEMs, select home centers, auto parts stores and our traditional distribution channel.


CEO BACKGROUND

Patrick J. McHale
Mr. McHale, 46, is President and Chief Executive Officer of Graco Inc., a position he has held since June 2007. He served as Vice President and General Manager, Lubrication Equipment Division of Graco from June 2003 until June 2007. He was Vice President of Manufacturing and Distribution Operations from April 2001 until June 2003. He served as Vice President, Contractor Equipment Division from February 2000 to March 2001. Prior to becoming Vice President, Lubrication Equipment Division in September 1999, he held various manufacturing management positions in Minneapolis, Minnesota; Plymouth, Michigan; and Sioux Falls, South Dakota. Mr. McHale joined the company in December 1989.

Lee R. Mitau
Mr. Mitau, 59, is the Executive Vice President and General Counsel of U.S. Bancorp, a regional bank holding company. He assumed this position in 1995. Mr. Mitau has been a director of Graco since May 1990. He served as Chairman of the Board of the Company from May 2002 until April 2006 and has been serving as the Chairman of the Board of the Company since June 2007. He also serves as Chairman of the Board of H.B. Fuller Company.

Marti Morfitt
Ms. Morfitt, 50, is the former President and Chief Executive Officer of CNS, Inc., a manufacturer and marketer of consumer products, including the Breathe Right® nasal strip. She held this position from 2001 through March 2007. From 1998 to 2001, she was Chief Operating Officer of CNS, Inc. Ms. Morfitt left her position at CNS, Inc. effective March 2007 as a result of the acquisition of CNS, Inc. by GlaxoSmithKline plc in December 2006. Ms. Morfitt has been a director of Graco since October 1995 and is also a director of Thermage Inc.


William J. Carroll
Mr. Carroll, 63, is a principal of Highland Jebco L.L.C., which provides advisory and consulting services to the automotive parts industry. He assumed this position in May 2006. He was the Director of Economic and Community Development for the city of Toledo, Ohio, a position he held from September 2004 until January 2006. From September 2003 to March 2004, Mr. Carroll was the President and Chief Operating Officer of Dana Corporation. Dana Corporation engineers, manufactures and distributes components and systems for vehicular and industrial manufacturers worldwide. From 1997 to March 2004, Mr. Carroll was the President – Automotive Systems Group of Dana Corporation. Mr. Carroll has been a director of Graco since June 1999.

Jack W. Eugster
Mr. Eugster, 62, was the Chairman, President and Chief Executive Officer of Musicland Stores, Inc., a retail music and home video company, from 1980 until his retirement in January 2001. Mr. Eugster has been a director of Graco since February 2004, and is also a director of Donaldson Company, Inc. and Black Hills Corporation.

R. William Van Sant
Mr. Van Sant, 69, is an operating partner of Stone Arch Capital, a private equity firm. He assumed this position in January 2008. From August 2006 through December 2007, he was the President and Chief Executive Officer of Paladin, a Dover Corporation company, which manufactures attachments for construction equipment. From 2003 until August 2006, Mr. Van Sant was Chairman of Paladin L.L.C, and from 2003 until November 2005, Mr. Van Sant was Chairman and Chief Executive Officer of Paladin. He was an Operating Partner with Norwest Equity Partners, a leading private equity firm, from 2001 through 2006. Mr. Van Sant has been a director of Graco since February 2004 and is also a director of H.B. Fuller Company.


J. Kevin Gilligan
Mr. Gilligan, 53, is the President and Chief Executive Officer of United Subcontractors, Inc., a national construction services company. He assumed this position in October 2004. He was President and Chief Executive Officer, Automation and Control Solutions, Honeywell International, Inc., a diversified technology and manufacturing company, from 2001 until January 2004. Mr. Gilligan has been a director of Graco since February 2001 and is also a director of ADC Telecommunications, Inc.

