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Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

Quarterly Report Pursuant to Section 13 or 15 (d) of the

Securities Exchange Act of 1934

For the quarterly period ended March 28, 2014

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      X                 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    

60,616,000 shares of the Registrant’s Common Stock, $1.00 par value, were outstanding as of April 16, 2014.


Table of Contents

INDEX

 

 

           

 

Page Number

 

  

 

PART I   FINANCIAL INFORMATION   
  Item 1.      Financial Statements   
       Consolidated Statements of Earnings      3             
       Consolidated Statements of Comprehensive Income      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      16             
  Item 3.      Quantitative and Qualitative Disclosures About Market Risk      22             
  Item 4.      Controls and Procedures      22             
PART II   OTHER INFORMATION   
  Item 1A.      Risk Factors      23             
  Item 2.      Unregistered Sales of Equity Securities and Use of Proceeds      23             
  Item 6.      Exhibits      24             
SIGNATURES   
EXHIBITS   

 

2


Table of Contents

PART I    Item 1.

GRACO INC. AND SUBSIDIARIES 

CONSOLIDATED STATEMENTS OF EARNINGS 

(Unaudited) (In thousands except per share amounts)

 

    Thirteen Weeks Ended  
      March 28,  
2014
      March 29,  
2013
 

Net Sales

   $ 289,962       $ 269,046   

Cost of products sold

    130,650        118,402   
 

 

 

   

 

 

 

Gross Profit

    159,312        150,644   

Product development

    13,159        12,421   

Selling, marketing and distribution

    46,342        43,354   

General and administrative

    25,106        23,372   
 

 

 

   

 

 

 

Operating Earnings

    74,705        71,497   

Interest expense

    4,588        4,762   

Other expense (income), net

    (3,428)        (4,395)   
 

 

 

   

 

 

 

Earnings Before Income Taxes

    73,545        71,130   

Income taxes

    22,800        19,000   
 

 

 

   

 

 

 

Net Earnings

   $ 50,745       $ 52,130   
 

 

 

   

 

 

 

Per Common Share

   

Basic net earnings

   $ 0.83       $ 0.86   

Diluted net earnings

   $ 0.81       $ 0.84   

Cash dividends declared

   $ 0.28       $ 0.25   

See notes to consolidated financial statements.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME 

(Unaudited) (In thousands)

 

    Thirteen Weeks Ended  
      March 28,  
2014
      March 29,  
2013
 

Net Earnings

   $ 50,745       $ 52,130   

Other comprehensive income (loss)

   

Cumulative translation adjustment

    (86)        (8,487)   

Pension and postretirement medical liability adjustment

    1,188        2,456   

Income taxes

   

Pension and postretirement medical liability adjustment

    (428)        (878)   
 

 

 

   

 

 

 

Other comprehensive income (loss)

    674        (6,909)   
 

 

 

   

 

 

 

Comprehensive Income

    $ 51,419       $ 45,221   
 

 

 

   

 

 

 

See notes to consolidated financial statements.

 

3


Table of Contents

GRACO INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Unaudited)

(In thousands)

 

     March 28,
2014
          Dec 27,     
2013
 

ASSETS

     

Current Assets

     

Cash and cash equivalents

    $ 24,082        $ 19,756   

Accounts receivable, less allowances of $6,300 and $6,300

     210,102         183,293   

Inventories

     147,373         133,787   

Deferred income taxes

     21,144         18,827   

Investment in businesses held separate

     422,297         422,297   

Other current assets

     10,371         14,633   
  

 

 

    

 

 

 

Total current assets

     835,369         792,593   

Property, Plant and Equipment

     

Cost

     417,338         407,887   

Accumulated depreciation

     (261,332)         (256,170)   
  

 

 

    

 

 

 

Property, plant and equipment, net

     156,006         151,717   

Goodwill

     227,204         189,967   

Other Intangible Assets, net

     166,655         147,940   

Deferred Income Taxes

     20,891         20,366   

Other Assets

     24,452         24,645   
  

 

 

    

 

 

 

Total Assets

    $     1,430,577        $ 1,327,228   
  

 

 

    

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

     

Current Liabilities

     

Notes payable to banks

    $ 11,049        $ 9,584   

Trade accounts payable

     43,695         34,282   

Salaries and incentives

     23,475         38,939   

Dividends payable

     16,720         16,881   

Other current liabilities

     73,954         69,167   
  

 

 

    

 

 

 

Total current liabilities

     168,893         168,853   

Long-term Debt

     503,010         408,370   

Retirement Benefits and Deferred Compensation

     94,990         94,705   

Deferred Income Taxes

     21,030         20,935   

Shareholders’ Equity

     

Common stock

     60,738         61,003   

Additional paid-in-capital

     364,060         347,058   

Retained earnings

     263,531         272,653   

Accumulated other comprehensive income (loss)

     (45,675)         (46,349)   
  

 

 

    

 

 

 

Total shareholders’ equity

     642,654         634,365   
  

 

 

    

 

 

 

Total Liabilities and Shareholders’ Equity

    $ 1,430,577        $ 1,327,228   
  

 

 

    

 

 

 

See notes to consolidated financial statements.

