FORM 10-Q
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 July 1, 2011

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    

60,850,000 shares of the Registrant’s Common Stock, $1.00 par value, were outstanding as of July 20, 2011.


Table of Contents

INDEX

 

              Page Number
PART I    FINANCIAL INFORMATION   
   Item 1.  

Financial Statements

  
    

Consolidated Statements of Earnings

   3
    

Consolidated Balance Sheets

   4
    

Consolidated Statements of Cash Flows

   5
    

Notes to Consolidated Financial Statements

   6
   Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations    15
   Item 3.   Quantitative and Qualitative Disclosures About Market Risk    21
   Item 4.   Controls and Procedures    21
PART II    OTHER INFORMATION   
   Item 1A.   Risk Factors    22
   Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds    22
   Item 6.   Exhibits    23

SIGNATURES

    

EXHIBITS

    

 

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PART I

Item 1.

GRACO INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF EARNINGS

(Unaudited)

(In thousands except per share amounts)

 

         Thirteen Weeks Ended           Twenty-six Weeks Ended    
     July 1,
2011
    June 25,
2010
    July 1,
2011
    June 25,
2010
 

Net Sales

     $   234,663        $   192,088        $ 452,342        $   356,809   

Cost of products sold

     102,217        90,168        195,499        165,594   
                                

Gross Profit

     132,446        101,920        256,843        191,215   

Product development

     10,354        9,472        20,285        18,946   

Selling, marketing and distribution

     39,582        32,647        77,065        61,807   

General and administrative

     24,255        20,592        44,169        38,547   
                                

Operating Earnings

     58,255        39,209        115,324        71,915   

Interest expense

     1,732        1,041        2,348        2,121   

Other expense, net

     324        (268)        324        (107)   
                                

Earnings Before Income Taxes

     56,199        38,436        112,652        69,901   

Income taxes

     18,100        13,600        37,300        24,500   
                                

Net Earnings

     $ 38,099        $ 24,836        $ 75,352        $ 45,401   
                                

Basic Net Earnings per Common Share

     $ 0.63        $ 0.41        $ 1.25        $ 0.75   

Diluted Net Earnings per Common Share

     $ 0.61        $ 0.41        $ 1.22        $ 0.74   

Cash Dividends Declared per Common Share

     $ 0.21        $ 0.20        $ 0.42        $ 0.40   

See notes to consolidated financial statements.

 

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GRACO INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Unaudited)

(In thousands)

 

           July 1,      
2011
          Dec 31,      
2010
 

ASSETS

    

Current Assets

    

Cash and cash equivalents

    $ 119,267       $ 9,591   

Accounts receivable, less allowances of $5,700 and $5,600

     159,807        124,593   

Inventories

     113,494        91,620   

Deferred income taxes

     20,952        18,647   

Other current assets

     3,616        7,957   
                

Total current assets

     417,136        252,408   

Property, Plant and Equipment

    

Cost

     345,871        344,854   

Accumulated depreciation

     (212,933)        (210,669)   
                

Property, plant and equipment, net

     132,938        134,185   

Goodwill

     93,400        91,740   

Other Intangible Assets, net

     23,250        28,338   

Deferred Income Taxes

     15,550        14,696   

Other Assets

     9,995        9,107   
                

Total Assets

    $     692,269       $     530,474   
                

LIABILITIES AND SHAREHOLDERS’ EQUITY

    

Current Liabilities

    

Notes payable to banks

    $ 13,935       $ 8,183   

Trade accounts payable

     27,418        19,669   

Salaries and incentives

     24,350        34,907   

Dividends payable

     12,751        12,610   

Other current liabilities

     42,832        44,385   
                

Total current liabilities

     121,286        119,754   

Long-term Debt

     150,000        70,255   

Retirement Benefits and Deferred Compensation

     78,246        76,351   

Shareholders’ Equity

    

Common stock

     60,816        60,048   

Additional paid-in-capital

     238,016        212,073   

Retained earnings

     94,305        44,436   

Accumulated other comprehensive income (loss)

     (50,400)        (52,443)   
                

Total shareholders’ equity

     342,737        264,114   
                

Total Liabilities and Shareholders’ Equity

    $ 692,269       $ 530,474   
                

See notes to consolidated financial statements.

