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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
| þ | Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
| for the fiscal year ended December 31, 2010, or |
| o | Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
| for the transition period from to . |
Commission File No. 001-09249
Graco Inc.
(Exact name of Registrant as specified in its charter)
| Minnesota (State or other jurisdiction of incorporation or organization) |
41-0285640 (I.R.S. Employer Identification No.) |
88 —11th Avenue Northeast
Minneapolis, MN 55413
(Address of principal executive offices) (Zip Code)
Minneapolis, MN 55413
(Address of principal executive offices) (Zip Code)
(612) 623-6000
(Registrant’s telephone number, including area code)
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, par value $1.00 per share
Preferred Share Purchase Rights
Shares registered on the New York Stock Exchange.
Common Stock, par value $1.00 per share
Preferred Share Purchase Rights
Shares registered on the New York Stock Exchange.
Securities registered pursuant to Section 12(g) of the Act:
None
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of
the Securities Act. Yes þ No o
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or
Section 15(d) of the Act. Yes o No þ
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 (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ No o
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 for such shorter period
that the registrant was required to submit and post such files). Yes þ No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is
not contained herein, and will not be contained, to the best of registrant’s knowledge, in
definitive proxy or information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K o
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” and “accelerated filer” in Rule 12b-2 of the Exchange Act (Check one):
| Large accelerated filer þ | Accelerated filer o | Non-accelerated filer o (Do not check if a smaller reporting company) |
Smaller reporting company o |
Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the
Act).
Yes o No þ
The aggregate market value of 59,889,113 shares of common stock held by non-affiliates of the
registrant was $1,797,272,295 as of June 25, 2010.
60,105,842 shares of common stock were outstanding as of February 14, 2011.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Company’s definitive Proxy Statement for its Annual Meeting of Shareholders to be
held on April 21, 2011, are incorporated by reference into Part III, as specifically set forth in
said Part III.
INDEX TO ANNUAL REPORT
ON FORM 10-K
ON FORM 10-K
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| Item 1B | 9 | |||||||||||
| Item 2 | 9 | |||||||||||
| Item 3 | 9 | |||||||||||
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| Item 5 | 12 | |||||||||||
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| Item 7 | 15 | |||||||||||
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| Part III | ||||||||||||
| Item 10 | 48 | |||||||||||
| Item 11 | 49 | |||||||||||
| Item 12 | 49 | |||||||||||
| Item 13 | 49 | |||||||||||
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| Item 15 | 50 | |||||||||||
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| EX-10.16 | ||||||||||||
| EX-21 | ||||||||||||
| EX-23 | ||||||||||||
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| EX-32 | ||||||||||||
| EX-99 | ||||||||||||
| EX-101 INSTANCE DOCUMENT | ||||||||||||
| EX-101 SCHEMA DOCUMENT | ||||||||||||
| EX-101 CALCULATION LINKBASE DOCUMENT | ||||||||||||
| EX-101 LABELS LINKBASE DOCUMENT | ||||||||||||
| EX-101 PRESENTATION LINKBASE DOCUMENT | ||||||||||||
| EX-101 DEFINITION LINKBASE DOCUMENT | ||||||||||||
ACCESS TO REPORTS
| Investors may obtain access free of charge to the Graco Inc. annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, other reports and amendments to those reports by visiting the Graco website at www.graco.com. These reports will be available as soon as reasonably practicable following electronic filing with, or furnishing to, the Securities and Exchange Commission. |
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PART I
ITEM 1 — BUSINESS
Graco Inc. and its subsidiaries (which we refer to in this Form 10-K as “us,” “we,” “our Company”
or the “Company”) design, manufacture and sell equipment that pumps, meters, mixes, dispenses and
sprays a wide variety of fluids and semi-solids. Contractors and original equipment manufacturers
are the primary users of our Company’s equipment, in a wide variety of applications, in the
construction, manufacturing, processing and maintenance industries. Our equipment is used to
paint, finish, fill, glue and seal a wide range of goods and materials. Our equipment is sold
primarily through third-party distributors with approximately 30,000 outlets worldwide.
Our Company sells a full line of its products in each of the following geographic markets: the
Americas (North and South America), Europe (including the Middle East and Africa) and Asia Pacific.
Sales in the Americas represent approximately 55 percent of our Company’s total sales; sales in
Europe approximately 24 percent; and sales in Asia Pacific approximately 21 percent. Part II, Item
7, Results of Operations and Note B to the Consolidated Financial Statements of this Form 10-K
contain financial information about these geographic markets. Our Company provides marketing,
product design and application assistance to, and employs sales personnel in, each of these
geographic regions. Subsidiaries located in Belgium, the People’s Republic of China (“P.R.C.”),
Australia, Japan and Korea distribute our Company’s products. The majority of our manufacturing
occurs in the United States, but certain products are manufactured or assembled in the P.R.C. and
Belgium.
Our Company classifies its business into three reportable segments, each with a worldwide focus:
Industrial, Contractor and Lubrication. Financial information concerning these segments is set
forth in Part II, Item 7, Results of Operations and Note B to the Consolidated Financial Statements
of this Form 10-K.
Graco Inc. is a Minnesota corporation and was incorporated in 1926. For more information about our
Company and its products, services and solutions, visit our website at www.graco.com. The
information on the website is not part of this report nor any other report filed or furnished to
the Securities and Exchange Commission (“SEC”).
Our Company’s Strengths and Objectives
Our Company strives to develop technologically superior, multi-featured, high-quality products. We
specialize in providing pumping and spraying solutions for difficult-to-handle materials with high
viscosities, abrasive or corrosive properties, and multiple component materials that require
precise ratio control. Our Company’s products enable customers to reduce their use of labor,
material and energy, improve quality and achieve environmental compliance. All business segments
target growth with new products, through global expansion, particularly in advancing economies, and
in new markets. Targeted acquisitions, and the worldwide addition of specialized sales employees
and specialized distributors, are key components to our Company’s growth strategy. We coordinate
and drive these growth strategies across our geographic regions.
Our Company strives to generate 30 percent of its annual sales from products introduced in the
prior three years. In 2010, we generated 27 percent of our sales from new products. In 2009, the
percentage of sales represented by new products was 26 percent and in 2008 it was 26 percent.
Manufacturing is a key competency of Graco. Our manufacturing is aligned with our business
segments and is co-located with product development to accelerate new product development and
improve cost and quality. Our Company invests significant resources in maximizing the quality,
responsiveness and cost-effectiveness of our production operations by investing in equipment and
doing critical machining, assembly and testing in-house. Products are manufactured in focused
factories and product cells. Raw materials and purchased components are sourced from suppliers
around the world. The segments manage operations devoted to the manufacture of their products.
Our corporate manufacturing staff provides oversight and strategic direction of our manufacturing
resources. Our corporate manufacturing staff also manages those factories not fully aligned with a
single segment, and our warehouses, customer service and other shared corporate manufacturing
functions.
Facilities
Major product development efforts are carried out in facilities located in Minneapolis, Anoka and
Rogers, Minnesota; North Canton, Ohio; and Suzhou, P.R.C. The product development and engineering
groups in each segment focus on new product design, product improvements, new applications for
existing products and strategic technologies for their specific customer base. Total product
development expenditures for all segments were $38 million in 2010, $38 million in 2009, and $37
million in 2008.
Our Company’s headquarters are located in a 142,000 sq. ft. facility in Minneapolis, Minnesota.
The facility is also occupied by the management, marketing and product development personnel for
the Industrial segment. Information systems, accounting services and
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purchasing for our Company are housed in a 42,000 sq. ft. office building nearby. In 2010, our
Company purchased a small parcel of land adjacent to our owned property in Minneapolis, Minnesota.
A large percentage of our Company’s facilities are devoted to the manufacture and distribution of
the various products offered for sale by the business segments.
Products marketed by the Industrial segment are manufactured in owned facilities in Minneapolis,
Minnesota (405,000 sq. ft. manufacturing/warehouse/office), Sioux Falls, South Dakota (149,000 sq.
ft. manufacturing/office), and North Canton, Ohio (132,000 sq. ft. manufacturing/office). The
North Canton, Ohio facility specializes in developing and manufacturing specialized product
configurations, and it has an application development laboratory where we work with distributors,
materials suppliers and end users to test new materials and reconfigure existing equipment for use
in new applications. Some Industrial products are assembled in owned facilities in Suzhou, P.R.C.
(79,000 sq. ft. assembly/warehouse/office), and Maasmechelen, Belgium (175,000 sq. ft.
assembly/warehouse/office). The Maasmechelen facility also functions as the site of our European
headquarters, as well as our European training, testing and education center (8,600 sq. ft.).
Products marketed by the Contractor segment are manufactured primarily in owned facilities in
Rogers, Minnesota (333,000 sq. ft. manufacturing/warehouse/office). Segment management, marketing,
engineering, customer service, warehouse, shipping, sales and training are also located at the
Rogers facility. The Company leases space in Rogers, Minnesota to store inventory and assemble
small electric sprayers (33,000 sq. ft. warehouse/assembly). Our Sioux Falls, South Dakota plant
manufactures spray guns and accessories for the Contractor segment. Some Contractor products are
manufactured or assembled in our owned facility in Suzhou, P.R.C. In 2010, the Company ceased the
manufacture and warehousing of Airlessco®-branded sprayers and spray guns in Moorpark, California
(32,778 sq. ft. manufacturing/warehouse/office) and terminated its lease. Airlessco products are
now manufactured at our existing facilities in Sioux Falls, South Dakota and Suzhou, P.R.C. and
warehoused in and distributed from Sioux Falls, South Dakota, Suzhou, P.R.C. and Maasmechelen,
Belgium.
The Lubrication segment conducts its manufacturing operations in an owned facility located in
Anoka, Minnesota (207,000 sq. ft. manufacturing/office). Management, marketing, engineering,
customer service, warehouse, sales and training functions for the Lubrication segment are also
housed in this building. Some Lubrication products are being assembled in our owned facility in
Suzhou, P.R.C.
Some products are distributed to the P.R.C. market from a warehouse located in Shanghai, P.R.C.