 

4


Table of Contents

GRACO INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited) (In thousands)

 

     Thirteen Weeks Ended  
         March 28,    
2014
        March 29,    
2013
 

Cash Flows From Operating Activities

    

Net Earnings

    $ 50,745       $ 52,130   

Adjustments to reconcile net earnings to net cash provided by operating activities

    

Depreciation and amortization

     9,262        9,272   

Deferred income taxes

     (3,244)        (2,597)   

Share-based compensation

     4,401        3,401   

Excess tax benefit related to share-based payment arrangements

     (1,500)        (1,700)   

Change in

    

Accounts receivable

     (23,251)        (14,244)   

Inventories

     (9,985)        (9,412)   

Trade accounts payable

     6,164        3,359   

Salaries and incentives

     (16,125)        (11,755)   

Retirement benefits and deferred compensation

     1,496        3,020   

Other accrued liabilities

     6,044        8,045   

Other

     4,235        (320)   
  

 

 

   

 

 

 

Net cash provided by operating activities

     28,242        39,199   
  

 

 

   

 

 

 

Cash Flows From Investing Activities

    

Property, plant and equipment additions

     (6,879)        (3,320)   

Acquisition of businesses, net of cash acquired

     (65,150)         

Proceeds from sale of assets

            1,600   

Investment in businesses held separate

           835   

Other

           (133)   
  

 

 

   

 

 

 

Net cash used in investing activities

     (72,026)        (1,018)   
  

 

 

   

 

 

 

Cash Flows From Financing Activities

    

Borrowings (payments) on short-term lines of credit, net

     1,141        (1,280)   

Borrowings on long-term line of credit

     177,710        90,095   

Payments on long-term line of credit

     (83,070)        (125,585)   

Excess tax benefit related to share-based payment arrangements

     1,500        1,700   

Common stock issued

     15,275        17,718   

Common stock repurchased

     (47,542)         

Cash dividends paid

     (16,813)        (15,192)   
  

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     48,201        (32,544)   
  

 

 

   

 

 

 

Effect of exchange rate changes on cash

     (91)        213   
  

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

     4,326        5,850   

Cash and cash equivalents

    

Beginning of year

     19,756        31,120   
  

 

 

   

 

 

 

End of period

    $ 24,082       $ 36,970   
  

 

 

   

 

 

 

See notes to consolidated financial statements.

 

 

5


Table of Contents

GRACO INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1. The consolidated balance sheet of Graco Inc. and Subsidiaries (the “Company”) as of March 28, 2014 and the related statements of earnings for the thirteen weeks ended March 28, 2014 and March 29, 2013, and cash flows for the thirteen weeks ended March 28, 2014 and March 29, 2013 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 the Company as of March 28, 2014, 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 2013 Annual Report on Form 10-K.

The results of operations for interim periods are not necessarily indicative of results that will be realized for the full fiscal year.

 

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

 

    Thirteen Weeks Ended      
         March 28,     
2014
         March 29,     
2013
   

 

Net earnings available to common shareholders

   $ 50,745      $ 52,130    

 

Weighted average shares outstanding for basic earnings per share

    60,822       60,961    

 

Dilutive effect of stock options computed using the treasury stock method and the average market price

    1,616       1,447    

 

Weighted average shares outstanding for diluted earnings per share

    62,438       62,408    

Basic earnings per share

   $ 0.83      $ 0.86    

 

Diluted earnings per share

   $ 0.81      $ 0.84    

 

6


Table of Contents

Stock options to purchase 838,000 and 872,000 shares were not included in the March 28, 2014 and March 29, 2013 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 thirteen weeks ended March 28, 2014 is shown below (in thousands, except per share amounts):

 

    Option
  Shares  
      Weighted  
Average
Exercise
Price
    Options
Exercisable
      Weighted  
Average
Exercise
Price
 

Outstanding, December 27, 2013

    5,149      $ 41.03       3,311     $ 33.20  

Granted

    436        74.80      

Exercised

    (170)        33.53      

Canceled

    (6)        67.04      
 

 

 

       

Outstanding, March 28, 2014

    5,409      $ 43.96       3,666     $ 34.64  
 

 

 

       

The Company recognized year-to-date share-based compensation of $4.4 million in 2014 and $3.4 million in 2013. As of March 28, 2014, there was $22.5 million of unrecognized compensation cost related to unvested options, expected to be recognized over a weighted average period of 2.1 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:

 

    Thirteen Weeks Ended      
        March 28,    
2014
        March 29,    
2013
   

Expected life in years

    6.5            6.5         

Interest rate

    2.0 %         1.3 %      

Volatility

    36.1 %         36.3 %      

Dividend yield

    1.5 %         1.7 %      

Weighted average fair value per share

  $ 24.90          $ 18.29         

 

7


Table of Contents

Under the Company’s Employee Stock Purchase Plan, the Company issued 193,000 shares in 2014 and 197,000 shares in 2013. 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:

 

    Thirteen Weeks Ended      
        March 28,    
2014
        March 29,    
2013
   

Expected life in years

    1.0            1.0         

Interest rate

    0.1 %         0.2 %      

Volatility

    21.4 %         26.0 %      

Dividend yield

    1.4 %         1.7 %      

Weighted average fair value per share

  $ 17.81          $ 14.16         

 

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

 

    Thirteen Weeks Ended      
          March 28,      
2014
          March 29,      
2013
   

Pension Benefits

     

Service cost

  $ 1,742      $ 1,801     

Interest cost

    4,136        3,569     

Expected return on assets

    (5,419)        (4,714)     

Amortization and other

    1,333        2,503     
 

 

 

   

 

 

   

Net periodic benefit cost

  $ 1,792      $ 3,159     
 

 

 

   

 

 

   

 

Postretirement Medical

     

Service cost

  $ 125      $ 155     

Interest cost

    277        246     

Amortization

    (128)        (52)     
 

 

 

   

 

 

   

Net periodic benefit cost

  $ 274      $ 349     
 

 

 

   

 

 

   

 

8


Table of Contents
5. Changes in components of accumulated other comprehensive income (loss), net of tax were (in thousands):

 

    Pension and
Post-
retirement
Medical
    Cumulative
Translation
Adjustment
    Total  

Thirteen Weeks Ended

    March 29, 2013

                 

Beginning balance

  $ (79,716)      $ (4,029)      $ (83,745)   

Other comprehensive income before reclassifications

          (8,487)        (8,487)   

Amounts reclassified from accumulated other comprehensive income

    1,578              1,578   
 

 

 

   

 

 

   

 

 

 

Ending balance

  $       (78,138)      $ (12,516)      $ (90,654)   
 

 

 

   

 

 

   

 

 

 

Thirteen Weeks Ended

    March 28, 2014

                 

Beginning balance

  $ (50,132)      $ 3,783      $ (46,349)   

Other comprehensive income before reclassifications

          (86)        (86)   

Amounts reclassified from accumulated other comprehensive income

    760              760   
 

 

 

   

 

 

   

 

 

 

Ending balance

  $ (49,372)      $       3,697      $       (45,675)   
 

 

 

   

 

 

   

 

 

 

Amounts related to pension and postretirement medical adjustments are reclassified to pension cost, which is allocated to cost of products sold and operating expenses based on salaries and wages, approximately as follows (in thousands):

 

    Thirteen Weeks Ended      
        March 28,    
2014
        March 29,    
2013
     

Cost of products sold

   $ 436       $ 909     

Product development

    187        393     

Selling, marketing and distribution

    335        666     

General and administrative

    230        488     
 

 

 

   

 

 

   

Total before tax

   $ 1,188       $ 2,456     

Income tax (benefit)

    (428)        (878)     
 

 

 

   

 

 

   

Total after tax

   $ 760       $ 1,578     
 

 

 

   

 

 

   

 

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Table of Contents
6. The Company has three reportable segments: Industrial (which aggregates five operating segments), Contractor and Lubrication. Sales and operating earnings by segment for the thirteen weeks ended March 28, 2014 and March 29, 2013 were as follows (in thousands):

 

    Thirteen Weeks Ended      
          March 28,      
2014
          March 29,      
2013
   

Net Sales

     

Industrial

   $ 176,426       $ 164,175     

Contractor

    84,906        77,628     

Lubrication

    28,630        27,243     
 

 

 

   

 

 

   

Total

   $ 289,962       $ 269,046     
 

 

 

   

 

 

   

Operating Earnings

     

Industrial

   $ 55,215       $ 55,219     

Contractor

    18,250        16,432     

Lubrication

    6,533        5,141     

Unallocated corporate (expense)

    (5,293)        (5,295)     
 

 

 

   

 

 

   

Total

   $ 74,705       $ 71,497     
 

 

 

   

 

 

     

Assets by segment were as follows (in thousands):

 

          March 28,      
2014
          Dec 27,      
2013
         

Industrial

   $ 665,437       $ 591,135       

Contractor

    173,692        152,300       

Lubrication

    83,313        82,503       

Unallocated corporate

    508,135        501,290       
 

 

 

   

 

 

     