 

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GRACO INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited) (In thousands)

 

         Twenty-six Weeks Ended      
     July 1,
2011
    June 25,
2010
 

Cash Flows From Operating Activities

    

Net Earnings

    $ 75,352       $ 45,401   

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

    

Depreciation and amortization

     17,542        17,319   

Deferred income taxes

     (4,223)        (5,247)   

Share-based compensation

     6,287        5,127   

Excess tax benefit related to share-based payment arrangements

     (1,700)        (900)   

Change in

    

Accounts receivable

     (32,590)        (40,392)   

Inventories

     (21,446)        (17,742)   

Trade accounts payable

     7,642        9,552   

Salaries and incentives

     (11,633)        7,624   

Retirement benefits and deferred compensation

     4,040        4,996   

Other accrued liabilities

     62        1,287   

Other

     4,558        1,020   
                

Net cash provided by operating activities

     43,891        28,045   
                

Cash Flows From Investing Activities

    

Property, plant and equipment additions

     (9,999)        (5,932)   

Proceeds from sale of property, plant and equipment

     188        123   

Acquisition of business

     (2,139)          

Investment in life insurance

            (1,499)   

Capitalized software and other intangible asset additions

     (485)        (193)   
                

Net cash used in investing activities

     (12,435)        (7,501)   
                

Cash Flows From Financing Activities

    

Borrowings on short-term lines of credit

     13,550        6,410   

Payments on short-term lines of credit

     (8,328)        (3,406)   

Borrowings on long-term notes and line of credit

     252,175        45,800   

Payments on long-term line of credit

     (172,430)        (52,060)   

Payments of debt issuance costs

     (1,131)          

Excess tax benefit related to share-based payment arrangements

     1,700        900   

Common stock issued

     18,705        8,815   

Common stock repurchased

            (3,462)   

Cash dividends paid

     (25,342)        (24,122)   
                

Net cash provided by (used in) financing activities

     78,899        (21,125)   
                

Effect of exchange rate changes on cash

     (679)        47   
                

Net increase (decrease) in cash and cash equivalents

     109,676        (534)   

Cash and cash equivalents

    

Beginning of year

     9,591        5,412   
                

End of period

    $     119,267       $     4,878   
                

See notes to consolidated financial statements.

 

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GRACO INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1. The consolidated balance sheet of Graco Inc. and Subsidiaries (the Company) as of July 1, 2011 and the related statements of earnings for the thirteen and twenty-six weeks ended July 1, 2011 and June 25, 2010, and cash flows for the twenty-six weeks ended July 1, 2011 and June 25, 2010 have been prepared by the Company and have not been audited.

In the opinion of management, these consolidated financial statements reflect all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the financial position of Graco Inc. and Subsidiaries as of July 1, 2011, and the results of operations and cash flows for all periods presented.

In the fourth quarter of 2010, the Company changed its cash flow presentation of notes payable activity, for all periods presented, to separately disclose borrowings and payments. The Company also changed the cash flow presentation of activity on the swingline portion of its long-term revolving credit arrangement by changing the method it uses to accumulate borrowing and payment amounts. In prior periods, such activity was disclosed on a net basis. The effect of this change was to increase both borrowings and payments on long-term line of credit by $46 million in the first half of 2010. These changes had no impact on net cash used in financing activities.

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 2010 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.

 

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

 

        Thirteen Weeks Ended           Twenty-six Weeks Ended    
    July 1,
2011
    June 25,
2010
    July 1,
2011
    June 25,
2010
 

Net earnings available to common shareholders

   $       38,099       $       24,836       $       75,352       $       45,401   

Weighted average shares outstanding for basic earnings per share

    60,721        60,597        60,496        60,402   

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

    1,349        587        1,219        546   

Weighted average shares outstanding for diluted earnings per share

    62,070        61,184        61,715        60,948   

Basic earnings per share

   $ 0.63       $ 0.41       $ 1.25       $ 0.75   

Diluted earnings per share

   $ 0.61       $ 0.41       $ 1.22       $ 0.74   

Stock options to purchase 438,000 and 2,987,000 shares were not included in the 2011 and 2010 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 twenty-six weeks ended July 1, 2011 is shown below (in thousands, except per share amounts):

 

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

Outstanding, December 31, 2010

    5,509      $     30.42        2,980      $     31.99   

Granted

    569        43.15       

Exercised

    (425)        26.00       

Canceled

    (33)        35.18       
             

Outstanding, July 1, 2011

    5,620      $ 32.01        3,304      $ 32.01   
             

The Company recognized year-to-date share-based compensation of $6.3 million in 2011 and $5.1 million in 2010. As of July 1, 2011, there was $11.3 million of unrecognized compensation cost related to unvested options, expected to be recognized over a weighted average period of 2.2 years.