(13,730 sq. ft. warehouse). In 2010, we formed Graco Trading (Suzhou) Co., Ltd., a foreign
invested commercial enterprise, for further distribution of our products to the P.R.C.
Our Company opened an Indonesian Representative Office of Graco Hong Kong Ltd. in the third quarter
of 2010. In 2010, our Company also signed a lease for a 29,000 sq. ft. office facility in the
Huangpu District of Shanghai. In the second quarter of 2011, our Company plans to move its Asia
Pacific headquarters and Shanghai Representative Office from their current location in the Xuhui
District of Shanghai to the newly-leased facility in the Huangpu District.
Business Segments
Industrial Segment
The Industrial segment is the largest of our Company’s businesses and represents approximately 55
percent of our total sales. This segment includes the Industrial Products and the Applied Fluid
Technologies divisions. End users of our industrial equipment require solutions to their
manufacturing and maintenance challenges and are driven by the return on investment that our
products provide. The Industrial Products division markets its equipment and services to customers
who manufacture, assemble, maintain, repair and refinish products such as appliances, vehicles,
airplanes, electronics, cabinets and furniture, and other articles. In addition to marketing its
equipment to customers in similar industries, the Applied Fluid Technology division also sells to
contractors who use its plural component equipment to apply foam insulation and protective coatings
to buildings and other structures such as ships and bridges.
Most Industrial segment equipment is sold worldwide through general and specialized third-party
distributors, integrators, design centers and original equipment manufacturers. We also work with
material suppliers to develop or adapt our equipment for use with specialized and hard-to-handle
materials. Distributors promote and sell the equipment, hold inventory, provide product
application expertise and offer on-site service, technical support and integration capabilities.
Integrators implement large individual installations in manufacturing plants where products and
services from a number of different vendors are aggregated into a single system. Design centers
engineer systems for their customers using our products. Original equipment manufacturers
incorporate our Company’s Industrial segment products into systems and assemblies that they then
supply to their customers.
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Industrial Products
The Industrial Products division focuses its product development and sales efforts on two main
applications: equipment that applies paint and other coatings to products such as motor vehicles,
appliances, furniture and other industrial and consumer products (finishing); and process pump
equipment that moves and dispenses chemicals and liquid and semi-solid foods (process pumps).
Our finishing equipment pumps, meters and applies liquids on all types of wood, metal and plastic.
Manufacturers in the automotive, automotive feeder, truck/bus/recreational vehicle, military and
utility vehicle, aerospace, farm and construction, wood and general metals industries use our
liquid finishing products. Our liquid finishing equipment includes paint circulating and paint
supply pumps, plural component coating proportioners, various accessories to filter, transport,
agitate and regulate fluid, and spare parts such as spray tips, seals and filter screens. We also
offer a variety of applicators that use different methods of atomizing and spraying the paint or
other coatings depending on the viscosity of the fluid, the type of finish desired, and the need to
maximize transfer efficiency, minimize overspray and minimize the release of volatile organic
compounds (VOCs) into the air.
Our finishing application strategies include being a technology leader and providing environmental
compliance solutions. In 2010, we introduced the ProMix® 2KE, a compact, entry-level two-component
proportioner that is ideally suited for spraying single color solvent borne and waterborne
polyurethanes and epoxies to wood and metals in manufacturing settings. The ProMix 2KE helps
reduce waste and VOCs, and has control technology that allows the user to set up, operate and
monitor the system from an LCD display as the system performs. We also introduced the ProMix 3KS
and the ProControl™ 1KS, to complete our new family of configurable liquid finishing proportioners
first introduced in 2009.
Our process pumps move chemicals, petroleum, food and other fluids. Manufacturers and processors
in the food and beverage, dairy, pharmaceutical, cosmetic, oil and gas, electronics, wastewater,
mining and ceramics industries use our process pumps. We offer pumps for sanitary applications
including FDA-compliant 3-A sanitary pumps, diaphragm pumps, transfer pumps and drum and bin
unloaders. Our process pumps provide a mechanized solution to a traditionally manual process in a
factory of moving fluids, such as the transfer of bulk tomato paste, from large barrels into
equipment that dispenses the fluid into jars or other containers. In 2010, we introduced PVDF,
conductive polypropylene and hastelloy options of the Husky™ 1050 one-inch pump, allowing the pump
to be used with a greater variety of fluids and chemicals. The Husky 1050 one-inch pump, which we
first introduced in 2009 in aluminum, polypropylene and stainless steel options, is the first in a
new series of air-operated double diaphragm pumps. In 2010, we also introduced new Saniforce™
sanitary transfer pumps, including drum and bin unloaders, which move a broad range of fluids such
as fruit juices, pizza sauce, caramel and peanut butter. Saniforce pumps increase end-user
efficiency and have a lower cost of ownership compared to more traditional solutions.
Applied Fluid Technologies
The Applied Fluid Technologies division directs its engineering, sales and marketing efforts toward
two broad types of applications: equipment to pump, meter, mix and dispense high performance
protective coatings and foam (protective coatings and foam); and equipment to pump, meter, mix and
dispense sealants, adhesives, molded polyurethane parts and composites (advanced fluid dispense).
We offer sprayer systems and plural component proportioning equipment to apply protective coatings
and foam to a wide variety of surfaces. Reactor® plural component pumps are used to apply foam to
insulate things such as walls, water heaters, refrigeration, and hot tubs, create commercial
roofing membranes and for packaging, architectural design and cavity filling. This equipment is
also used to apply two-component polyurea coatings to tanks, pipes, roofs, truck beds and
foundations. The Graco XM Plural-Component Sprayer™ series is used for corrosion-control
applications such as tank and pipeline coatings, shipbuilding, marine and railcar maintenance, wind
tower coating, bridge and infrastructure projects and coating structural steel. The XM sprayers
provide precise ratio control in a highly configurable system. User controls provide a real-time
display of ratio and a USB port for downloading data on spray pressures, temperatures, actual ratio
and total flow output.
Our Company offers pumps, meters, applicators and valves for the metering, mixing and dispensing of
precision beads of sealant and adhesive to bond, mold, seal, vacuum encapsulate, pot, laminate and
gasket parts and devices in a wide variety of industrial applications. We also offer resin pumping
and metering solutions for advanced composites, which are used in the manufacture of vehicles and
aircraft, wind turbines and bridge materials.
Key product strategies of the Applied Fluid Technologies division are to maintain technology
leadership in plural component applications, process controls, and electric pumps; and to offer a
full range of best-value standard products by using a standardized, modular product structure, with
pre-engineered products to cover a broad range of configurations and applications. In the second
half of 2010, we launched the XP70, which is an entry-point two-component high-pressure sprayer
used to apply protective coatings to tanks, pipes, ships, bridges, and other surfaces requiring
industrial coatings. The XP70 is an entry-point plural-component sprayer and an additional option
in our protective coatings and foam equipment.
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In the second quarter of 2010, we released the Graco HFR Metering System™, an in-plant, hydraulic,
fixed-ratio metering system that applies a range of materials from rigid and flexible polyurethanes
to elastomers and epoxies used for noise dampening, insulation, and structural integrity. The
hydraulic motor control module gives the ability to more precisely control ratio and volume of the
system as compared to air-operated systems. It is offered at a lower price point than traditional
custom in-plant polyurethane processing systems, and is one of the first modular, configurable
in-plant polyurethane processing systems.
The Graco PGM Metering System™, which dispenses sealants and adhesives, was launched in the second
quarter of 2010. It combines consistent bead dispense with high flow rates, which means users can
improve production rates. It is ideally suited to apply seals to solar panels and automotive
windshields.
There are a variety of applications for Graco equipment throughout the alternative energy markets.
Graco’s sealant and adhesive application equipment is widely used by manufacturers and material
suppliers serving the solar energy market, through the application of primary and secondary seals
to solar panels, potting or encapsulating junction boxes, inverters and charge controllers,
gasketing or sealing junction box lids, solar module frames, battery cell plates and battery lids,
thermal management of solar cells, inverters and charge controllers and the bonding of solar cells
and solar mirrors. We offer durable reliable fluid-handling systems for the manufacture and
maintenance of wind power components from spraying protective foam and other coatings on wind
turbine towers to the manufacture of rotor blades. Our equipment is used worldwide by wind turbine
manufacturers to supply a catalyzed plastic resin for the formation of the blades used on turbines
and to apply an adhesive for bonding parts of the blades.
Contractor Segment
The Contractor segment generated approximately 35 percent of our Company’s 2010 total sales. The
Contractor segment directs its product development, sales and marketing efforts toward three broad
applications: paint, texture, and pavement maintenance. The Contractor segment markets airless
paint and texture sprayers (air, gas, hydraulically- and electrically-powered), accessories such as
spray guns, hoses and filters and spare parts such as tips and seals, to professional painters in
the construction and maintenance industries, tradesmen and do-it-yourselfers. The products are
distributed primarily through distributor outlets whose main products are paint and other coatings.
Contractor products are also sold through general equipment distributors. Certain sprayers and
accessories are distributed globally through the home center channel.
Contractor equipment encompasses a wide variety of sprayers, including sprayers that apply markings
on roads, parking lots, fields and floors; texture to walls and ceilings; highly viscous coatings
to roofs; and paint to walls and structures. Many of these sprayers and their accessories contain
one or more technological features such as micro-processor-based controls for consistent spray and
protective shut-down, a pump that may be removed and re-installed without tools, an easy clean
feature, gas/electric convertibility, and a durable pump finish. Continual technological
innovation and broad product families with multiple offerings are characteristic of our Contractor
segment. Painters are encouraged to upgrade their equipment regularly to take advantage of the new
and/or more advanced features.
A strategy of the Contractor segment is to expand base markets using our core technologies. In
2010, we introduced new professional-grade handheld paint sprayers designed for the professional
and the do-it-yourselfer. After conducting research, we found an opportunity to expand our base
markets by adapting core technologies found in our professional sprayers into a compact, handheld
design. By leveraging our existing channels, we were able to access customer segments quickly.