Total

   $ 1,430,577       $ 1,327,228       
 

 

 

   

 

 

     

 

10


Table of Contents

Geographic information follows (in thousands):

 

    Thirteen Weeks Ended          
          March 28,      
2014
          March 29,      
2013
         

Net sales

       

(based on customer location)

       

United States

  $ 133,922     $ 116,080      

Other countries

    156,040       152,966      
 

 

 

   

 

 

     

Total

  $ 289,962     $ 269,046      
 

 

 

   

 

 

     
          March 28,      
2014
          Dec 27,      
2013
         

Long-lived assets

       

United States

  $ 125,108     $ 120,262      

Other countries

    30,898       31,455      
 

 

 

   

 

 

     

Total

  $ 156,006     $ 151,717      
 

 

 

   

 

 

     

 

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

 

          March 28,      
2014
          Dec 27,      
2013
     

Finished products and components

  $ 73,841      $ 65,963     

Products and components in various stages of completion

    45,135         41,458     

Raw materials and purchased components

    71,446        69,051     
 

 

 

   

 

 

   
    190,422        176,472     

Reduction to LIFO cost

    (43,049)        (42,685)     
 

 

 

   

 

 

   

Total

  $ 147,373      $ 133,787     
 

 

 

   

 

 

   

 

11


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

 

    Estimated
Life
(years)
  Cost     Accumulated
Amortization
    Foreign
Currency
Translation
    Book
Value
 

March 28, 2014

                           

Customer relationships

  3 - 14   $ 118,975     $ (14,861)      $ 1,397     $     105,511  

Patents, proprietary technology

and product documentation

  5 - 11     18,125       (5,774)        117       12,468  

Trademarks, trade names
and other

  5     175       (18)              157  
   

 

 

   

 

 

   

 

 

   

 

 

 
   

 

 

 

137,275

 

 

    (20,653)        1,514       118,136  

Not Subject to Amortization:

         

Brand names

      47,800             719       48,519  
   

 

 

   

 

 

   

 

 

   

 

 

 

 

Total

    $     185,075     $ (20,653)      $ 2,233     $ 166,655  
   

 

 

   

 

 

   

 

 

   

 

 

 

 

December 27, 2013

                           

Customer relationships

  3 - 14   $ 121,205     $ (26,377)      $ 1,458     $ 96,286  

Patents, proprietary technology

and product documentation

  3 - 11     16,125       (5,869)        118       10,374  

Trademarks, trade names
and other

  5     175       (9)              166  
   

 

 

   

 

 

   

 

 

   

 

 

 
   

 

 

 

137,505

 

 

    (32,255)        1,576       106,826  

Not Subject to Amortization:

         

Brand names

      40,400             714       41,114  
   

 

 

   

 

 

   

 

 

   

 

 

 

 

Total

   

 

$

 

    177,905

 

 

  $ (32,255)      $ 2,290     $ 147,940  
   

 

 

   

 

 

   

 

 

   

 

 

 

Amortization of intangibles for the first quarter was $3.1 million in 2014 and $3.4 million in 2013. Estimated annual amortization expense is as follows: $11.2 million in 2014, $10.8 million in 2015, $10.5 million in 2016, $10.2 million in 2017, $10.2 million in 2018 and $68.3 million thereafter.

Changes in the carrying amount of goodwill in 2014 were as follows (in thousands):

 

    Industrial     Contractor     Lubrication     Total  

Beginning balance

  $ 157,738      $ 12,732      $ 19,497     $       189,967   

Additions from business acquisitions

    37,271                    37,271   

Foreign currency translation

    (34)                    (34)   
 

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

  $       194,975      $ 12,732      $ 19,497     $ 227,204   
 

 

 

   

 

 

   

 

 

   

 

 

 

 

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In the first quarter of 2014, the Company paid $65 million cash to acquire a manufacturer of fluid management solutions for environmental monitoring and remediation, markets where Graco had little or no previous exposure. The acquired business will expand and complement the Company’s Industrial segment. The purchase price was allocated based on estimated fair values, including $37 million of goodwill, $22 million of other identifiable intangible assets and $6 million of net tangible assets.