Mark H. Rauenhorst
Mr. Rauenhorst, 55, is the Chairman and Chief Executive Officer of Opus Corporation, which is engaged in design, construction and real estate development activities. He assumed this position in June 2007. He served as President and Chief Executive Officer of Opus Corporation from and after 1999 and 2000, respectively. Beginning in 1996, he was President and Chief Executive Officer of Opus Northwest L.L.C. Mr. Rauenhorst has been a director of Graco since September 2000 and is also a director of Opus Corporation.

William G. Van Dyke
Mr. Van Dyke, 62, was Chairman of the Board of Donaldson Company, Inc., a diversified manufacturer of air and liquid filtration products from August 2004 until his retirement in August 2005. He was Chief Executive Officer and President of Donaldson Company, Inc. from 1996 to August 2004. Mr. Van Dyke has been a director of Graco since May 1995. Mr. Van Dyke is also a director of Polaris Industries, Inc. and Alliant Techsystems Inc.

MANAGEMENT DISCUSSION FROM LATEST 10K

Overview

Our Company’s key strategies include development of new products, expansion of distribution, new market penetration and completion of acquisitions. Long-term financial growth targets accompany these strategies, including 10 percent revenue growth, 12 percent net earnings and earnings per share growth.

Graco’s business is classified by management into three reportable segments, each responsible for product development, marketing and sales of their products. The segments are headquartered in North America. They have responsibility for sales and marketing in the Americas and joint responsibility with Europe and Asia Pacific regional management for sales and marketing in those geographic areas.

Manufacturing is a key competency of the Company, and to facilitate our growth we are aligning manufacturing responsibility with our divisions. Strategic manufacturing expertise will continue to be provided by a management team in Minneapolis, who will also be responsible for factories not fully aligned with a single division. Our primary manufacturing facilities are in the United States and distribution facilities are located in the United States, Belgium, Japan, Korea and China. In 2007 manufacturing activities for the Lubrication division were centralized in Anoka, Minnesota and in 2006, a new assembly factory in Suzhou, China began production.

Results of Operations

Highlights include:
• Sales grew by 3 percent in 2007 and 12 percent in 2006, with continued strong growth in Europe and Asia Pacific of 23 percent and 18 percent, respectively, in 2007. Sales in the Americas decreased by 6 percent in 2007, primarily due to the weak housing and construction industries.
• Sales were higher in the Industrial and Lubrication segments, with growth in 2007 of 7 percent and 13 percent respectively, offset by a 4 percent decline in Contractor.
• Net sales increased by approximately $17 million in 2007 and $5 million in 2006 from favorable currency translation.
• Net earnings grew 2 percent in 2007 and 19 percent in 2006. Currency translation increased net earnings by approximately $7 million in 2007 and $2 million in 2006.
• Investment in new products was 3.6 percent of sales in 2007 and 3.7 percent of sales in 2006.
• The full year impact of the Lubriquip acquisition increased net sales by $11 million or 1 percent in 2007. In 2006, the Lubriquip acquisition and the full year impact of businesses acquired in 2005 (Gusmer, Liquid Control and PBL) increased net sales by $18 million or 2 percent.
• Increased cash flows from operations in each year.

Sales in the Americas declined by 6 percent overall and by 4 percent and 14 percent in the Industrial and Contractor segments, respectively, in 2007 as compared to the prior year. Lubrication sales in the Americas increased by 10 percent, primarily due to the full year impact of the Lubriquip acquisition. Strong growth in Europe and Asia Pacific in all three segments reflects a favorable business environment, continued emphasis on expanding sales and marketing resources in those regions and focus on new distribution as well as the positive effect of foreign currency translation rates.