Two TrueCoat™ corded handheld sprayers are designed for the do-it-yourselfer. The TrueCoat Pro™
and ProShot® cordless handheld sprayers are designed for the do-it-yourselfer, property manager,
remodeler, tradesman and professional painting contractor. In 2010, we supported these handheld
sprayers with a comprehensive marketing program that included television, print and online
advertising, and a dedicated website with resources and tips for successful completion of painting
projects. Our Company also offers handheld sprayers for international markets under other Graco
brand names.
Another strategy of the Contractor segment is to expand base markets using new technologies. We
introduced our first scarifier systems in 2010. The GrindLazer™ products are designed to remove
pavement lines and smooth uneven pavement surfaces. The GrindLazer products bring new technologies
to the pavement maintenance industry, such as Graco InstaCut™ technology, which allows the user to
turn the cutters off and on without having to lift hands off the handles.
In 2010, we also upgraded our electric and gas airless paint sprayers by adding a built-in
QuikReel™ hose reel to minimize contractors’ hose management difficulties and by adding FastFlush™
technology to decrease clean-up time.
Contractor products are marketed and sold in all major geographic areas. In 2010, we added
distributors throughout the world that specialize in the sale of particular Contractor products.
In Europe and Asia Pacific, we are pursuing a broad strategy of converting contractors accustomed
to the manual application of paint and other coatings by brush and roller to spray technology.
This requires extensive in-person demonstration of the productivity advantages, cost savings and
finish quality of our spray equipment. This also
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requires the conversion of local paint distributors who may have a different method of selling
their product. For example, some paint companies in the P.R.C. include spray application in the
price they charge for their paint.
Lubrication Segment
The Lubrication segment represented approximately 10 percent of our Company’s sales during 2010.
The Lubrication segment focuses its engineering, marketing and sales efforts on two main
lubrication markets: vehicle services and industrial. We supply pumps, hose reels, meters, valves
and accessories to the motor vehicle lubrication market where our customers include fast oil change
facilities, service garages, fleet service centers, automobile dealerships and auto parts stores.
In the industrial lubrication market, we offer systems, components, and accessories for the
automatic lubrication of industrial and commercial equipment, compressors, turbines, and on-road
and off-road vehicles. Markets served include gas transmission and petrochemical, pulp and paper,
mining and construction, agricultural equipment, food and beverage, material handling, metal
manufacturing and wind energy. For the maintenance of wind power components, we offer products
that automatically lubricate bearings, gears and generators, and products that evacuate and
dispense oil, grease, anti-freeze and hydraulic fluids. Our lubrication products are sold through
independent third party distributors, oil jobbers and directly to original equipment manufacturers.
One of our key Lubrication segment strategies is to provide products with differentiated features
that are unique to the industries served. The G3™ electric lubrication pump, used to pump grease
or oil in automatic lubrication systems, was released for sale in 2010. The G3 is designed to
lubricate grease points on vehicles, in-plant machines and conveyors, and wind energy equipment.
The G3 is a highly versatile pump platform, offering end users the unique ability to choose from
three types of controls, multiple reservoir sizes and types, three power choices and the ability to
record pump performance through the optional G3 Data Management System (DMS™). The G3 works with
all major automatic metering systems (single line resistive, single line parallel, and series
progressive). Monitoring of its on and off time, pressure, cycle counts, and machine counts make
the G3 pump suitable for virtually any lubrication system application.
The Lubrication segment markets and sells our lubrication equipment worldwide, although the bulk of
its sales come from North America. Products are distributed in each of our Company’s major
geographic markets, primarily through independent distributors serviced by a mix of independent
sales representatives and Graco sales people. In 2010, the Lubrication segment focused efforts on
developing products for expanded geographic markets. In 2010, we introduced the LD™ Series hose
reel targeted for use in European, Asian and South American markets. The LD Series hose reels were
jointly designed by our Lubrication engineering groups in the United States and in the P.R.C. for
market specific applications and are manufactured in our owned facility in Suzhou, P.R.C. The
Lubrication segment also upgraded the Matrix® automated oil dispense tracking system, and released
Matrix software intended for use in European markets.
Raw Materials
The primary materials and components used in the manufacturing process are steel of various alloys,
sizes and hardness; specialty stainless steel and aluminum bar stock, tubing and castings; tungsten
carbide; electric motors; injection molded plastics; sheet metal; forgings; powdered metal; hoses;
and electronic components. The raw materials and components used are generally adequately
available through multiple sources of supply. In order to manage cost, our Company continues to
increase its global sourcing of materials and components, primarily in the Asia Pacific region.
During 2010, the prices of aluminum, nickel, copper, steel, rubber and plastics significantly
increased over 2009 pricing levels. Our Company endeavors to address fluctuations in the price and
availability of various materials and components through adjustable surcharges and credits, close
management of current suppliers, price negotiations and an intensive search for new suppliers. In
2010, a worldwide electronic component supply shortage increased lead times on these components.
We have performed risk assessments of our key suppliers of electronic components and other
commodities, and are factoring the risks identified into our commodity plans.
Intellectual Property
We own a number of patents and have patent applications pending both in the United States and in
other countries, license our patents to others, and are a licensee of patents owned by others. In
our opinion, our business is not materially dependent upon any one or more of these patents or
licenses. Our Company also owns a number of trademarks in the United States and foreign countries,
including registered trademarks for “GRACO,” several forms of a capital “G,” “Airlessco,” “ASM,”
and various product trademarks that are material to our business, inasmuch as they identify Graco
and our products to our customers.
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Competition
We face substantial competition in all of our markets. The nature and extent of this competition
varies in different markets due to the depth and breadth of our Company’s products. Product
quality, reliability, design, customer support and service, personal relationships, specialized
engineering and pricing are the major competitive factors in our markets. Although no competitor
duplicates all of our products, some competitors are larger than our Company, both in terms of
sales of directly competing products and in terms of total sales and financial resources. We also
face competitors with different cost structures and expectations of profitability and these
companies offer competitive products at lower prices. We believe we are one of the world’s leading
producers of high-quality specialized fluid handling equipment in the markets we serve.
Environmental Protection
Our compliance with federal, state and local environmental laws and regulations did not have a
material effect upon our capital expenditures, earnings or competitive position during the fiscal
year ended December 31, 2010.
Employees
As of December 31, 2010, we employed approximately 2,200 persons. Of this total, approximately
500 were employees based outside the United States, and 800 were hourly factory workers in the
United States. None of our Company’s U.S. employees are covered by a collective bargaining
agreement. Various national industry-wide labor agreements apply to certain employees in various
countries outside the United States. Compliance with such agreements has no material effect on our
Company or its operations.
Item 1A. Risk Factors
Economic
Environment — Demand for our products depends on the level of commercial and industrial activity worldwide.
An economic downturn or financial market turmoil may depress demand for our equipment in all major
geographies and markets. If our distributors and OEMs are unable to purchase our products because
of unavailable credit or unfavorable credit terms or are simply unwilling to purchase our products,
our net sales and earnings will be adversely affected.
Major Customers — Our Contractor segment depends on a few large customers for a significant
portion of its sales. Significant declines in the level of purchases by these customers could
reduce our sales and impact segment profitability.
Our Contractor segment derives a significant amount of revenue from a few large customers.
Substantial decreases in purchases by these customers, difficulty in collecting amounts due or the
loss of their business would adversely affect the profitability of this segment. The business of
these customers is dependent upon the economic vitality of the construction and home maintenance
markets. If these markets decline, the business of our customers could be adversely affected and
their purchases of our equipment could decrease.
Foreign Operations — Conditions in foreign countries and changes in foreign exchange rates may
impact our sales volume, rate of growth or profitability.
In 2010, approximately 54 percent of our sales were generated by customers located outside the
United States. Operations located outside the United States expose us to special risks, including
the risk of terrorist activities, civil disturbances, environmental catastrophes, supply chain
disruptions, and special taxes, regulations and restrictions. We are increasing our presence in
advancing economies and our revenues and net income may be adversely affected by the more volatile
economic and political conditions prevalent in these regions. Changes in exchange rates between
the U.S. dollar and other currencies will impact our reported sales and earnings and may make it
difficult for some of our distributors to purchase products.
Suppliers — Risks associated with foreign sourcing of raw materials and components, supply
interruption, delays in raw material or component delivery or supply shortages may adversely affect
our production or profitability.
Our Company is sourcing an increasing percentage of our materials and components from suppliers
outside the United States. Long lead times or supply interruptions associated with a global supply
base may reduce our flexibility and make it more difficult to respond promptly to fluctuations in
demand or respond quickly to product quality problems. Changes in exchange rates between the U.S.
dollar and other currencies and fluctuations in the price of commodities may impact the
manufacturing costs of our products and affect our profitability. Protective tariffs,
unpredictable changes in duty rates, and trade regulation changes may make certain foreign-sourced
parts no longer competitively priced. Long supply chains may be disrupted by environmental events.
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Acquisitions — Our growth strategy includes acquisitions. Suitable acquisitions must be located,
completed and effectively integrated into our existing businesses in order for this strategy to be
successful.
We have identified acquisitions as one of the strategies by which we intend to grow our business.
If we are unable to obtain financing at a reasonable cost, are unsuccessful in acquiring and
integrating businesses into our business, or do not realize projected efficiencies and cost-savings
from the businesses we acquire, we may be unable to meet our growth or profit objectives.
Natural Disasters — Our operations are at risk of damage or destruction by natural disasters, such
as earthquakes, tornadoes or unusually heavy precipitation.
The loss of, or substantial damage to, one of our facilities could make it difficult to supply our
customers with product and provide our employees with work. Our manufacturing and distribution
facility in Minneapolis is on the banks of the Mississippi River where it is exposed to flooding.
Flooding could also damage our European headquarters and warehouse in Maasmechelen, Belgium or our
factory in Suzhou, P.R.C. Tornadoes could damage or destroy our facilities in Sioux Falls, Rogers,
Minneapolis or Anoka and a typhoon could do the same to our facility in Suzhou. An earthquake may
adversely impact our operations in Suzhou.
Competition — Demand for our products may be affected by new entrants who copy our products and
infringe on our intellectual property.