 

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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:

 

         Twenty-six Weeks Ended          
     July 1,
2011
    June 25,
2010
   

Expected life in years

     6.5            6.0          

Interest rate

     2.8 %         2.7 %      

Volatility

     33.7 %         34.0 %      

Dividend yield

     2.0 %         3.0 %      

Weighted average fair value per share

   $     13.35          $     7.38         

Under the Company’s Employee Stock Purchase Plan, the Company issued 313,000 shares in 2011 and 436,000 shares in 2010. 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:

 

       Twenty-six Weeks Ended        
     July 1,
2011
    June 25,
2010
   

Expected life in years

     1.0             1.0         

Interest rate

     0.3 %         0.3 %      

Volatility

     27.8 %         42.8 %      

Dividend yield

     2.1 %         2.9 %      

Weighted average fair value per share

   $     10.05          $     8.48         

 

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

 

        Thirteen Weeks Ended             Twenty-six Weeks Ended      
    July 1,
2011
    June 25,
2010
    July 1,
2011
    June 25,
2010
 

Pension Benefits

       

Service cost

  $         1,232      $ 894      $ 2,465      $ 2,135   

Interest cost

    3,370        3,138        6,740        6,415   

Expected return on assets

    (4,000)        (3,325)        (8,000)        (6,800)   

Amortization and other

    1,465        1,548        2,946        3,052   
                               

Net periodic benefit cost

  $ 2,067      $         2,255      $         4,151      $         4,802   
                               

Postretirement Medical

       

Service cost

  $ 125      $ 150      $ 250      $ 275   

Interest cost

    325        295        650        620   

Amortization

           (95)               (95)   
                               

Net periodic benefit cost

  $ 450      $ 350      $ 900      $ 800   
                               

 

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

 

        Thirteen Weeks Ended             Twenty-six Weeks Ended      
    July 1,
2011
    June 25,
2010
    July 1,
2011
    June 25,
2010
 

Net earnings

  $         38,099      $         24,836      $         75,352      $         45,401   

Pension and postretirement medical liability adjustment

    1,429        1,491        2,792        2,959   

Gain (loss) on interest rate hedge contracts

           933        454        1,638   

Income taxes

    (537)        (896)        (1,203)        (1,701)   
                               

Comprehensive income

  $ 38,991      $ 26,364      $ 77,395      $ 48,297   
                               

 

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

 

         July 1,    
2011
        Dec 31,    
2010
     

Pension and postretirement medical liability adjustment

   $ (49,577)      $ (51,334)     

Gain (loss) on interest rate hedge contracts

            (286)     

Cumulative translation adjustment

     (823)        (823)     
  

 

 

   

 

 

   

Total

   $     (50,400)      $     (52,443)     
  

 

 

   

 

 

   

 

6. The Company has three reportable segments: Industrial, Contractor and Lubrication. Sales and operating earnings by segment for the thirteen and twenty-six weeks ended July 1, 2011 and June 25, 2010 were as follows (in thousands):

 

        Thirteen Weeks Ended           Twenty-six Weeks Ended    
    July 1,
2011
    June 25,
2010
    July 1,
2011
    June 25,
2010
 

Net Sales

       

Industrial

  $     129,304      $     100,461      $     252,134      $     197,253   

Contractor

    80,702        73,782        150,907        124,579   

Lubrication

    24,657        17,845        49,301        34,977   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 234,663      $ 192,088      $ 452,342      $ 356,809   
 

 

 

   

 

 

   

 

 

   

 

 

 

Operating Earnings

       

Industrial

  $ 45,339      $ 29,565      $ 90,364      $ 60,039   

Contractor

    16,424        13,203        27,539        18,086   

Lubrication

    4,045        1,868        9,272        3,575   

Unallocated corporate (expense)

    (7,553)        (5,427)        (11,851)        (9,785)   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 58,255      $ 39,209      $ 115,324      $ 71,915   
 

 

 

   

 

 

   

 

 

   

 

 

 

Unallocated corporate includes $3 million of expense in 2011 related to the pending acquisition of ITW’s finishing businesses.