 

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

 

          March 28,      
2014
          Dec 27,      
2013
     

Accrued self-insurance retentions

  $ 6,616     $ 6,381    

Accrued warranty and service liabilities

    7,727       7,771    

Accrued trade promotions

    4,211       7,245    

Payable for employee stock purchases

    1,780       7,908    

Customer advances and deferred revenue

    12,190       11,693    

Income taxes payable

    20,195       4,561    

Other

    21,235       23,608    
 

 

 

   

 

 

   

Total other current liabilities

  $       73,954     $ 69,167    
 

 

 

   

 

 

   

A liability is established for estimated future warranty and service claims that relate to current and prior period sales. The Company estimates warranty costs based on historical claim experience and other factors including evaluating specific product warranty issues. Following is a summary of activity in accrued warranty and service liabilities (in thousands):

 

    Thirteen
 Weeks Ended 
March 28,
2014
     Year Ended 
Dec 27,
2013
     

Balance, beginning of year

   $ 7,771       $ 7,943     

Assumed in business acquisition

    12           

Charged to expense

    1,401        6,119     

Margin on parts sales reversed

    576        3,819     

Reductions for claims settled

    (2,033)        (10,110)     
 

 

 

   

 

 

   

Balance, end of period

   $ 7,727       $ 7,771     
 

 

 

   

 

 

   

 

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10. Assets and liabilities measured at fair value on a recurring basis and fair value measurement level were as follows (in thousands):

 

                         
       Level      March 28,
2014
     Dec 27,
2013
    

Assets

           

Cash surrender value of life insurance

   2     $ 12,675       $       12,611     

Forward exchange contracts

   2      49        291     
     

 

 

    

 

 

    

Total assets at fair value

       $ 12,724       $ 12,902     
     

 

 

    

 

 

    

Liabilities

           

Deferred compensation

   2     $ 2,471       $ 2,296     

Forward exchange contracts

   2                 
     

 

 

    

 

 

    

Total liabilities at fair value

       $ 2,471       $ 2,296     
     

 

 

    

 

 

    

Contracts insuring the lives of certain employees who are eligible to participate in certain non-qualified pension and deferred compensation plans are held in trust. Cash surrender value of the contracts is based on performance measurement funds that shadow the deferral investment allocations made by participants in certain deferred compensation plans. The deferred compensation liability balances are valued based on amounts allocated by participants to the underlying performance measurement funds.

Long-term notes payable with fixed interest rates have a carrying amount of $300 million and an estimated fair value of $320 million as of March 28, 2014 and $320 million as of December 27, 2013. The fair value of variable rate borrowings approximates carrying value. The Company uses significant other observable inputs to estimate fair value (level 2 of the fair value hierarchy) based on the present value of future cash flows and rates that would be available for issuance of debt with similar terms and remaining maturities.

 

11. On April 2, 2012, the Company completed the purchase of the finishing businesses of Illinois Tool Works Inc. (“ITW”). The acquisition included powder finishing and liquid finishing equipment operations, technologies and brands (separately, the “Powder Finishing” and “Liquid Finishing” businesses). Results of the Powder Finishing businesses have been included in the Industrial segment since the date of acquisition.

In May 2012, the United States Federal Trade Commission (“FTC”) issued a proposed decision and order which requires Graco to sell the Liquid Finishing business assets no later than 180 days from the date the order becomes final. The FTC continues to work on resolving issues related to a proposed final decision and order.

The Company has retained the services of an investment bank to help it market the Liquid Finishing businesses and identify potential buyers. While it seeks a buyer, Graco must hold the Liquid Finishing business assets separate from its other businesses and maintain them as viable and competitive.

The Company does not have a controlling interest in the Liquid Finishing businesses, nor is it able to exert significant influence over those businesses. Consequently, the Company’s investment in the shares of the Liquid Finishing businesses has been

 

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reflected as a cost-method investment on the Consolidated Balance Sheets, and its results of operations have not been consolidated with those of the Company.

As a cost-method investment, income is recognized based on dividends received from after-tax earnings of Liquid Finishing and included in other expense (income) on the Consolidated Statements of Earnings. Dividends received totaled $4 million in the first quarter of 2014 and $4 million in the first quarter of 2013. Once the FTC issues its final decision and order, and the Company completes the sale of its investment, there will be no further dividends from Liquid Finishing.

The Company evaluates its cost-method investment for other-than-temporary impairment at each reporting period. As of March 28, 2014, the Company evaluated its investment in Liquid Finishing and determined that there was no impairment.

Sales and operating earnings of the Liquid Finishing businesses were as follows (in thousands):

 

     Thirteen Weeks Ended            
           March 28,      
2014
           March 29,      
2013
           

Net Sales

   $ 70,509      $ 63,198        

Operating Earnings

     15,286        13,580        

 

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Table of Contents
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 and coating materials. Management classifies the Company’s business into three reportable segments: Industrial, Contractor and Lubrication. Key strategies include developing and marketing new products, expanding distribution globally, opening new markets with technology and channel expansion and completing strategic 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.

Acquisition in 2012

On April 2, 2012, the Company completed the purchase of the finishing businesses of ITW. The acquisition included Powder Finishing and Liquid Finishing equipment operations, technologies and brands. Results of the Powder Finishing business have been included in the Industrial segment since the date of acquisition.

Pursuant to a March 2012 order, the Liquid Finishing businesses were to be held separate from the rest of Graco’s businesses while the United States Federal Trade Commission (“FTC”) considered a settlement with Graco and determined which portions of the Liquid Finishing businesses Graco must divest.