From time to time, our Company has been faced with instances where competitors have intentionally
infringed our intellectual property and/or taken advantage of our design and development efforts.
In some instances, these competitors have launched broad marketing campaigns. The inability of our
Company to effectively meet these challenges could adversely affect our revenues and profits and
hamper our ability to grow.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
The information concerning the location and general character of the physical properties of our
Company contained under Item 1 — BUSINESS of this 2010 Annual Report on Form 10-K is incorporated
herein by reference.
Sales activities in the country of Japan are conducted out of a leased facility in Yokohama, Japan
(18,500 gross sq. ft. office) and warehousing is provided by a third-party logistics supplier.
Sales and distribution activities in Korea are provided out of leased facilities in Gwangju-Gun,
Korea (15,750 sq. ft. total for two separate facilities-warehouse and office). Our Company also
leases space for liaison offices in the P.R.C., Vietnam and India.
Our Australian subsidiary has a third-party logistics arrangement with a global supplier to handle
storage and order fulfillment for Graco products sold to Australian and New Zealand distributors.
The operations, accounting, customer service and administrative staff of the Australian subsidiary
are housed in leased office space in Melbourne, Australia.
Our Company’s facilities are in satisfactory condition, suitable for their respective uses and are
generally adequate to meet current needs. During 2010, manufacturing capacity met business demand.
Production requirements in the immediate future are expected to be met through existing
facilities, the installation of new automatic and semi-automatic machine tools, efficiency and
productivity improvements, the use of leased space and available subcontract services.
Item 3. Legal Proceedings
Our Company is engaged in routine litigation incident to our business, which management believes
will not have a material adverse effect upon our operations or consolidated financial position.
Item 4. (Removed and Reserved)
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Executive Officers of Our Company
The following are all the executive officers of Graco Inc. as of February 22, 2011:
Patrick J. McHale, 49, is President and Chief Executive Officer, a position he has held since June
2007. He served as Vice President and General Manager, Lubrication Equipment Division from June
2003 to June 2007. He was Vice President of Manufacturing and Distribution Operations from April
2001 to June 2003. He served as Vice President, Contractor Equipment Division from February 2000
to March 2001. Prior to becoming Vice President, Lubrication Equipment Division in September 1999,
he held various manufacturing management positions in Minneapolis, Minnesota; Plymouth, Michigan;
and Sioux Falls, South Dakota. Mr. McHale joined the Company in December 1989.
David M. Ahlers, 52, became Vice President, Human Resources and Corporate Communications in April
2010. From September 2008 through March 2010, he served as the Company’s Vice President, Human
Resources. Prior to joining Graco, Mr. Ahlers held various human resources positions, including,
most recently, Chief Human Resources Officer and Senior Managing Director of GMAC Residential
Capital, from August 2003 to August 2008. He joined the Company in September 2008.
Caroline M. Chambers, 46, became Vice President and Controller in December 2006 and has served as
the Company’s principal accounting officer since September 2007. She was Corporate Controller from
October 2005 to December 2006 and Director of Information Systems from July 2003 through September
2005. Prior to becoming Director of Information Systems, she held various management positions in
the internal audit and accounting departments. Prior to joining Graco, Ms. Chambers was an auditor
with Deloitte & Touche in Minneapolis, Minnesota and Paris, France. Ms. Chambers joined the
Company in 1992.
Karen Park Gallivan, 54, became Vice President, General Counsel and Secretary in September 2005.
She was Vice President, Human Resources from January 2003 to September 2005. Prior to joining
Graco, she was Vice President of Human Resources and Communications at Syngenta Seeds, Inc., from
January 1999 to January 2003. From 1988 through January 1999, she was the general counsel of
Novartis Nutrition Corporation. Prior to joining Novartis, Ms. Gallivan was an attorney with the
law firm of Rider, Bennett, Egan and Arundel. She joined the Company in January 2003.
James A. Graner, 66, became Chief Financial Officer and Treasurer in September 2005. He was Vice
President and Controller from March 1994 to September 2005. He was Treasurer from May 1993 through
February 1994. Prior to becoming Treasurer, he held various managerial positions in the treasury,
accounting and information systems departments. He joined the Company in 1974.
Dale D. Johnson, 56, became Vice President and General Manager, Contractor Equipment Division in
April 2001. From January 2000, through March 2001, he served as President and Chief Operating
Officer. From December 1996 to January 2000, he was Vice President, Contractor Equipment Division.
Prior to becoming the Director of Marketing, Contractor Equipment Division, in June 1996, he held
various marketing and sales positions in the Contractor Equipment Division and the Industrial
Equipment Division. He joined the Company in 1976.
Jeffrey P. Johnson, 51, is Vice President and General Manager, Asia Pacific, a position he has held
since February 2008. He served as Director of Sales and Marketing, Applied Fluid Technologies
Division, from June 2006 until February 2008. Prior to joining Graco, he held various sales and
marketing positions, including, most recently, President of Johnson Krumwiede Roads, a full-service
advertising agency, and European sales manager at General Motors Corp. He joined the Company in
2006.
David M. Lowe, 55, became Vice President and General Manager, Industrial Products Division in
February 2005. He was Vice President and General Manager, European Operations from September 1999
to February 2005. Prior to becoming Vice President, Lubrication Equipment Division in December
1996, he was Treasurer. Mr. Lowe joined the Company in February 1995.
Simon J. W. Paulis, 63, became Vice President and General Manager, Europe in September 2005. From
February 2005 to September 2005, he served as Director and General Manager, Europe. He served as
Sales and Marketing Director, Contractor Equipment Europe from January 1999 to September 2005.
Prior to joining Graco, he served as business unit manager for Black & Decker N.V., general sales
manager for Alberto Culver, and marketing manager for Ralston Purina/Quaker Oats. Mr. Paulis
joined the Company in January 1999.
Charles L. Rescorla, 59, became Vice President of Manufacturing, Information Systems and
Distribution Operations in April 2009. He served as Vice President, Manufacturing and
Distribution Operations from September 2005 to April 2009. From June 2003 to until September 2005,
he was Vice President, Manufacturing/Distribution Operations and Information Systems. From April
2001 until June 2003, he was Vice President of the Industrial/Automotive Equipment Division. Prior
to June 2003, he held various positions in manufacturing and engineering management. Mr. Rescorla
joined the Company in June 1988.
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Mark W. Sheahan, 46, became Vice President and General Manager, Applied Fluid Technologies Division
in February 2008. He served as Chief Administrative Officer from September 2005 until February
2008, and was Vice President and Treasurer from December 1998 to September 2005. Prior to becoming
Treasurer in December 1996, he was Manager, Treasury Services, where he was responsible for
strategic and financial activities. He joined the Company in September 1995.
Brian J. Zumbolo, 41, became Vice President and General Manager, Lubrication Equipment Division in
August 2007. He was Director of Sales and Marketing, Lubrication Equipment and Applied Fluid
Technologies, Asia Pacific, from November 2006 through July 2007. From February 2005 to November
2006, he was the Director of Sales and Marketing, High Performance Coatings & Foam, Applied Fluid
Technologies Division. Mr. Zumbolo was the Director of Sales and Marketing, Finishing Equipment
from May 2004 to February 2005. Prior to May 2004, he held various marketing positions in the
Industrial Equipment Division. Mr. Zumbolo joined the Company in 1999.
The Board of Directors re-elected each of the above executive officers to their current position on
April 23, 2010.
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PART II
Item 5. Market for the Company’s Common Equity, Related Shareholder Matters and Issuer Purchases of
Equity Securities
Graco Common Stock
Graco common stock is traded on the New York Stock Exchange under the ticker symbol “GGG.” As of
February 14, 2011, the share price was $42.50 and there were 60,105,842 shares outstanding and
2,884 common shareholders of record, which includes nominees or broker dealers holding stock on
behalf of an estimated 45,000 beneficial owners.
The graph below compares the cumulative total shareholder return on the common stock of the Company
for the last five fiscal years with the cumulative total return of the S&P 500 Index and the Dow
Jones Industrial Machinery Index over the same period (assuming the value of the investment in
Graco common stock and each index was $100 on December 31, 2005, and all dividends were
reinvested).
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Quarterly Financial Information (Unaudited)
(In thousands, except per share amounts)
(In thousands, except per share amounts)
| First | Second | Third | Fourth | |||||||||||||
| Quarter | Quarter | Quarter | Quarter | |||||||||||||
2010 |
||||||||||||||||
Net sales |
$ | 164,721 | $ | 192,088 | $ | 189,963 | $ | 197,293 | ||||||||
Gross profit |
89,295 | 101,920 | 104,558 | 107,672 | ||||||||||||
Net earnings |
20,565 | 24,836 | 30,431 | 27,008 | ||||||||||||
Per common share |
||||||||||||||||
Basic net earnings |
$ | 0.34 | $ | 0.41 | $ | 0.51 | $ | 0.45 | ||||||||
Diluted net earnings |
0.34 | 0.41 | 0.50 | 0.44 | ||||||||||||
Dividends declared |
0.20 | 0.20 | 0.20 | 0.21 | ||||||||||||
Stock price (per share) |
||||||||||||||||
High |
$ | 31.82 | $ | 35.98 | $ | 32.61 | $ | 40.56 | ||||||||
Low |
25.82 | 28.74 | 27.05 | 30.05 | ||||||||||||
| First | Second | Third | Fourth | |||||||||||||
| Quarter | Quarter | Quarter | Quarter | |||||||||||||
2009 |
||||||||||||||||
Net sales |
$ | 137,880 | $ | 147,712 | $ | 147,308 | $ | 146,312 | ||||||||
Gross profit |
64,328 | 73,008 | 78,141 | 77,339 | ||||||||||||
Net earnings |
2,768 | 11,634 | 17,336 | 17,229 | ||||||||||||
Per common share |
||||||||||||||||
Basic net earnings |
$ | 0.05 | $ | 0.19 | $ | 0.29 | $ | 0.29 | ||||||||
Diluted net earnings |
0.05 | 0.19 | 0.29 | 0.28 | ||||||||||||
Dividends declared |
0.19 | 0.19 | 0.19 | 0.20 | ||||||||||||
Stock price (per share) |
||||||||||||||||
High |
$ | 26.42 | $ | 24.94 | $ | 30.77 | $ | 32.09 | ||||||||
Low |
14.17 | 16.40 | 20.57 | 26.37 | ||||||||||||
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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 authorization, the Company purchases shares of
common stock held by employees who wish to tender owned shares to satisfy the exercise price or tax
withholding on stock option exercises.