Assets by segment were as follows (in thousands):

 

         July 1,    
2011
        Dec 31,    
2010
     

Industrial

   $ 302,554      $ 270,160     

Contractor

     159,373        134,938     

Lubrication

     88,130        81,746     

Unallocated corporate

     142,212        43,630     
  

 

 

   

 

 

   

Total

   $     692,269      $     530,474     
  

 

 

   

 

 

   

 

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

 

         July 1,    
2011
        Dec 31,    
2010
     

Finished products and components

   $ 56,934      $ 48,670     

Products and components in various stages of completion

     37,636        31,275     

Raw materials and purchased components

     55,928        46,693     
  

 

 

   

 

 

   
     150,498        126,638     

Reduction to LIFO cost

     (37,004)        (35,018)     
  

 

 

   

 

 

   

Total

   $     113,494      $     91,620     
  

 

 

   

 

 

   

 

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

 

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

July 1, 2011

                            

Customer relationships

   2 - 8   $     40,925      $     (27,716)      $     (181)      $     13,028   

Patents, proprietary technology and product documentation

   3 -10     14,752        (9,688)        (87)        4,977   

Trademarks, trade names and other

   2 - 3     6,970        (4,905)               2,065   
    

 

 

   

 

 

   

 

 

   

 

 

 
       62,647        (42,309)        (268)        20,070   

Not Subject to Amortization:

          

Brand names

       3,180                      3,180   
    

 

 

   

 

 

   

 

 

   

 

 

 

Total

     $ 65,827      $ (42,309)      $ (268)      $ 23,250   
    

 

 

   

 

 

   

 

 

   

 

 

 

December 31, 2010

                            

Customer relationships

   3 - 8   $ 41,075      $ (24,840)      $ (181)      $ 16,054   

Patents, proprietary technology and product documentation

   3 - 10     19,902        (13,956)        (87)        5,859   

Trademarks, trade names and other

   3 - 10     8,154        (4,909)               3,245   
    

 

 

   

 

 

   

 

 

   

 

 

 
       69,131        (43,705)        (268)        25,158   

Not Subject to Amortization:

          

Brand names

       3,180                      3,180   
    

 

 

   

 

 

   

 

 

   

 

 

 

Total

     $ 72,311      $ (43,705)      $ (268)      $ 28,338   
    

 

 

   

 

 

   

 

 

   

 

 

 

 

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Amortization of intangibles was $2.9 million in the second quarter of 2011 and $5.7 million year-to-date. Estimated annual amortization expense is as follows: $10.9 million in 2011, $9.0 million in 2012, $4.3 million in 2013, $0.9 million in 2014, $0.5 million in 2015 and $0.2 million thereafter.

 

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

 

     July 1,
2011
    Dec 31,
2010
     

Accrued self-insurance retentions

   $ 6,900      $ 6,675     

Accrued warranty and service liabilities

     6,859        6,862     

Accrued trade promotions

     4,150        5,947     

Payable for employee stock purchases

     3,129        5,655     

Income taxes payable

     2,220        733     

Other

     19,574        18,513     
  

 

 

   

 

 

   

Total other current liabilities

   $         42,832      $         44,385     
  

 

 

   

 

 

   

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):

 

     Twenty-six
Weeks Ended
July 1,

2011
    Year Ended
Dec 31,
2010
     

Balance, beginning of year

    $ 6,862       $ 7,437     

Charged to expense

     2,385        3,484     

Margin on parts sales reversed

     2,058        3,412     

Reductions for claims settled

     (4,446)        (7,471)     
  

 

 

   

 

 

   

Balance, end of period

    $         6,859       $         6,862     
  

 

 

   

 

 

   

 

10. The Company accounts for all derivatives, including those embedded in other contracts, as either assets or liabilities and measures those financial instruments at fair value. The accounting for changes in the fair value of derivatives depends on their intended use and designation.

As part of its risk management program, the Company may periodically use forward exchange contracts and interest rate swaps to manage known market exposures. Terms of derivative instruments are structured to match the terms of the risk being managed and are generally held to maturity. The Company does not hold or issue derivative financial instruments for trading purposes. All other contracts that contain provisions meeting the definition of a derivative also meet the requirements of, and have been designated as, normal purchases or sales. The Company’s policy is to not enter into contracts with terms that cannot be designated as normal purchases or sales.