In May 2012, the FTC issued a proposed decision and order which requires Graco to sell the Liquid Finishing business assets, including certain business activities related to the development, manufacture, and sale of products under the Binks®, DeVilbiss®, Ransburg® and BGK® brand names, no later than 180 days from the date the order becomes final. The FTC continues to work on resolving issues related to a proposed final decision and order.

The Company has retained the services of an investment bank to help it market the Liquid Finishing businesses and identify potential buyers. While it seeks a buyer, Graco must continue to hold the Liquid Finishing business assets separate from its other businesses and maintain them as viable and competitive.

The Company does not control the Liquid Finishing businesses, nor is it able to exert influence over those businesses. Consequently, the Company’s investment in the shares of the Liquid Finishing businesses has been reflected as a cost-method investment, and its financial results have not been consolidated with those of the Company.

As a cost-method investment, income is recognized based on dividends received from after-tax earnings of Liquid Finishing and included in other expense (income) on the Consolidated Statements of Earnings. Dividends received totaled $4 million in the first quarter of 2014 and $4 million in the first quarter of 2013. Once the FTC issues its final decision and order, and the

 

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Company completes the sale of its investment, there will be no further dividends from Liquid Finishing.

The Company evaluates its cost-method investment for other-than-temporary impairment at each reporting period. As of March 28, 2014, the Company evaluated its investment in Liquid Finishing and determined that there was no impairment.

Consolidated Results

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

 

     Thirteen Weeks Ended  
       March 28,  
2014
       March 29,  
2013
     %
Change
 

Net Sales

   $ 290.0      $ 269.0        8%   

Operating Earnings

   $ 74.7       $ 71.5         4%   

Net Earnings

   $ 50.7      $ 52.1        (3)%   

Diluted Net Earnings per Common Share

   $ 0.81      $ 0.84        (4)%   

Sales increased 8 percent, with increases in the Americas and EMEA and a decrease in Asia Pacific. Sales included $7 million (3 percentage points of growth) from operations acquired in the fourth quarter of 2013 and early in the first quarter of 2014.

Acquisition-related inventory charges, lower margins from acquired operations and changes in product mix contributed to a decrease in gross margin rate compared to the first quarter last year.

Operating earnings increased 4 percent, but a higher effective income tax rate led to a decrease in net earnings.

The following table presents components of changes in sales:

 

     Year-to-Date  
     Segment      Region         
     Industrial      Contractor      Lubrication      Americas      EMEA      Asia
Pacific
     Total  

Volume and Price

     2 %         9 %         7 %         11 %         3 %         (7)%         5 %   

Acquisitions

     4 %         - %         - %         5 %         - %         1 %         3 %   

Currency

     1 %         - %         (2)%         (1)%         4 %         (1)%         - %   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     7 %         9 %         5 %         15 %         7 %         (7)%         8 %   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

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

 

     Thirteen Weeks Ended  
        March 28,   
2014
        March 29,   
2013
 

Americas

   $ 158.8       $ 138.2   

EMEA

     73.4         68.8   

Asia Pacific

     57.8         62.0   
  

 

 

    

 

 

 

Consolidated

   $     290.0       $ 269.0   
  

 

 

    

 

 

 

North and South America, including the U.S.

Europe, Middle East and Africa

Sales increased 8 percent, including increases of 15 percent in the Americas and 7 percent in EMEA (3 percent at consistent translation rates). Sales decreased 7 percent in Asia Pacific (6 percent at consistent translation rates). Sales included $7 million (3 percentage points of growth) from operations acquired in the fourth quarter of 2013 and early in the first quarter of 2014.

Gross profit margin, expressed as a percentage of sales, was 55 percent, down from 56 percent last year. Non-recurring inventory-related purchase accounting effects of $1 million and lower margins in acquired operations accounted for more than half of the decrease. Changes in product mix also contributed to the decrease.

Total operating expenses of $85 million were 29 percent of sales, consistent with the first quarter last year. Operating expenses in 2014 included $1 million of acquisition and divestiture expenses. Such expenses were not significant in 2013.

Other expense (income) included dividends received from the Liquid Finishing businesses that are held separate from the Company’s other businesses. Such dividends totaled $4 million for the first quarter in both 2014 and 2013.

The effective income tax rate of 31 percent was 4 percentage points higher than the comparable period last year because last year’s rate included the $3.6 million impact of the federal R&D credit that was renewed in the first quarter, effective retroactive to the beginning of 2012. There was no R&D credit allowed in 2014.