No shares were purchased in the fourth quarter of 2010. As of December 31, 2010, there were
5,179,638 shares that may yet be purchased under the Board authorization.
Item 6. Selected Financial Data
Graco Inc. and Subsidiaries (in thousands, except per share amounts)
| 2010 | 2009 | 2008 | 2007 | 2006 | ||||||||||||||||
Net sales |
$ | 744,065 | $ | 579,212 | $ | 817,270 | $ | 841,339 | $ | 816,468 | ||||||||||
Net earnings |
102,840 | 48,967 | 120,879 | 152,836 | 149,766 | |||||||||||||||
Per common share |
||||||||||||||||||||
Basic net earnings |
$ | 1.71 | $ | 0.82 | $ | 2.01 | $ | 2.35 | $ | 2.21 | ||||||||||
Diluted net earnings |
1.69 | 0.81 | 1.99 | 2.32 | 2.17 | |||||||||||||||
Cash dividends declared |
0.81 | 0.77 | 0.75 | 0.68 | 0.60 | |||||||||||||||
Total assets |
$ | 530,474 | $ | 476,434 | $ | 579,850 | $ | 536,724 | $ | 511,603 | ||||||||||
Long-term debt (including current
portion) |
70,255 | 86,260 | 180,000 | 107,060 | — | |||||||||||||||
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following Management’s Discussion and Analysis reviews significant factors affecting the
Company’s consolidated results of operations, financial condition and liquidity. This discussion
should be read in conjunction with our financial statements and the accompanying notes to the
financial statements. The discussion is organized in the following sections:
| • | Overview | ||
| • | Results of Operations | ||
| • | Segment Results | ||
| • | Financial Condition and Cash Flow | ||
| • | Critical Accounting Estimates | ||
| • | Outlook |
Overview
Graco designs, manufactures and markets systems and equipment to pump, meter, mix and dispense a
wide variety of fluids. The Company specializes in equipment for applications that involve
difficult-to-handle materials with high viscosities, materials with abrasive or corrosive
properties and multiple-component materials that require precise ratio control. Graco sells
primarily through independent third-party distributors worldwide to industrial and contractor
end-users. More than half of our sales are outside of the United States. Graco’s business is
classified by management into three reportable segments, each responsible for product development,
manufacturing, marketing and sales of their products. The segments are headquartered in North
America. They have responsibility for sales and marketing in the Americas and joint responsibility
with Europe and Asia Pacific regional management for sales and marketing in those geographic areas.
Graco’s
key strategies include developing and marketing new products, expanding distribution
globally, opening new markets with technology and channel expansion and completing strategic
acquisitions. Long-term financial growth targets accompany these strategies, including our
expectation of 10 percent revenue growth and 12 percent net earnings growth.
Manufacturing is a key competency of the Company. Our management team in Minneapolis provides
strategic manufacturing expertise, and is also responsible for factories not fully aligned with a
single division. Our primary manufacturing facilities are in the United States and distribution
facilities are located in the United States, Belgium, Japan, Korea, China and Australia.
Results of Operations
Net sales, operating earnings, net earnings and earnings per share were as follows (in millions
except per share amounts):
| 2010 | 2009 | 2008 | ||||||||||
Net Sales |
$ | 744 | $ | 579 | $ | 817 | ||||||
Operating Earnings |
153 | 74 | 187 | |||||||||
Net Earnings |
103 | 49 | 121 | |||||||||
Diluted Net Earnings per Common Share |
$ | 1.69 | $ | 0.81 | $ | 1.99 | ||||||
2010 Summary:
| • | Revenues grew by 28 percent, benefiting from the global industrial recovery and the Company’s investments in new products, innovative technologies and commercial capabilities to support geographic expansion. Sales growth in all segments and regions exceeded 20 percent. By region, sales increased 24 percent in the Americas, 25 percent in Europe and 46 percent in Asia Pacific. Sales in the Industrial segment grew by 31 percent; sales in the Contractor segment grew by 23 percent and sales in the Lubrication segment increased by 35 percent. | ||
| • | Translation rates did not have a significant impact on sales and earnings in 2010. Changes in Asian currencies and the Canadian dollar largely offset the effects of changes in the euro. | ||
| • | Operating earnings were $153 million as compared to $74 million in the prior year, and as a percentage of sales were 21 percent, up from 13 percent in 2009. | ||
| • | Net earnings totaled $103 million or $1.69 diluted earnings per share as compared to $49 million or $0.81 diluted earnings per share in 2009. | ||
| • | There were 53 weeks in fiscal 2010 and 52 weeks in fiscal 2009. | ||
| • | Gross profit margin as a percentage of sales improved by 31/2 points from 2009, mainly due to reduction in unabsorbed manufacturing costs as compared to the prior year. Other factors contributing to improvement in the gross margin rate |
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| included selling price increases and lower pension costs in 2010, and costs related to workforce reductions that lowered the 2009 rate. | |||
| • | Investment in new product development was $38 million or 5 percent of sales in 2010. | ||
| • | Total operating expenses were $32 million higher than 2009. The significant recovery in sales and earnings in 2010 resulted in higher incentive expense, accounting for approximately two-thirds of the increase in operating expense for the year. Operating expense as a percentage of sales decreased to 331/2 percent in 2010 from 371/2 percent. | ||
| • | The effective tax rate was 31 percent as compared to 29 percent in 2009. The effect of the federal R&D tax credit of $21/2 million and the domestic production deduction was lower in 2010 as a percentage of pre-tax earnings as compared to 2009. | ||
| • | Cash flows from operations were strong at $101 million, though lower than the prior year as working capital requirements for accounts receivable and inventory increased in-line with sales growth. |
2009 Summary:
| • | Weak economic conditions worldwide affected the Company’s operating results. Although sales strengthened in the second half as compared to the first half of 2009, sales decreased in all segments and regions as compared to the prior year. By region, the sales decline was 28 percent in the Americas, 39 percent in Europe and 17 percent in Asia Pacific. Sales in the Industrial segment declined by 32 percent; sales in the Contractor segment declined by 22 percent and sales in the Lubrication segment declined by 34 percent. | ||
| • | Unfavorable currency translation decreased net sales by approximately $10 million and decreased net earnings by approximately $4 million in 2009. | ||
| • | The Company incurred $5 million of cost related to workforce reductions. | ||
| • | Gross profit margin as a percentage of sales decreased by 2 percentage points from 2008. The favorable effects of pricing, product mix, lower material costs and other cost reduction activities partially offset the effects of low production volumes and increased pension costs. | ||
| • | Investment in new product development was $38 million or 61/2 percent of sales in 2009. | ||
| • | Overall, total operating expenses were 11 percent lower than the prior year, due to lower workforce reduction costs and lower volume-related expenses. Expense reductions were partially offset by higher pension costs. | ||
| • | The effective tax rate was 29 percent as compared to 32 percent in 2008. The effect of federal business credits and the domestic production deduction was greater in 2009 as a percentage of pre-tax earnings as compared to the prior year. | ||
| • | Cash flows from operations remained strong at $147 million. |
The following table presents net sales by geographic region (in millions):
| 2010 | 2009 | 2008 | ||||||||||
Americas1 |
$ | 408 | $ | 329 | $ | 455 | ||||||
Europe2 |
178 | 143 | 232 | |||||||||
Asia Pacific |
158 | 107 | 130 | |||||||||
Total |
$ | 744 | $ | 579 | $ | 817 | ||||||
| 1 | North and South America, including the United States. Sales in the United States were $341 million in 2010, $280 million in 2009 and $384 million in 2008. | |
| 2 | Europe, Africa and Middle East |
In 2010, sales in the Americas increased by 24 percent overall, with increases of 26 percent in the
Industrial segment, 22 percent in the Contractor segment and 23 percent in the Lubrication segment
as compared to the prior year. Most end-markets strengthened in 2010, though some select
industries, such as residential and commercial construction, remain weak. More than half of the
increase in the Contractor segment was due to new product launches.
In 2010, sales in Europe were strong across all segments, with an increase of 25 percent overall
and 24 percent in the Industrial segment, 24 percent in the Contractor segment and 56 percent in
the Lubrication segment. Sales growth was strong throughout the region.
In 2010, sales growth in Asia Pacific was especially significant, increasing of 46 percent overall
and exceeding pre-recession levels. Sales grew 49 percent in the Industrial segment, 24 percent in
the Contractor segment and more than double the prior year sales in the Lubrication segment. The
Company has continued to invest in this region with additional commercial resources and focus on
new distribution to support growing end markets.
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In 2009, sales in the Americas declined by 28 percent overall, with declines of 32 percent in the
Industrial segment, 19 percent in the Contractor segment and 34 percent in the Lubrication segment
as compared to the prior year. In Europe, sales declined by 40 percent in the Industrial segment,
35 percent in the Contractor segment and 45 percent in the Lubrication segment. In Asia Pacific,
sales declined by 21 percent in the Industrial segment, increased by 1 percent in the Contractor
segment and declined by 26 percent in the Lubrication segment. Despite the severity of the global
recession, commercial resources were maintained and new distribution outlets were opened in all
regions and segments.