Operating expenses in 2007 were $215 million compared to $208 million in the prior year. Although spending increased for selling, marketing and distribution (increase of $5 million) and general and administrative (increase of $1 million), total operating expenses as a percentage of sales was consistent with the prior year at 26 percent. Included in cost of goods sold and operating expenses were costs and expenses related to the closure and move of the Lubriquip operations in Cleveland, Ohio and Madison, Wisconsin to the Anoka, Minnesota factory totaling $2.3 million in 2007. Operating expenses included $7 million of stock compensation in 2007.

Operating expenses in 2006 were $208 million versus $188 million in 2005. Acquired businesses had approximately $4 million of operating expenses in 2006. Although spending increased for product development (increase of $3 million), selling (increase of $9 million) and general and administrative (increase of $8 million), total operating expenses as a percentage of sales was consistent with the prior year at 26 percent. Included in cost of goods sold and operating expenses were costs and inventory charges related to closure of the Gusmer New Jersey facility and move of production totaling $5 million for the year. Operating expenses included $7 million of stock compensation due to adoption of SFAS No. 123(R) in 2006.

Consolidated operating earnings increased 3 percent to $232 million, or 28 percent of sales in fiscal 2007, with growth in sales of 3 percent as compared to the prior year and consistent gross profit margins and expenses. Gross profit margin as a percentage was consistent with the prior year, as the favorable impact of pricing and foreign currency translation offset higher spending and material costs.

Consolidated operating earnings increased 18 percent to $226 million, or 28 percent of sales in fiscal 2006, compared to $191 million, or 26 percent of sales in fiscal 2005. The increase in earnings as a percentage of sales was primarily due to stronger gross profit margin of 53.2 percent in 2006 compared to 51.8 percent in 2005. A substantial portion of this difference is due to the higher cost of inventory of the acquired businesses in 2005. Improved manufacturing efficiencies and higher sales volume more than offset the negative impact of higher material, labor and overhead costs.

Interest expense increased by $2.5 million in 2007 as the Company increased its utilization of credit lines to purchase Company stock.

The Company’s effective tax rate was 33 percent in 2007, consistent with the effective tax rate in 2006. The rate in both periods is lower than the U.S. federal statutory rate of 35 percent due primarily to U.S. business credits and the Domestic Production Deduction (DPD).

Segment Results

In 2007, sales in the Industrial segment increased by 7 percent, with sales growth in Europe and Asia offsetting sales declines in the Americas. Sales in Europe grew by 19 percent, including 9 percentage points related to favorable currency translation rates. The sales growth in Asia Pacific was 18 percent and the effect of currency translation rates was not significant.

In 2007, operating earnings in the Industrial segment were up 19 percent due to the increase in sales, improvements in gross profit margins and lower spending as percentage of sales. The lower spending is primarily the result of efficiencies obtained following the move of Gusmer operations into the Minneapolis, Sioux Falls and Ohio facilities and closure of the New Jersey facility in 2006.

In 2006, sales in the Industrial segment grew by 13 percent, with growth in all geographic regions. Growth in various product categories, such as high performance coatings and foam equipment, and full year impact of businesses acquired in 2005 contributed to the strong sales growth in the Industrial segment in 2006. Europe continued to experience strong sales growth in Eastern Europe and the Middle East.

In 2006, operating earnings in the Industrial segment were up 31 percent compared to 2005. Sales increased by 13 percent and gross profit margin as a percentage of sales increased by 2 percentage points. The increase in gross profit margin was primarily due to the higher cost of inventory of the acquired businesses in 2005.

In this segment, sales in each geographic region are significant and management looks at economic and financial indicators in each region, including gross domestic product, industrial production, capital investment rates and the level of the U.S. dollar versus the euro, Japanese yen, South Korean won and the Canadian dollar.

Contractor

In 2007, sales in the Contractor segment decreased by 4%. Although sales in the Americas decreased by 14 percent, sales in Europe and Asia Pacific grew by 28 percent and 17 percent, respectively. Sales in the Americas were lower due to declines in both the home center and professional paint store channels. Sales growth in both Europe and Asia Pacific is attributed to continued focus on converting professional contractors from manual to spray applications and new distribution.