 

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The Company periodically evaluates its monetary asset and liability positions denominated in foreign currencies. The Company enters into forward contracts or options, or borrows in various currencies, in order to hedge its net monetary positions. These instruments are recorded at current market values and the gains and losses are included in other expense (income), net. The notional amount of contracts outstanding as of July 1, 2011, totaled $23 million. The Company believes it uses strong financial counterparts in these transactions and that the resulting credit risk under these hedging strategies is not significant.

The Company uses significant other observable inputs to value the derivative instruments used to hedge interest rate volatility and net monetary positions, including reference to market prices and financial models that incorporate relevant market assumptions. The fair market value and balance sheet classification of such instruments follows (in thousands):

 

     Balance Sheet
Classification
          July 1,        
2011
            Dec 31,        
2010
 

Gain (loss) on interest rate hedge contracts

   Other current liabilities           $      $         (454)   
    

 

 

   

 

 

 

Gain (loss) on foreign currency forward contracts

      

Gains

     $ 41      $ 92   

Losses

       (344)        (284)   
    

 

 

   

 

 

 

Net

   Other current liabilities   $         (303)      $ (192)   
    

 

 

   

 

 

 

 

11. In March 2011, the Company entered into a note agreement and sold $150 million of unsecured notes (series A and B) in a private placement. Proceeds were used to repay revolving line of credit borrowings and invested in cash equivalents. In July 2011, the Company sold an additional $150 million in unsecured notes (series C and D). Proceeds were invested in cash equivalents.

Interest rates and maturity dates on the four series of notes are as follows (dollars in millions):

 

Series

       Amount                Rate                  Maturity        

A

     $ 75          4.00    %           March 2018     

B

     $ 75          5.01    %           March 2023     

C

     $ 75          4.88    %           January 2020     

D

     $ 75          5.35    %           July 2026     

The note agreement requires the Company to maintain certain financial ratios as to cash flow leverage and interest coverage.

The Company is in compliance with all financial covenants of its debt agreements.

The estimated fair value of the notes sold in March 2011 is not significantly different from the $150 million carrying amount as of July 1, 2011.

 

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12. In April 2011, the Company entered into a definitive agreement to purchase the finishing businesses of Illinois Tool Works Inc. (ITW) in a $650 million cash transaction. Closing on the purchase is subject to regulatory reviews and other customary closing conditions. The Company is cooperating with the Federal Trade Commission to obtain clearance to close on the transaction. The Company plans to finance the acquisition through a new committed $450 million revolving credit facility that will become effective upon closing of the purchase, and funds available under the long-term notes referenced above.

Also in April 2011, the Company acquired the assets and assumed certain liabilities of Eccentric Pumps, LLC (“Eccentric”) for approximately $2.1 million cash. Eccentric was engaged in the business of designing and selling peristaltic hose pumps for metering, dosing and transferring fluids. The Company expects to employ the Eccentric assets to expand and complement its Industrial segment business. The purchase price was allocated based on estimated fair values, including $1.7 million of goodwill and $0.7 million of other identifiable intangible assets.

 

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Item 2.    GRACO INC. AND SUBSIDIARIES   
  

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

  

Overview

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

Results of Operations

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

 

    Thirteen Weeks Ended     Twenty-six Weeks Ended  
        July 1,    
2011
      June 25,  
2010
    %
Change
        July 1,    
2011
      June 25,  
2010
    %
Change
 

Net Sales

  $     234.7      $     192.1        22%      $     452.3      $     356.8        27%   

Net Earnings

  $ 38.1      $ 24.8        53%      $ 75.4      $ 45.4        66%   

Diluted Net Earnings per Common Share

  $ 0.61      $ 0.41        49%      $ 1.22      $ 0.74        65%   

All segments and geographic regions had strong percentage revenue growth over last year for the quarter and year-to-date. Volume increases continued to drive improvement in net earnings. Changes in translation rates increased net earnings for the quarter by approximately $4 million and increased year-to-date earnings by approximately $5 million.