The following table presents components of net sales change:
| 2010 | ||||||||||||||||||||||||||||
| Segment | Region | |||||||||||||||||||||||||||
| Industrial | Contractor | Lubrication | Americas | Europe | Asia Pacific | Consolidated | ||||||||||||||||||||||
Volume and Price |
30 | % | 23 | % | 33 | % | 23 | % | 29 | % | 41 | % | 28 | % | ||||||||||||||
Currency |
1 | % | — | % | 2 | % | 1 | % | (4 | )% | 5 | % | — | % | ||||||||||||||
Total |
31 | % | 23 | % | 35 | % | 24 | % | 25 | % | 46 | % | 28 | % | ||||||||||||||
| 2009 | ||||||||||||||||||||||||||||
| Segment | Region | |||||||||||||||||||||||||||
| Industrial | Contractor | Lubrication | Americas | Europe | Asia Pacific | Consolidated | ||||||||||||||||||||||
Volume and Price |
(31 | )% | (23 | )% | (33 | )% | (28 | )% | (36 | )% | (17 | )% | (29 | )% | ||||||||||||||
Acquisitions |
— | % | 3 | % | — | % | 1 | % | 1 | % | — | % | 1 | % | ||||||||||||||
Currency |
(1 | )% | (2 | )% | (1 | )% | (1 | )% | (4 | )% | — | % | (1 | )% | ||||||||||||||
Total |
(32 | )% | (22 | )% | (34 | )% | (28 | )% | (39 | )% | (17 | )% | (29 | )% | ||||||||||||||
The following table presents an overview of components of operating earnings as a percentage of net
sales:
| 2010 | 2009 | 2008 | ||||||||||
Net Sales |
100.0 | % | 100.0 | % | 100.0 | % | ||||||
Cost of products sold |
45.8 | 49.4 | 47.1 | |||||||||
Gross profit |
54.2 | 50.6 | 52.9 | |||||||||
Product development |
5.1 | 6.5 | 4.5 | |||||||||
Selling, marketing and distribution |
18.2 | 19.9 | 17.0 | |||||||||
General and administrative |
10.3 | 11.3 | 8.5 | |||||||||
Operating earnings |
20.6 | 12.9 | 22.9 | |||||||||
Interest expense |
0.5 | 0.8 | 0.9 | |||||||||
Other expense, net |
0.1 | 0.2 | 0.1 | |||||||||
Earnings before income taxes |
20.0 | 11.9 | 21.9 | |||||||||
Income taxes |
6.2 | 3.4 | 7.1 | |||||||||
Net Earnings |
13.8 | % | 8.5 | % | 14.8 | % | ||||||
2010 Compared to 2009
Operating earnings as a percentage of sales were 21 percent in 2010, up from 13 percent in 2009,
with improvements in gross margins and expense leverage as compared to the prior year. Major
factors for the improvement included improved product cost, mix and pricing, reduced unabsorbed
manufacturing costs and absence of workforce reduction costs incurred in 2009.
Gross profit margin as a percentage of sales was 54 percent in 2010 as compared to 51 percent in
2009. Higher volume rates reduced unabsorbed manufacturing costs from $26 million in 2009 to $12
million in 2010 and accounted for approximately half of the improvement in gross margins. Other
factors contributing to improvement in the gross margin rate included selling price increases and
lower pension costs in 2010, and costs related to workforce reductions that lowered the 2009 rate.
Total operating expense increased $32 million as compared to 2009 and operating expense as a
percentage of sales was 331/2 percent, decreasing from 371/2 percent the prior year. Higher incentive
expense accounted for approximately two-thirds of the increase. Investment in new product development was $38 million or 5 percent of sales in 2010. Selling,
marketing and distribution costs were
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$136 million in 2010 as compared to $116 million in 2009.
General and administrative costs were $77 million as compared to $65 million in the prior year.
Interest expense was $4 million in 2010 as compared to $5 million in 2009. Debt was reduced by $20
million in 2010 from the prior year.
The Company’s effective tax rate was 31 percent in 2010, higher than the effective tax rate of 29
percent in 2009. The rate is lower than the U.S. federal statutory rate of 35 percent due
primarily to U.S. business credits, the Domestic Production Deduction (DPD) and changes in
unrecognized tax benefits resulting from favorable tax rulings. Overall, the effect of the
business credits and domestic production deductions in 2010 was lower in 2010 as a percentage of
pre-tax earnings as compared to the prior year.
2009 Compared to 2008
Gross profit margin as a percentage of sales was 51 percent in 2009 as compared to 53 percent in
2008. Lower production volumes accounted for approximately 4 percentage points of the reduction
and increased pension costs accounted for an additional 1 percentage point of the reduction.
Favorable effects of pricing, product mix, lower material costs and other cost reduction activities
partially offset the effects of low production volumes and increased pension costs.
Although operating expenses in 2009 declined to $218 million compared to $245 million in the prior
year, the reduction in expense as a percentage of net sales was not as great as the change in sales
volume. Product development spending was $38 million as compared to $37 million in the prior year,
reflecting the Company’s strategic decision to continue investing in new product development.
Selling, marketing and distribution costs were $116 million in 2009 as compared to $139 million in
2008. General and administrative costs were $65 million in 2009 as compared to $70 million in the
prior year. Included in operating expenses was an increase in pension cost of $11 million as
compared to 2008.
Consolidated operating earnings decreased 60 percent to $74 million, or 13 percent of sales in
2009, reflecting the effects of lower sales volumes, unfavorable currency translation and increased
pension costs, partially offset by spending reductions and lower volume-related expenses.
Interest expense was $5 million in 2009 as compared to $8 million in 2008. Debt was reduced by
$100 million in 2009 from the prior year.
The Company’s effective tax rate was 29 percent in 2009, lower than the effective tax rate of 32
percent in 2008. The rate is lower than the U.S. federal statutory rate of 35 percent due
primarily to U.S. business credits and the Domestic Production Deduction (DPD). The effect of the
business credits and the DPD was greater in 2009 as a percentage of pre-tax earnings as compared to
the prior year.
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Segment Results
The following table presents net sales and operating earnings by business segment (in millions):
| 2010 | 2009 | 2008 | ||||||||||
Sales |
||||||||||||
Industrial |
$ | 409 | $ | 313 | $ | 463 | ||||||
Contractor |
257 | 208 | 267 | |||||||||
Lubrication |
78 | 58 | 87 | |||||||||
Total |
$ | 744 | $ | 579 | $ | 817 | ||||||
Operating Earnings |
||||||||||||
Industrial |
$ | 126 | $ | 68 | $ | 138 | ||||||
Contractor |
37 | 29 | 47 | |||||||||
Lubrication |
9 | (3 | ) | 13 | ||||||||
Unallocated corporate |
(19 | ) | (20 | ) | (11 | ) | ||||||
Total |
$ | 153 | $ | 74 | $ | 187 | ||||||
Management looks at economic and financial indicators relevant to each segment and geography to
gauge the business environment, as noted in the discussion below for each segment.
Industrial
The following table presents net sales, components of net sales change and operating earnings as a
percentage of sales for the Industrial segment (dollars in millions):
| 2010 | 2009 | 2008 | ||||||||||
Sales |
||||||||||||
Americas |
$ | 187 | $ | 149 | $ | 220 | ||||||
Europe |
109 | 89 | 148 | |||||||||
Asia Pacific |
113 | 75 | 95 | |||||||||
Total |
$ | 409 | $ | 313 | $ | 463 | ||||||
Components of Net Sales Change |
||||||||||||
Volume and Price |
30 | % | (31 | )% | — | % | ||||||
Acquisitions |
— | % | — | % | 2 | % | ||||||
Currency |
1 | % | (1 | )% | 2 | % | ||||||
Total |
31 | % | (32 | )% | 4 | % | ||||||
Operating Earnings as a Percentage of Sales |
31 | % | 22 | % | 30 | % | ||||||
In 2010, sales in the Industrial segment increased 31 percent, with increases in all regions. By
geography, sales increased by 26 percent in the Americas, 24 percent in Europe (27 percent at
consistent translation rates) and 49 percent in Asia Pacific (44 percent at consistent translation
rates).
In 2010, operating earnings were $126 million or 31 percent of sales as compared to $68 million or
22 percent of sales in 2009, with the higher sales and resulting increases in production volume
leading to improvement in operating earnings as a percentage of sales. One percentage point of the
change in operating earnings is attributed to favorable product cost, mix and selling prices, one
percentage point is attributed to cost of workforce reductions in 2009, two percentage points is
attributed to reduction in unabsorbed manufacturing costs and five percentage points is attributed
to improved expense leverage.
In 2009, sales in the Industrial segment decreased by 32 percent, with declines in all regions.
Sales declined by 32 percent in the Americas, 40 percent in Europe (36 percent at consistent
translation rates) and 21 percent in Asia Pacific. Although still below the prior year, sales
improved in the fourth quarter of 2009 as compared to earlier quarters.
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In 2009, operating earnings in the Industrial segment were $68 million, or 22 percent of sales
in 2009 as compared to $138 million, or 30 percent the prior year. One percentage point of the
change in operating earnings is attributable to unfavorable currency translation and 4 percentage
points of the change in operating earnings is attributable to greater unabsorbed manufacturing
costs. The favorable effects of reductions in product cost, mix and price partially offset the
effects of volume on operating earnings.
In this segment, sales in each geographic region are significant and management looks at economic
and financial indicators in each region, including gross domestic product, industrial production,
capital investment rates, automobile production, building construction and the level of the U.S.
dollar versus the euro, the Canadian dollar, the Australian dollar and various Asian currencies.
Contractor
The following table presents net sales, components of net sales change and operating earnings as a
percentage of sales for the Contractor segment (dollars in millions):
| 2010 | 2009 | 2008 | ||||||||||
Sales |
||||||||||||
Americas |
$ | 163 | $ | 133 | $ | 165 | ||||||
Europe |
63 | 50 | 77 | |||||||||
Asia Pacific |
31 | 25 | 25 | |||||||||
Total |
$ | 257 | $ | 208 | $ | 267 | ||||||
Components of Net Sales Change |
||||||||||||
Volume and Price |
23 | % | (23 | )% | (15 | )% | ||||||
Acquisitions |
— | % | 3 | % | 1 | % | ||||||
Currency |
— | % | (2 | )% | 1 | % | ||||||
Total |
23 | % | (22 | )% | (13 | )% | ||||||
Operating Earnings as a Percentage of Sales |
14 | % | 14 | % | 18 | % | ||||||
In 2010, sales in the Contractor segment increased 23 percent, with increases in all regions. By
geography, sales increased by 22 percent in the Americas, 24 percent in Europe (29 percent at
consistent translation rates) and 24 percent in Asia Pacific (18 percent at consistent translation
rates). In the Americas, the professional paint stores channel was the primary driver of the sales
increase, with more than half of the increase coming from the new handheld product line. The new
handheld product was also a significant contributor to growth in Europe, though less significant in
Asia Pacific due to product launch late in the year.