In 2007, operating earnings in the Contractor segment decreased by 9 percent. Operating earnings include approximately $1 million of incremental expense related to the launch and production of a new paint sprayer line for the home center channel. Gross profit margins and spending levels were otherwise consistent with the prior year.

In 2006, sales in the Contractor segment increased by 5 percent. Sales in the Americas were $244 million or 76 percent of total segment sales, an increase of 1 percent from 2005. The lower rate of growth as compared to 2005 reflected the slowing housing market in the United States. Sales in Europe and Asia Pacific increased by 20 percent and 25 percent respectively due to new product introductions and increased distribution throughout both regions.

In 2006, operating earnings in the Contractor segment increased 15 percent due to higher net sales, gross profit margin improvement and spending that was slightly lower than the prior year as a percentage of sales.

In this segment, sales in the Americas and Europe are significant and management reviews economic and financial indicators in each region, including levels of residential, commercial and institutional building, remodeling rates and interest rates. Management also reviews gross domestic product for the regions and the level of the U.S. dollar versus the euro.

Lubrication

In 2007, sales in the Lubrication segment increased by 13 percent. Sales in the Americas increased by $7 million, with full year effect of the Lubriquip acquisition of $9 million for the region. Sales in Europe increased by 46 percent, including 7 percentage points related to favorable currency translation rates. Sales in Asia Pacific increased by 26 percent; the effect of currency translation was not significant.

In 2007, operating earnings decreased by $9 million, including $2.3 million of expenses related to the integration of the Lubriquip manufacturing operations, closure of the Lubriquip facilities in Madison, Wisconsin and Cleveland, Ohio and the transfer of Lubrication manufacturing from the facility in Minneapolis to the new facility in Anoka, Minnesota. The segment also had higher spending than the prior year in new product development, marketing and warranty expense, partially due to the full year impact of the Lubriquip acquisition.

In 2006, sales in the Lubrication segment increased by 34 percent, with the acquired Lubriquip business providing 19 percentage points of the overall sales growth and the full year impact of the 2005 PBL acquisition providing 6 percentage points of the sales growth.

In 2006, operating earnings in the Lubrication Equipment segment increased by 20 percent with an increase in segment sales of 34 percent. Lubriquip contributed approximately one half of the sales growth and $4 million of incremental operating expenses in 2006.

The Americas represent the vast majority of sales for the Lubrication Equipment segment and indicators in that region are the most important. The indicators used by management include levels of capital investment, industrial production and gross domestic product.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

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, new market penetration and completion of acquisitions.

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

Foreign currency translation rates had a favorable impact on sales and net earnings. Translated at consistent exchange rates, sales for the quarter and year-to-date were 2 percent and 1 percent lower than last year, respectively, and net earnings decreased 20 percent for the quarter and 12 percent year-to-date.



Sales include $9 million from GlasCraft operations since the date of acquisition, with $3.5 million in the third quarter.



Deteriorating economic conditions in the U.S. and other parts of the world affected sales growth. Strategic investments in product and market development, along with rising costs of doing business, continued to apply pressure on earnings.



Purchases and retirement of approximately 3.1 million shares of Company common stock, including approximately 0.9 million shares in the third quarter, had a positive impact on earnings per share.

Results of Operations



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

Foreign currency translation rates had a favorable impact on sales and net earnings. Translated at consistent exchange rates, sales for the quarter and year-to-date were 2 percent and 1 percent lower than last year, respectively, and net earnings decreased 20 percent for the quarter and 12 percent year-to-date.



Sales include $9 million from GlasCraft operations since the date of acquisition, with $3.5 million in the third quarter.



Deteriorating economic conditions in the U.S. and other parts of the world affected sales growth. Strategic investments in product and market development, along with rising costs of doing business, continued to apply pressure on earnings.