 

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Consolidated Results

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

 

     Thirteen Weeks Ended      Twenty-six Weeks Ended  
         July 1,    
2011
         June 25,    
2010
         July 1,    
2011
         June 25,    
2010
 

Americas1

   $ 125.7       $ 110.2       $ 241.3       $ 196.9   

Europe2

     58.0         44.0         111.3         85.8   

Asia Pacific

     51.0         37.9         99.7         74.1   
  

 

 

    

 

 

    

 

 

    

 

 

 

Consolidated

   $ 234.7       $ 192.1       $ 452.3       $ 356.8   
  

 

 

    

 

 

    

 

 

    

 

 

 

1 North and South America, including the U.S.

2 Europe, Africa and Middle East

Sales for the quarter increased 22 percent (18 percent at consistent translation rates), including increases of 14 percent in the Americas, 32 percent in Europe (21 percent at consistent translation rates) and 34 percent in Asia Pacific (27 percent at consistent translation rates). Year-to-date sales increased 27 percent (24 percent at consistent translation rates), with increases of 23 percent in the Americas, 30 percent in Europe (24 percent at consistent translation rates) and 35 percent in Asia Pacific (29 percent at consistent translation rates).

Gross profit margin, expressed as a percentage of sales, was 56 1/2 percent for the quarter, up 3 percentage points from the second quarter last year. The year-to-date gross margin rate was 57 percent, also 3 percentage points higher than the rate for the comparable period last year. The favorable effects of higher volume, translation, and selling price increases were offset somewhat by higher material costs for both the quarter and the year-to-date.

Total operating expenses increased $11 million for the quarter and $22 million year-to-date. Selling, marketing and distribution expenses increased $7 million for the quarter and $15 million year-to-date, from translation, headcount increases (mostly in Europe and Asia Pacific) and higher marketing and promotion expenses (mainly in Contractor segment). General and administrative expense for the quarter increased $4 million, including $3 million related to the pending acquisition of ITW’s finishing businesses.

The effective income tax rate of 32 percent for the quarter and 33 percent for the year-to-date is lower than the 35 percent rate for both the quarter and year-to-date periods last year. The decrease is mainly due to the federal R&D credit included in the 2011 rate (the federal R&D credit was not available in 2010 until the fourth quarter).

 

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Segment Results

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

Industrial

 

        Thirteen Weeks Ended           Twenty-six Weeks Ended    
    July 1,
2011
    June 25,
2010
    July 1,
2011
    June 25,
2010
 

Net sales (in millions)

       

Americas

  $ 55.9      $ 45.5      $ 108.8      $ 87.4   

Europe

    36.1        27.1        70.5        55.0   

Asia Pacific

    37.3        27.9        72.8        54.9   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 129.3      $ 100.5      $ 252.1      $ 197.3   
 

 

 

   

 

 

   

 

 

   

 

 

 

Operating earnings as a percentage of net sales

    35 %        29 %        36 %        30 %   
 

 

 

   

 

 

   

 

 

   

 

 

 

Industrial segment sales for the quarter increased 23 percent in the Americas, 33 percent in Europe (22 percent at consistent translation rates) and 34 percent in Asia Pacific (28 percent at consistent translation rates). Year-to-date sales increased 25 percent in the Americas, 28 percent in Europe (23 percent at consistent translation rates) and 33 percent in Asia Pacific (28 percent at consistent translation rates).

Higher volume and expense leverage contributed to the improvement in operating earnings as a percentage of sales.

Contractor

 

        Thirteen Weeks Ended           Twenty-six Weeks Ended    
    July 1,
2011
    June 25,
2010
    July 1,
2011
    June 25,
2010
 

Net sales (in millions)

       

Americas

  $ 52.5      $ 51.6      $ 97.4      $ 83.5   

Europe

    19.6        15.2        36.3        27.8   

Asia Pacific

    8.6        7.0        17.2        13.3   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 80.7      $ 73.8      $ 150.9      $ 124.6   
 

 

 

   

 

 

   

 

 

   

 

 

 

Operating earnings as a percentage of net sales

    20 %        18 %        18 %        15 %   
 

 

 

   

 

 

   

 

 

   

 

 

 

Contractor segment sales for the quarter increased 2 percent in the Americas, 29 percent in Europe (17 percent at consistent translation rates) and 23 percent in Asia Pacific (13 percent at consistent translation rates). Year-to-date sales increased 17 percent in the Americas, 30 percent in Europe (24 percent at consistent translation rates) and 30 percent in Asia Pacific (22 percent at consistent translation rates).

Higher volume and expense leverage contributed to the improvement in operating earnings as a percentage of sales. High product development expenses affected the operating margin rate

 

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in 2010, and increased marketing, including product launch and promotion expenses, moderated the improvement in 2011.