In 2010, operating earnings were $37 million as compared to $29 million in 2009, or 14 percent of
sales in both years. Operating margin percentages were held down by costs and expenses related to
new product introductions and expanding distribution as well as increase in volume-related items
including incentives and distributor rebates.
In 2009, sales in the Contractor segment decreased by 22 percent, with declines of 19 percent and
35 percent (31 percent at consistent translation rates) in the Americas and Europe, respectively.
Sales in Asia Pacific were steady compared to last year. In the Americas, sales declined in both
the professional paint store and home center channels.
In 2009, operating earnings in the Contractor segment were $29 million or 14 percent of sales in
2009 as compared to $47 million or 18 percent the prior year. One percentage point of the change
in operating earnings is attributable to unfavorable currency translation and 2 percentage points
of the change is attributable to greater unabsorbed manufacturing costs in 2009. The favorable
effects of reductions in product cost, mix and price partially offset the effects of volume on
operating earnings.
In this segment, sales in all regions are significant and management reviews economic and financial
indicators in each region, including levels of residential, commercial and institutional
construction, remodeling rates and interest rates. Management also reviews gross domestic product
for the regions and the level of the U.S. dollar versus the euro and other currencies.
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Lubrication
The following table presents net sales, components of net sales change and operating earnings as a
percentage of sales for the Lubrication segment (dollars in millions):
| 2010 | 2009 | 2008 | ||||||||||
Sales |
||||||||||||
Americas |
$ | 58 | $ | 47 | $ | 71 | ||||||
Europe |
6 | 4 | 8 | |||||||||
Asia Pacific |
14 | 7 | 9 | |||||||||
Total |
$ | 78 | $ | 58 | $ | 88 | ||||||
Components of Net Sales Change |
||||||||||||
Volume and Price |
33 | % | (33 | )% | (4 | )% | ||||||
Acquisitions |
— | % | — | % | 1 | % | ||||||
Currency |
2 | % | (1 | )% | — | % | ||||||
Total |
35 | % | (34 | )% | (3 | )% | ||||||
Operating Earnings as a Percentage of Sales |
11 | % | (5 | )% | 14 | % | ||||||
In 2010, sales in the Lubrication segment increased 35 percent, with increases in all regions. By
geography, sales increased by 23 percent in the Americas, 56 percent in Europe (61 percent at
consistent translation rates) and more than doubled in Asia Pacific. Sales of industrial
lubrication products contributed significantly to the strong growth seen in 2010 and the Company
has begun to benefit from the increase in dedicated commercial resources in Asia Pacific and Europe
supporting this segment.
In 2010, operating earnings were $9 million or 11 percent of sales as compared to an operating loss
of $3 million in 2009. The improvement in operating earnings as a percentage of sales can be
attributed to improved product cost, mix and pricing (six percentage points), lower unabsorbed
manufacturing costs (two percentage points) and improved expense leverage (six percentage points).
In 2009, sales in the Lubrication segment decreased by 34 percent, with declines of 34 percent in
the Americas, 45 percent (44 percent at consistent translation rates) in Europe and 26 percent (27
percent at consistent translation rates) in Asia Pacific, with declines in both the vehicle
services and industrial lubrication channels.
In 2009, the operating loss in the Lubrication segment was $3 million or 5 percent of sales in 2009
as compared to operating earnings of $12 million or 14 percent of sales the prior year. The
segment continued to invest in new product development and growth in international commercial
capabilities, but was severely affected by low volumes and unabsorbed manufacturing costs.
Although the Americas represent the substantial majority of sales for the Lubrication segment and
indicators in that region are the most significant, management monitors indicators such as levels
of gross domestic product, capital investment, industrial production and mining activity worldwide.
Unallocated corporate
(in millions)
(in millions)
| 2010 | 2009 | 2008 | ||||||||||
Unallocated corporate (expense) |
$ | (19 | ) | $ | (20 | ) | $ | (11 | ) | |||
Unallocated corporate includes items such as stock compensation, bad debt expense, contributions to
the Company’s charitable foundation and certain other charges or credits driven by corporate
decisions. In 2010, unallocated corporate included $10 million of stock compensation, $4 million
related to the non-service cost portion of pension expense and $3 million of contributions to the
Company’s charitable foundation. In 2009, unallocated corporate included $9 million related to the
non-service cost portion of pension expense and $9 million of stock compensation.
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Financial Condition and Cash Flow
Working Capital. The following table highlights several key measures of asset performance (dollars
in millions):
| 2010 | 2009 | |||||||
Working capital |
$ | 133 | $ | 85 | ||||
Current ratio |
2.1 | 1.8 | ||||||
Days of sales in receivables outstanding |
62 | 63 | ||||||
Inventory turnover (LIFO) |
4.5 | 3.9 | ||||||
In 2010, the Company’s financial condition and cash flows from operations were strong, with cash
flows from operations totaling $101 million. Our working capital investment increased in-line with
increased sales volumes. Inventories increased by $33 million with an improvement in turns from
the prior year and include build-up of certain Contractor products to support 2011 growth
activities. Accounts receivable increased by $24 million, with days of sales outstanding remaining
consistent with the prior year. Other primary uses of cash included capital expenditures of $17
million, a voluntary contribution of $10 million to a funded pension plan, dividends of $48 million
and share repurchases of $24 million.
Cash flows from operations totaled $147 million in 2009. The primary uses of cash included
repayment of debt of $100 million, dividends of $45 million, capital expenditures of $11 million
and a contribution of $15 million into the funded pension plan. Accounts receivable decreased by
$27 million due mostly to lower sales during the year as compared to the prior year. Inventories
decreased by $33 million.
Capital Structure. At December 31, 2010, the Company’s capital structure included current debt of
$8 million, long-term debt of $70 million and shareholders’ equity of $264 million.
Shareholders’ equity increased by $54 million in 2010. The key components of changes in
shareholders’ equity include current year earnings of $103 million, reduced by $49 million of
dividends declared and $24 million of share repurchases.
Liquidity and Capital Resources. At December 31, 2010, the Company had various lines of credit
totaling $270 million, including a $250 million, five year credit facility entered into in 2007 and
$20 million with foreign banks. At year-end, long-term debt outstanding was $70 million. The
unused portion of committed credit lines was $194 million at year-end. In addition, the Company
has unused, uncommitted lines of credit totaling $11 million.
The Company has also reviewed long-term financing requirements, taking into consideration the
favorable interest rates available and subsequent to year-end, reached an agreement-in-principle
with a major lender to provide long-term private placement debt up to $300 million. Maturities
would be between 7 years and 15 years. We expect to use this debt for general corporate purposes,
working capital needs, share repurchases and acquisitions.
Internally generated funds and the Company’s other sources of financing are expected to provide the
Company with the flexibility to meet its liquidity needs in 2010, including its capital expenditure
plan of approximately $30 million, planned dividends (estimated at $50 million) and acquisitions.
If acquisition opportunities increase, the Company believes that reasonable financing alternatives
are available for the Company to execute on those opportunities.
In December 2010, the Company’s Board of Directors increased the Company’s regular common dividend
from an annual rate of $0.80 to $0.84 per share, a 5 percent increase.
Cash Flow. A summary of cash flow follows (in millions):
| 2010 | 2009 | 2008 | ||||||||||
Operating Activities |
$ | 101 | $ | 147 | $ | 162 | ||||||
Investing Activities |
(19 | ) | (13 | ) | (85 | ) | ||||||
Financing Activities |
(77 | ) | (139 | ) | (71 | ) | ||||||
Effect of exchange rates on cash |
(1 | ) | (2 | ) | 1 | |||||||
Net cash provided (used) |
4 | (7 | ) | 7 | ||||||||
Cash and cash equivalents at year-end |
$ | 10 | $ | 5 | $ | 12 | ||||||
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Cash Flows Provided by Operating Activities. During 2010, $101 million was generated from
operating cash flows, compared to $147 million in 2009. The effect of higher net earnings on cash
flow was partially offset by use of cash for increases in working capital items, including
increases in accounts receivable of $23 million and inventory of $33 million. Higher provisions
for incentives increased accruals for salaries and incentives by $20 million in 2010, with payment
expected in early 2011.
During 2009, $147 million was generated from operating cash flows, compared to $162 million in
2008. The effect of lower net earnings on cash flow was partially offset by cash provided by
decreases in accounts receivable and inventory of $28 million and $33 million, respectively.
Cash Flows Used in Investing Activities. During 2010, cash was used to fund $17 million of
additions to property, plant and equipment. During 2009, cash was used to fund $11 million of
additions to property, plant and equipment.
Cash Flows Used in Financing Activities. During 2010, $77 million was used in financing activities
as compared to $139 million in 2009. Cash dividends paid totaled $48 million, an increase of $3
million from the prior year and share repurchases totaled $24 million. During 2009, $139 million
was used in financing activities, with net payments on borrowings totaling $100 million and cash
dividends of $45 million.
In September 2009, the Board of Directors authorized the Company to purchase up to 6 million shares
of its outstanding stock, primarily through open-market transactions. This authorization will
expire on September 30, 2012 and 5.2 million shares remain available under this authorization as of
December 31, 2010. The Company may make opportunistic share repurchases in the future.