Purchases and retirement of approximately 3.1 million shares of Company common stock, including approximately 0.9 million shares in the third quarter, had a positive impact on earnings per share.

Consolidated Results

Growth in Europe and Asia Pacific offset decreases in contractor and lubrication sales in the Americas. In Europe, sales for the quarter and year-to-date were 9 percent and 18 percent higher than last year, respectively. Translated at consistent exchange rates, sales in Europe increased 2 percent for the quarter and 7 percent year-to-date. Sales in Asia Pacific increased by 23 percent for the quarter and 14 percent year-to-date.

Gross profit margin, expressed as a percentage of sales, was 53.2 percent for the quarter, close to last year’s percentage of 53.4 percent. Changes in geographic and product sales mix in Europe affected the margin rate for the quarter. Year-to-date gross profit margin percentage was 53.9 percent, up from 53.1 percent last year. Favorable currency translation rates added 1.1 percentage points to the year-do-date gross profit margin rate. The effects of higher material and other costs on gross margin rate have been offset by the impact of pricing and manufacturing efficiencies.

Operating expenses are up 11 percent for the quarter and 12 percent for the year-to-date. The effects of currency translation contributed approximately 2 percentage points of the increase for the quarter and 3 percentage points year-to-date. Operating expenses in 2008 include $1.5 million for the quarter from acquired GlasCraft operations and $4 million year-to-date. Continued strategic investments in product and market development also contributed to the increase in operating expenses, including expenses related to the introduction of new product lines in the home center channel, new product development teams and additional sales and marketing personnel in developing countries. Compared to last year, product development expense was up $2.5 million for the quarter and $3.7 million year-to-date.

Year-to-date interest expense is $3.5 million higher than last year due to borrowings used for the purchase and retirement of Company shares and for business acquisitions. Graco repurchased approximately 3.1 million shares of its common stock for $114 million in the first nine months of 2008.

The Company’s effective tax rate for the third quarter was 34 percent, up from 32 percent last year. The lower rate in 2007 resulted from expiring statutes of limitations and a higher than expected benefit upon filing of prior year tax returns. The completion of the examination of the Company’s income tax returns in the first quarter of 2008 resulted in a lower year-to-date effective tax rate compared to last year.

Segment Results



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

Strong sales in Asia Pacific (up 27 percent) drove the increase in Industrial segment sales for the quarter. Sales in this segment were 5 percent higher in the Americas and in Europe, although the increase in Europe came from currency translation. Year-to-date sales in this segment are up 18 percent in Europe (approximately 11 percentage points from currency translation), 11 percent in Asia Pacific and 8 percent in the Americas. Most of the sales growth in this segment came from high performance coatings and foam products.

Operating earnings in this segment were affected by selling and product development initiatives and costs and expenses resulting from acquisition and integration related activities. The move of GlasCraft operations from Indiana to the Company’s facilities in Ohio, South Dakota and Minnesota will be completed in the fourth quarter.

In the Contractor segment, sales growth in Europe lessened the impact of continued softness in both the North American paint store and home center channels. Sales for the quarter in this segment were up 16 percent in Europe (including 6 percentage points from currency translation), flat in Asia Pacific and down 22 percent in the Americas. Year-to-date increases in Europe (18 percent increase, including 11 percentage points from currency translation) and in Asia Pacific (11 percent increase, including 2 percentage points from currency translation) were not enough to offset the 21 percent decrease in the Americas.

The decrease in sales without a corresponding decrease in expenses had a large impact on the operating earnings of this segment. Strategic spending in this segment was for developing products for new markets and the launch and production of new paint sprayer units in the home center channel.

In the Lubrication segment, third quarter sales increases in Europe and Asia Pacific were not enough to offset a decrease in the Americas. Year-to-date, the increases in Europe and Asia Pacific offset the decrease in the Americas.



Improvement in year-to-date operating profitability is related to the integration and consolidation of Lubrication operations completed in 2007, although segment profitability has also been affected by a sales decline in the higher-margin vehicle services products.