 

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Table of Contents

Segment Results

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

Industrial

     Thirteen Weeks Ended  
        March 28,   
2014
        March 29,   
2013
 

Net sales (in millions)

     

Americas

   $ 78.5       $ 66.2   

EMEA

     54.4         50.3   

Asia Pacific

     43.5         47.7   
  

 

 

    

 

 

 

Total

   $ 176.4       $ 164.2   
  

 

 

    

 

 

 

Operating earnings as a percentage of net sales

     31 %         34 %   
  

 

 

    

 

 

 

Industrial segment sales increased 7 percent, with increases of 19 percent in the Americas and 8 percent in EMEA (5 percent at consistent translation rates), partially offset by a 9 percent decrease in Asia Pacific (8 percent at consistent translation rates). Acquired operations contributed $7 million to sales of this segment (4 percentage points of growth). Operating margin rate for the Industrial segment decreased compared to last year due to lower margins on acquired operations, including the impact of non-recurring acquisition-related inventory valuation adjustments, and other investments in regional and product expansion.

Contractor

     Thirteen Weeks Ended  
        March 28,   
2014
        March 29,   
2013
 

Net sales (in millions)

     

Americas

   $ 58.5       $ 51.5   

EMEA

     16.4         16.1   

Asia Pacific

     10.0         10.0   
  

 

 

    

 

 

 

Total

   $ 84.9       $ 77.6   
  

 

 

    

 

 

 

Operating earnings as a percentage of net sales

     21 %         21 %   
  

 

 

    

 

 

 

Contractor segment sales for the quarter increased 9 percent, including a 14 percent increase in the Americas, with strong growth in both paint store and home center channels. Sales were flat in EMEA and Asia Pacific. Operating margin rates in the Contractor segment were consistent with last year’s first quarter. Unfavorable effects of product mix offset the favorable effects of higher sales volume and expense leverage.

 

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Lubrication

     Thirteen Weeks Ended  
        March 28,   
2014
        March 29,   
2013
 

Net sales (in millions)

     

Americas

   $ 21.7       $ 20.5   

EMEA

     2.5         2.5   

Asia Pacific

     4.4         4.2   
  

 

 

    

 

 

 

Total

   $ 28.6       $ 27.2   
  

 

 

    

 

 

 

Operating earnings as a percentage of net sales

     23 %         19 %   
  

 

 

    

 

 

 

Lubrication segment sales for the quarter increased 5 percent, mostly from increases in the Americas. Higher sales volume, improved gross margin rate and expense leverage led to a higher operating margin rate in the Lubrication segment.

Liquidity and Capital Resources

Net cash provided by operating activities was $28 million in 2014 and $39 million in 2013. The first quarter increase in accounts receivable was $9 million higher in 2014 than in 2013. Accounts receivable and inventory balances have increased since the end of 2013 due to increases in business activity. Significant uses of cash in the first quarter of 2014 included $65 million for a business acquisition, $48 million for purchases of Company common stock and $17 million of dividends paid to shareholders.

In May 2012, the FTC issued a proposed decision and order which requires Graco to sell the Liquid Finishing business assets, including certain business activities related to the development, manufacture, and sale of products under the Binks, DeVilbiss, Ransburg and BGK brand names, no later than 180 days from the date the order becomes final. The FTC continues to work on resolving issues related to a proposed final decision and order.

The Company has retained the services of an investment bank to help it market the Liquid Finishing businesses and identify potential buyers. The Company believes its investment in the Liquid Finishing businesses, carried at a cost of $422 million, is not impaired.

Under terms of the FTC’s hold separate order, the Company is required to provide sufficient resources to maintain the viability, competitiveness and marketability of the Liquid Finishing businesses, including general funds, capital, working capital and reimbursement of losses. To the extent that the Liquid Finishing businesses generate funds in excess of financial resources needed, the Company has access to such funds consistent with practices in place prior to the acquisition. Since the date of acquisition, the Company received $44 million of dividends from current earnings of the Liquid Finishing businesses, including $4 million in the first quarter of 2014.

At March 28, 2014, the Company had various lines of credit totaling $503 million, of which $290 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 2014, including the needs of the Liquid Finishing businesses acquired in April 2012.

 

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Table of Contents

Outlook

Our outlook for 2014 has not changed, and we remain confident about achieving full year growth in all segments and regions. While U.S. housing starts began 2014 slower than anticipated, we continue to expect strong full year growth in the residential construction market to drive low double-digit growth in our Contractor segment in the Americas. Although certain emerging economies of EMEA are facing geopolitical and currency headwinds, and capital equipment demand in China remains uneven, we expect to benefit from the improving macro environment in developed economies around the world.