Lubrication

 

         Thirteen Weeks Ended            Twenty-six Weeks Ended    
     July 1,
2011
     June 25,
2010
     July 1,
2011
     June 25,
2010
 

Net sales (in millions)

           

Americas

   $ 17.2       $ 13.2       $ 35.0       $ 26.0   

Europe

     2.3         1.5         4.5         2.9   

Asia Pacific

     5.2         3.1         9.8         6.0   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 24.7       $ 17.8       $ 49.3       $ 34.9   
  

 

 

    

 

 

    

 

 

    

 

 

 

Operating earnings as a percentage of net sales

     16 %         10 %         19 %         10 %   
  

 

 

    

 

 

    

 

 

    

 

 

 

Lubrication segment sales for the quarter increased 30 percent in the Americas, 55 percent in Europe and 64 percent in Asia Pacific. Year-to-date sales increased 34 percent in the Americas, 55 percent in Europe and 63 percent in Asia Pacific.

Higher volume and expense leverage contributed to the improvement in operating earnings as a percentage of sales.

Liquidity and Capital Resources

Net cash provided by operating activities was $44 million in 2011 and $28 million in 2010. The effect of higher net earnings was offset by higher 2010 incentive and bonus payments made in the first quarter of 2011.

Since the end of 2010, inventories increased by $22 million to meet higher demand, and accounts receivable increased by $35 million due to higher sales levels.

At July 1, 2011, the Company had various lines of credit totaling $272 million, of which $261 million was unused.

In March 2011, the Company entered into a note agreement and sold $150 million of unsecured notes in a private placement. One series of notes totaling $75 million bears interest at 4.0 percent and matures in 2018. Another series of notes totaling $75 million bears interest at 5.01 percent and matures in 2023. Under terms of the agreement, the Company sold an additional $150 million of unsecured notes on July 26, 2011. One series of notes issued in July totaling $75 million bears interest at 4.88 percent and matures in 2020. Another series of notes issued in July totaling $75 million bears interest at 5.35 percent and matures in 2026. Proceeds were used to repay revolving line of credit borrowings and invested in cash equivalents.

Under terms of the note agreement, interest is payable quarterly. The Company is required to maintain a cash flow leverage ratio of not more than 3.25 to 1.00 and an interest coverage ratio of not less than 3.00 to 1.00. If a significant acquisition is consummated, the agreement allows, for a one-year period, for a cash flow leverage ratio of 3.75 to 1.00 and an interest coverage ratio of not less than 2.50 to 1.00. The note agreement contains covenants typical of

 

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unsecured credit facilities, including customary default provisions. If an event of default occurs, all outstanding obligations may become immediately due and payable. The Company was in compliance with all financial covenants at July 1, 2011.

In April 2011, the Company entered into a definitive agreement to purchase the finishing business operations of Illinois Tool Works Inc. (ITW) in a $650 million cash transaction. Closing on the purchase is subject to regulatory reviews and other customary closing conditions. On July 5, 2011, the Company received a request for additional information from the Federal Trade Commission. The issuance of this second request extends the waiting period to close the acquisition to thirty days after the Company has substantially complied with the request. The Company is in the process of responding to the second request.

The Company plans to finance the acquisition with borrowings under the long-term notes referenced above and with borrowings under a new revolving credit facility that will become effective upon closing of the purchase. In May 2011, the Company entered into a credit agreement providing the Company access to a $450 million unsecured revolving credit facility until May 2016. The Company may not obtain any loans under the credit agreement until certain conditions are met, including the closing of the acquisition of ITW’s finishing businesses and the Company receiving not less than $75 million in proceeds from the issuance of additional long-term notes.

Internally generated funds and unused financing sources are expected to provide the Company with the flexibility to meet its liquidity needs in 2011.

Outlook

On a global basis, incoming order rates are stable and management expects market conditions in the second half of 2011 to be generally favorable, with the exception of the U.S. housing and commercial construction markets, which continue to be challenging. Percentage growth trends in the second half of 2011 are expected to be lower as comparisons to prior year become more difficult.

The pending acquisition of the ITW finishing businesses would advance all of the Company’s stated core growth strategies, including new products and technology, geographic expansion, and new markets.

 

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SAFE HARBOR CAUTIONARY STATEMENT

A forward-looking statement is any statement made in this report and other reports that the Company files periodically with the Securities and Exchange Commission, or in press or earnings releases, analyst briefings and conference calls, which reflects the Company’s current thinking on the acquisition of the finishing businesses of ITW, market trends and the Company’s future financial performance at the time they are made. All forecasts and projections are forward-looking statements. The Company undertakes no obligation to update these statements in light of new information or future events.