Management intends to integrate all LubeSci operations (acquired in fiscal September) into the Company’s facility in Anoka, MN.

CONF CALL

Caroline M. Chambers - Vice President and Controller

Good morning and welcome to everyone. I'm here this morning with Pat McHale, President and CEO; and Jim Graner, our CFO. I'll briefly review our third quarter results. Pat will discuss business highlights by operating segment. Following these opening comments, we will open up the call for your questions.

Sales were flat in the third quarter as compared to the same quarter last year, though down 2% when translated at consistent exchange rates. We continue to see strong sales growth in Europe and Asia this quarter, offsetting weakness in the Contractor and Lubrication segments in North America. Sales in the second quarter included $3.5 million from GlasCraft. GlasCraft was acquired in March of this year.

Gross profit margin as a percentage of sales was 52.2% or 53.2% this quarter as compared to last year's rate of 53.4%. We saw the impact of higher material costs, though continue to offset them with pricing and manufacturing productivity improvements. The effect of currency translation rates was not significant this quarter. We have seen shifts in mix and a decline in sales growth rate for some higher margin product lines and in Western Europe, which has also affected gross profit margins.

Operating expenses for the quarter are 11% higher than last year, including the effect of currency translation, which was 2% of this increase. Operating expenses for GlasCraft were 3 percentage points of the increase, and the impact of new product development was another 4% points. Net earnings are down 5% year-to-date and down 17% for the quarter as compared to last year. Earnings per share decreased by 10% in the quarter.

A couple of additional points there. Interest expense was up approximately $1 million as compared to this quarter last year, though it is consistent with the second quarter of this year. The effective tax rate was 34% this quarter as compared to 32% in the third quarter last year. The lower rate in 2007 resulted from expiring statutes of limitations and a higher-than-expected benefit when we filed that year's tax returns.

Approximately 900,000 shares were repurchased this quarter. There are approximately 3 million shares remaining under our current Board authorization as of the end of September. Additional share repurchases are not contemplated in the near term.

A couple of brief comments regarding inventory. We did see inventory grow slightly this quarter. And for the year, we see that it's really in three main areas, as we continue to increase our international distribution, develop new products and continue to improve our service levels.

I'll now turn it over to Pat for a discussion of the business unit results by segment and a review of the key operating strategy.

Patrick J. McHale - President and Chief Executive Officer

Good morning. Before discussing the segments, I'd like to make a couple of general comments.

First of all, despite a difficult quarter, we are pleased that our gross profit margin held up well at that 53.2%, about the same as last year, as our manufacturing and purchasing group have done a good job on cost reductions during the first nine months of this year, helping to offset some of the commodity price spikes that we saw.

You'll also note that as I talk about the individual business segments, operating expenses for the growth initiatives are starting to kick in. New product development for the quarter was about 4.6% of sales versus 3.4% of sales for the same quarter last year. And you see an increase in selling, marketing and distribution expenses of about $2 million for the quarter. $400,000 of that was GlasCraft. A lot of the rest of it was the growth investments that we're making, primarily in the developing markets of Europe and in Asia.

Moving on to the segments, I'll talk about the Industrial segment first. Worldwide, our Industrial sales grew 9% for the quarter. We had sales growth in all regions. We did see a lot of variability in our end markets. Markets that are still strong for us include sanitary, oil and gas, alternative energy, electronics, medical, egg, rail, infrastructure, aerospace and military. So, we have quite a number of markets that are still holding up well.

However, we do have a number of markets that are getting quite soft. Certainly, automotive is very weak as is auto feeder. Anything related to the housing market has been difficult, whether it's been windows, door, furniture, cabinets, bath. And then big ticket consumer items like RVs and pleasure boats, of course, continue to be very soft.

Our business in Western Europe was extremely weak during the quarter with double-digit declines at constant currency on average across our Industrial product offering. That was offset by strong double-digit gains in Easter Europe, the Middle East and Africa.