SAFE HARBOR CAUTIONARY STATEMENT

The Company desires to take advantage of the “safe harbor” provisions regarding forward-looking statements of the Private Securities Litigation Reform Act of 1995 and is filing this Cautionary Statement in order to do so. From time to time various forms filed by our Company with the Securities and Exchange Commission, including our Form 10-K, our Form 10-Qs and Form 8-Ks, and other disclosures, including our 2013 Overview report, press releases, earnings releases, analyst briefings, conference calls and other written documents or oral statements released by our Company, may contain forward-looking statements. Forward-looking statements generally use words such as “expect,” “foresee,” “anticipate,” “believe,” “project,” “should,” “estimate,” “will,” and similar expressions, and reflect our Company’s expectations concerning the future. All forecasts and projections are forward-looking statements. Forward-looking statements are based upon currently available information, but various risks and uncertainties may cause our Company’s actual results to differ materially from those expressed in these statements. The Company undertakes no obligation to update these statements in light of new information or future events.

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: changes in laws and regulations; economic conditions in the United States and other major world economies; our Company’s growth strategies, which include making acquisitions, investing in new products, expanding geographically and targeting new industries; whether we are able to effectively complete a divestiture of the acquired Liquid Finishing businesses, which has not been completed and remains subject to FTC approval; political instability; new entrants who copy our products or infringe on our intellectual property; supply interruptions or delays; risks incident to conducting business internationally; the ability to meet our customers’ needs and changes in product demand; results of and costs associated with, litigation, administrative proceedings and regulatory reviews incident to our business; compliance with anti-corruption laws; the possibility of decline in purchases from few large customers of the Contractor segment; variations in activity in the construction and automotive industries; security breaches and natural disasters. Please refer to Item 1A of our Annual Report on Form 10-K for fiscal year 2013 for a more comprehensive discussion of these and other risk factors. These reports are available on the Company’s website at www.graco.com/ir and the Securities and Exchange Commission’s website at www.sec.gov. Shareholders, potential investors and other readers are urged to consider these factors in evaluating forward-looking statements and are cautioned not to place undue reliance on such forward-looking statements.

Investors should realize that factors other than those identified above and in Item 1A 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.

 

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Table of Contents

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 2013 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, the Vice President, Controller and Information Systems, and the Vice President, General Counsel and Secretary. Based upon that evaluation, they concluded that the Company’s disclosure controls and procedures are effective.

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.

 

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Table of Contents

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 2013 Annual Report on Form 10-K.

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

Issuer Purchases of Equity Securities

On September 14, 2012, the Board of Directors authorized the Company to purchase up to 6,000,000 shares of its outstanding common stock, primarily through open-market transactions. The authorization expires on September 30, 2015.

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 due upon exercise of options or vesting of restricted stock.

Information on issuer purchases of equity securities follows:

 

Period

   Total
Number
of  Shares
Purchased
       Average
Price

Paid per
Share
   Total
Number
of Shares
Purchased
as Part of
Publicly
Announced
Plans or
Programs
   Maximum
Number of
Shares that

May Yet Be
Purchased
Under the
Plans or
Programs
(at end of
period)

Dec 28, 2013 – Jan 24, 2014

   179,557      $        77.19    179,557    4,860,561

Jan 25, 2014 – Feb 21, 2014

   190,000      $        72.20    190,000    4,670,561

Feb 22, 2014 – Mar 28, 2014

   260,288    (1)   $        76.26    249,938    4,420,623

 

  (1) Includes 10,350 shares forfeited to the Company in satisfaction of tax withholding obligations by employees who vested in restricted stock under employee stock compensation plans.

 

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Table of Contents

Item 6.   Exhibits

 

  3.1       Restated Articles of Incorporation as amended April 26, 2013. (Incorporated by reference to Exhibit 3.1 to the Company’s Report on Form 8-K filed April 30, 2013.)
  3.2       Restated Bylaws as amended February 14, 2014. (Incorporated by reference to Exhibit 3.2 to the Company’s 2013 Annual Report on Form 10-K.)
  31.1       Certification of President and Chief Executive Officer pursuant to Rule 13a-14(a).
  31.2       Certification of Chief Financial Officer pursuant to Rule 13a-14(a).
  32       Certification of President and Chief Executive Officer and Chief Financial Officer pursuant to Section 1350 of Title 18, U.S.C.
  99.1       Press Release Reporting First Quarter Earnings dated April 23, 2014.
      101       Interactive Data File.

 

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Table of Contents

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

        GRACO INC.

 

 

Date:  

  April 23, 2014

  By:  

   /s/ Patrick J. McHale

         Patrick J. McHale
         President and Chief Executive Officer
         (Principal Executive Officer)
Date:  

  April 23, 2014

  By:  

   /s/ James A. Graner

         James A. Graner
         Chief Financial Officer
         (Principal Financial Officer)
Date:  

  April 23, 2014

  By:  

   /s/ Caroline M. Chambers

         Caroline M. Chambers
     

   Vice President, Corporate Controller

       and Information Systems

         (Principal Accounting Officer)