The Company desires to take advantage of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995 by making cautionary statements concerning any forward-looking statements made by or on behalf of the Company. The Company cannot give any assurance that the results forecasted in any forward-looking statement will actually be achieved. Future results could differ materially from those expressed, due to the impact of changes in various factors. These risk factors include, but are not limited to: economic conditions in the United States and other major world economies, currency fluctuations, political instability, changes in laws and regulations, and changes in product demand. In addition, risk factors related to the Company’s pending acquisition of the ITW finishing businesses include: whether and when the required regulatory approvals will be obtained, whether and when the closing conditions will be satisfied and whether and when the transaction will close, the ability to close on committed financing on satisfactory terms, the amount of debt that the Company will incur to complete the transaction, completion of purchase price valuation for acquired assets, whether and when the Company will be able to realize the expected financial results and accretive effect of the transaction, how customers, competitors, suppliers and employees will react to the transaction, and economic changes in global markets. Please refer to Item 1A of, and Exhibit 99 to, the Company’s Annual Report on Form 10-K for fiscal year 2010 and Item 1A of this Quarterly Report on Form 10-Q for a more comprehensive discussion of these and other risk factors.

Investors should realize that factors other than those identified above and in Item 1A and Exhibit 99 might prove important to the Company’s future results. It is not possible for management to identify each and every factor that may have an impact on the Company’s operations in the future as new factors can develop from time to time.

 

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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 2010 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 and Controller, and the Vice President, General Counsel and Secretary. Based upon that evaluation, they concluded that the Company’s disclosure controls and procedures are effective.

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 2010 Annual Report on Form 10-K, except for the addition of the risk factor described below:

Pending Acquisition - Our pending acquisition of the finishing business operations of Illinois Tool Works Inc. is subject to regulatory approvals and the expected benefits from the acquisition may not be fully realized.

We have entered into a definitive agreement to purchase the finishing business of Illinois Tools Works Inc. (ITW) in a $650 million cash transaction. We cannot predict whether or when the required regulatory approvals will be obtained or if the closing conditions will be satisfied. If we terminate the agreement before April 1, 2012 due to failure to obtain regulatory approval, we will be required to pay a $20 million termination fee. After the transaction closes, significant changes to our financial condition as a result of global economic changes or difficulties in the integration of the newly acquired businesses may affect our ability to obtain the expected benefits from the transaction or to satisfy the financial covenants included in the terms of the financing arrangements.

 

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

Issuer Purchases of Equity Securities

On September 18, 2009, 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, 2012.

In addition to shares purchased under the Board authorizations, the Company purchases shares of common stock held by employees who wish to tender owned shares to satisfy the exercise price or tax withholding on option exercises.

No shares were purchased in the second quarter of 2011. As of July 1, 2011, there were 5,179,638 shares that may yet be purchased under the Board authorization.

 

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Table of Contents

Item 6.    Exhibits

 

    2.1       Asset Purchase Agreement, dated April 14, 2011, by and among Graco Inc., Graco Holdings Inc., Graco Minnesota Inc., Illinois Tool Works Inc. and ITW Finishing LLC (excluding schedules and exhibits, which the Registrant agrees to furnish supplementally to the Securities and Exchange Commission upon request) (incorporated by reference to Exhibit 2.1 to the Company’s Report on Form 8-K filed April 15, 2011).
  10.1       Credit Agreement, dated May 23, 2011, among Graco Inc., the borrowing subsidiaries from time to time party thereto, the banks from time to time party thereto and U.S. Bank National Association, as administrative agent (incorporated by reference to Exhibit 10.1 to the Company’s Report on Form 8-K filed May 26, 2011).
  10.2       Amendment No. 1 to Note Agreement, dated May 23, 2011.
  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 Second Quarter Earnings, dated July 27, 2011.
  101       Interactive Data File.

 

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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:  

  July 27, 2011

    By:  

    /s/ Patrick J. McHale

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

  July 27, 2011

    By:  

    /s/ James A. Graner

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

  July 27, 2011

    By:  

    /s/ Caroline M. Chambers

          Caroline M. Chambers
          Vice President and Controller
          (Principal Accounting Officer)