For the Industrial Equipment business, the operating margins in Q3 were 30% versus 35% in the same quarter, prior year. There is a reconciliation included in the slide show. Our gross margins were slightly under 56%, down about 2 points from prior year. That's reflecting regional and product mix, including the impact of the GlasCraft acquisition.

Product development spending increased by about 50% versus Q3 of 2007, again, consistent with our initiative to try to drive organic growth with some nice projects. We also increased spending and selling and marketing and distribution by about 14% in the Industrial segment. The majority of that increase was related to GlasCraft and to our international growth initiative.

Moving on to the Contractor segment, our Contractor segment on a worldwide basis, we're down 12% for the quarter. We had a nice growth in Europe, 16%, 10% at constant currency. And we had good growth in most of Asia, a 2% number I'll talk more about in a minute. But those growing regions were not enough to offset the continued double-digit declines we're seeing in North America.

North America paint segment was down 18% and the home center rental business was down 34%. We continue to see purchases from our distribution channel be less than their out-the-door sales, as they continue to reduce inventory in… as they're reacting to a housing market that clearly hasn't bottomed yet. Also, another unfavorable trend is that end user purchasers at most of our accounts continue to show declining trends.

We have or we're announcing today that we got the Sherwin-Williams entry-level business for 2009 from Wagner. That's a nice development for us. Wagner had exclusivity in that product line. We'll be resetting the Sherwin-Williams stores and lifting the Wagner inventory. That will result in about a $3 million one-time cost here going into the fourth quarter that you should model, but we'll have the stores set early in Q1, and we'll get the incremental revenue on that program next year.

Also, on the Lowe's program, we expect to be at about 300 stores by yearend. We have seen some competitive reaction on that as Wagner is testing their Titan line that they tested against us at Home Depot last year. They're testing that in about 200 Lowe's stores beginning in November. Lowe's has advised us that they'll ultimately choose one supplier, and we expect that to happen sometime in the first half of next year.

Contractor sales in Europe, again, we saw the issue with Western Europe where we saw single-digit declines at constant currency in the West. Those were more than offset by strong double-digit sales gains in the East and the Middle East. The Asian number, 2% as reported, was not particularly concerning, as we did experience solid double-digit sales gains in all areas of Asia except for Australia and Japan.

We have something unique happening in Australia. We're implementing a Graco-owned distribution center. We fired that up here at the beginning of this month. So the last couple of months, we've been working the inventory off at a master distributor. And that's accounted for about a 50% or $1 million sales decrease in our Australian business that will right itself once the master distributor inventory is worked through.

On the earnings front, operating margins in Contractor were 22% compared to 27% for the same quarter last year. Gross margins remain relatively flat at 51%. Spending was essentially flat, but we have product development increase of 45% versus the same quarter last year. And we've talked a lot about our total market initiatives in Contractor. We've got some great projects that we're working on that will start to launch later in 2009 and more significantly in 2010. And you see the spend as we support that investment.

We had increases in selling and marketing expenses for Contractor in Europe and Asia. Those were largely offset by spending reductions in North America. As you can see, we weren't able to cut our expenses to the extent that volume… that our revenue dropped. And so we took some additional pressure on the margin side.

In terms of our fourth quarter outlook for the Contractor business, it's pretty clear housing hasn't reached bottom quite yet. Commercial construction is softening, although the painting side of that is still hanging in there. We're expecting a similar 20% kind of a drop in our North America Contractor business in Q4 versus Q4 '07, even though the comps were easier from a bad fourth quarter in '07.

In the Lube segment, sales declined 5% for the quarter versus same quarter last year. We had strong double-digit sales gains in Europe and Asia, but they weren't enough to offset a significant decline in our North America business.

Our vehicle service, the old historical Graco Lube business, declined by about 18% in the quarter, and we've really seen a rapid deterioration there of our business, especially as it related to the car dealership market during the past few weeks. On a positive note, our industrial lube growth initiative posted solid double-digit sales gains for the quarter and we're continuing to invest in that new market opportunity.

Operating margins in Lube were 16% for the quarter versus 11% last year's same quarter. And we do continue to make progress, improving the profitability of the acquired industrial lube segment. However, the steep decline in our more profitable VS business combined with lower factory volumes caused our Q3 operating margins to fall below our expectations and below Q2.

We are continuing to work on a solid list of cost reduction and profit improvement opportunities in this segment, and we do expect the operating margins to return to the mid-20s when business conditions in Lube return to more normal levels.

Although we don't give formal guidance, I am going to make a few comments regarding Q4 and 2009. In terms of Q4, our incoming order rate for the first three weeks of October is down about 15% from our run rate of October of last year. We are seeing that slowdown across all of our divisions and regions, and we're quite concerned about that. The economic uncertainty in the credit markets appear to be having an impact on our end users, and we are seeing some delays in capital equipment spending.

So we'll have to see how that all plays out here over the number of weeks, but we're monitoring that situation closely. On the positive note, for Q4, you should be modeling in the fact that R&D tax credit was reinstituted, and we'll get about $1.5 million of net earnings boost from that in the quarter.

From a long-term perspective, we're still very positive. We've got a great business model, strong fundamentals. Our end markets are very diverse. Our business is global with 45% of our sales from outside North America. We've got a strong well distribution channel with a large installed base and a good parts and accessories business. We do continue to have pricing power, and we're continuing to make disciplined ROI decisions within the business. And with a strong balance sheet and good cash flow, we can expect to continue to do well over the long term.

We're executing to a strategic growth plan. We have a five-year plan. It's fully supported by the Board. And that plan calls for us to invest in growth initiatives: new products, new markets, geographic expansion, and strategic acquisitions. So, our vision is clear. Our investments are ramping. And when this is over, we will emerge as a stronger and more diverse company.

Lastly, a few comments on 2009, we do expect that we're going to have some difficult end markets in 2009 and that it will probably have some significant currency headwinds, but we also see opportunities for us in 2009. We have some of our end markets we expect will remain relatively strong. Examples would be alternative energy, infrastructure, both our foam and process business we're very optimistic about, and of course our industrial lube initiative.

The GlasCraft integration will be completed in Q4 of this year. That's going to provide some earnings upside going into 2009. Airlessco and LubeSci acquisitions that we recently announced should be accretive to earnings next year. We had the big Home Depot rollout in the first half of 2008 with the associated expenses that won't repeat in 2009.

And we've got good slated new products coming from all the divisions. We've got the 300 Lowe's stores going into '09 that we didn't have in '08. We have the Sherwin-Williams entry-level program. We'll have launch expenses here, as I mentioned, in Q3 that will be non-recurring, but will get the revenue starting in 2009.

Our manufacturing group has got a good strong slate of projects… cost reduction projects lined up. And so, we're expecting that the slowing economy may provide some relief on commodity and transportation costs and we'll be able to take some of those manufacturing cost improvements to the bottomline. And we're also doing a January price increase that will be on our normal cycles.

While we are planning for EPS growth next year and we do see some opportunity, it is a difficult planning environment, probably the most difficult planning environment that I've been associated with during my 20 years here at Graco. We are managing discretionary expenses, and we are building contingency plans that we can execute should conditions warrant to do something more dramatic on expenses.

You should know that I am going to exercise some patience, as the incremental investments do have strong returns and that stopping and restarting these programs like new product development and our emerging market expansion has some pretty significant impacts from timing and then from the expense to get them going again in perspectives. So, we're going to exercise some patience and watch this thing play out for a while.

Ultimately, we're managing for growth. We think that's where our future is.

So with that, I will turn the conference back over to the operator, and we'll open it up for questions.

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