Off-Balance Sheet Arrangements and Contractual Obligations. As of December 31, 2010, the Company
is obligated to make cash payments in connection with its long-term debt, operating leases and
purchase obligations in the amounts listed below. The Company has no significant off-balance sheet
debt or other unrecorded obligations other than the items noted in the following table. In addition
to the commitments noted in the following table, the Company could be obligated to perform under
standby letters of credit totaling $2 million at December 31, 2010. The Company has also
guaranteed the debt of its subsidiaries for up to $32 million. All debt of subsidiaries is
reflected in the consolidated balance sheets.
| Payments due by period (in millions) | ||||||||||||||||||||
| Less than | 1-3 | 3-5 | More than | |||||||||||||||||
| Total | 1 year | years | years | 5 years | ||||||||||||||||
Long-term debt |
$ | 70 | $ | — | $ | 70 | $ | — | $ | — | ||||||||||
Operating leases |
10 | 3 | 4 | 2 | 1 | |||||||||||||||
Purchase obligations1 |
42 | 42 | — | — | — | |||||||||||||||
Interest on long-term debt |
1 | 1 | — | — | — | |||||||||||||||
Unfunded pension and postretirement medical benefits2 |
27 | 2 | 5 | 5 | 15 | |||||||||||||||
Total |
$ | 150 | $ | 48 | $ | 79 | $ | 7 | $ | 16 | ||||||||||
| 1 | The Company is committed to pay suppliers under the terms of open purchase orders issued in the normal course of business. The Company also has commitments with certain suppliers to purchase minimum quantities, and under the terms of certain agreements, the Company is committed for certain portions of the supplier’s inventory. The Company does not purchase, or commit to purchase, quantities in excess of normal usage or amounts that cannot be used within one year. | |
| 2 | The amounts and timing of future Company contributions to the funded qualified defined benefit pension plan are unknown because they are dependent on pension fund asset performance. The Company expects that no contribution to the funded pension plan will be required in 2011. |
Critical Accounting Estimates
The Company prepares its consolidated financial statements in conformity with generally accepted
accounting principles in the United States of America (“U.S. GAAP”). The Company’s most
significant accounting policies are disclosed in Note A to the consolidated financial statements.
The preparation of the consolidated financial statements, in conformity with U.S. GAAP, requires
management to make estimates and judgments that affect the amounts reported in the consolidated
financial statements and accompanying notes. Actual amounts will differ from those estimates. The
Company considers the following policies to involve the most judgment in the preparation of the
Company’s consolidated financial statements.
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Excess and Discontinued Inventory. The Company’s inventories are valued at the lower of cost or
market. Reserves for excess and discontinued products are estimated. The amount of the reserve is
determined based on projected sales information, plans for discontinued products and other factors.
Though management considers these balances adequate, changes in sales volumes due to unanticipated
economic or competitive conditions are among the factors that would result in materially different
amounts for this item.
Goodwill and Other Intangible Assets. The company performs impairment testing for goodwill and
other intangible assets annually, or more frequently if events or changes in circumstances indicate
that the asset might be impaired. For goodwill, the Company performs impairment reviews for the
Company’s reporting units, which have been determined to be the Company’s divisions using a
fair-value method based on management’s judgments and assumptions. The Company estimates the fair
value of the reporting units by an allocation of market capitalization value, cross-checked by a
present value of future cash flows calculation. The estimated fair value is then compared with the
carrying amount of the reporting unit, including recorded goodwill. The Company also performs a
separate impairment test for each other intangible asset with indefinite life, based on estimated
future use and discounting estimated future cash flows. A considerable amount of management
judgment and assumptions are required in performing the impairment tests. Though management
considers its judgments and assumptions to be reasonable, changes in product offerings or marketing
strategies could change the estimated fair values and result in impairment charges.
Product Warranty. A liability is established for estimated warranty claims to be paid in the
future that relate to current and prior period sales. The Company estimates these costs based on
historical claim experience, changes in warranty programs and other factors, including evaluating
specific product warranty issues. The establishment of reserves requires the use of judgment and
assumptions regarding the potential for losses relating to warranty issues. Though management
considers these balances adequate, changes in the Company’s warranty policy or a significant change
in product defects versus historical averages are among the factors that would result in materially
different amounts for this item.
Income Taxes. In the preparation of the Company’s consolidated financial statements, management
calculates income taxes. This includes estimating current tax liability as well as assessing
temporary differences resulting from different treatment of items for tax and financial statement
purposes. These differences result in deferred tax assets and liabilities, which are recorded on
the balance sheet using statutory rates in effect for the year in which the differences are
expected to reverse. These assets and liabilities are analyzed regularly and management assesses
the likelihood that deferred tax assets will be recoverable from future taxable income. A
valuation allowance is established to the extent that management believes that recovery is not
likely. Liabilities for uncertain tax positions are also established for potential and ongoing
audits of federal, state and international issues. The Company routinely monitors the potential
impact of such situations and believes that liabilities are properly stated. Valuations related to
amounts owed and tax rates could be impacted by changes to tax codes, changes in statutory rates,
the Company’s future taxable income levels and the results of tax audits.
Retirement Obligations. The measurements of the Company’s pension and postretirement medical
obligations are dependent on a number of assumptions including estimates of the present value of
projected future payments, taking into consideration future events such as salary increase and
demographic experience. These assumptions may have an impact on the expense and timing of future
contributions.
The assumptions used in developing the required estimates for pension obligations include discount
rate, inflation, salary increases, retirement rates, expected return on plan assets and mortality
rates. The assumptions used in developing the required estimates for postretirement medical
obligations include discount rates, rate of future increase in medical costs and participation
rates.
For U.S. plans, the Company establishes its discount rate assumption by reference to the “Citigroup
Pension Liability Index”, a published index commonly used as a benchmark. For plans outside the
U.S., the Company establishes a rate by country by reference to highly rated corporate bonds.
These reference points have been determined to adequately match expected plan cash flows. The
Company bases its inflation assumption on an evaluation of external market indicators. The salary
assumptions are based on actual historical experience, the near-term outlook and assumed inflation.
Retirement rates are based on experience. The investment return assumption is based on the
expected long-term performance of plan assets. In setting this number, the Company considers the
input of actuaries and investment advisors, its long-term historical returns, the allocation of
plan assets and projected returns on plan assets. The Company maintained its investment return
assumption at 8.5 percent for 2011. Mortality rates are based on a common group mortality table
for males and females.
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Table of Contents
Net pension cost in 2010 was $9 million and was allocated to cost of products sold and operating
expenses based on salaries and wages. At December 31, 2010, a one-half percentage point decrease
in the indicated assumptions would have the following effects (in millions):
| Assumption | Funded Status | Expense | ||||||
Discount rate |
$ | (17 | ) | $ | 2 | |||
Expected return on assets |
— | 1 | ||||||
Recent Accounting Pronouncements
The Financial Accounting Standards Board (FASB) has issued several Accounting Standards Updates
(ASU) that will be effective for the Company in 2011. New guidance on revenue recognition (ASU
2009-13 and 2009-14) and on goodwill impairment testing (ASU 2010-29) will not have a significant
impact on the Company’s consolidated financial statements. New guidance on pro forma financial
information for business combinations (ASU 2010-29) will be considered for disclosures of future
acquisitions.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The Company sells and purchases products and services in currencies other than the U.S. dollar and
pays variable interest rates on borrowings under its primary credit facility. Consequently, the
Company is subject to profitability risk arising from exchange and interest rate movements. The
Company may use a variety of financial and derivative instruments to manage foreign currency and
interest rate risks. The Company does not enter into any of these instruments for trading purposes
to generate revenue. Rather, the Company’s objective in managing these risks is to reduce
fluctuations in earnings and cash flows associated with changes in foreign currency exchange and
interest rates.
The Company may use forward exchange contracts, options and other hedging activities to hedge the
U.S. dollar value resulting from anticipated currency transactions and net monetary asset and
liability positions. At December 31, 2010, the currencies to which the Company had the most
significant balance sheet exchange rate exposure were the euro, Canadian dollar, British pound,
Japanese yen, Australian dollar, Chinese yuan renminbi and South Korean won. It is not possible to
determine the true impact of currency rate changes; however, the direct translation effect on net
sales and net earnings can be estimated. When compared to 2009 results, the effect of the stronger
U.S. dollar versus the euro was largely offset by strengthening of Asian currencies and for the
year ended December 31, 2010, the impact of currency translation resulted in a calculated increase
in net sales and net earnings of approximately $3 million and $2 million, respectively. For the
year ended December 25, 2009, the calculated impact of currency translation resulted in an increase
in net sales and net earnings of approximately $10 million and $4 million, respectively.
2011 Outlook
Management believes that the Company is well positioned for another year of solid growth in sales
and earnings in 2011, building on momentum created in 2010. Investments in new product
engineering, development of global commercial capabilities and channel expansion should continue to
provide growth in the coming year. Further recovery in the global industrial economy should drive
continued growth in the Industrial and Lubrication segments in all regions. The outlook for
industrial growth in advancing economies is particularly positive and the Company intends to move
forward aggressively with adding commercial resources in those areas. The Company remains cautious
about the residential and commercial construction recovery in the U.S. and other areas. However,
investments in new products, end-user conversion and channel expansion should provide opportunity
for success in the Contractor segment in 2011.
The Company’s backlog is typically small compared to annual sales and is not a good indicator of
future business levels. In addition to economic growth, the successful launch of new products and
expanded distribution coverage, the sales outlook is dependent on many factors, including
realization of price increases and stable foreign currency exchange rates.
The Company will continue to pursue strategies focused on growth, with new product development, international
expansion, entering new markets and strategic acquisitions. In 2011, the Company intends to expand
capital resources, make additional share repurchases and will continue to evaluate acquisition
prospects.
Forward-Looking Statements
A forward-looking statement is any statement made in this report and other reports that the Company
files periodically with the Securities and Exchange Commission, as well as in press or earnings
releases, analyst briefings, conference calls and the Company’s Annual Report to shareholders,
which reflects the Company’s current thinking on market trends and the Company’s future financial
25
Table of Contents
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. Please refer to Item 1A of, and Exhibit 99 to, this
Annual Report on Form 10-K for fiscal year 2010 for a more comprehensive discussion of these and
other risk factors.
Investors should realize that factors other than those identified above and in Item 1A and Exhibit
99 might prove important to the Company’s future results. It is not possible for management to
identify each and every factor that may have an impact on the Company’s operations in the future as
new factors can develop from time to time.
Item 8. Financial Statements and Supplementary Data
Management’s Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial
reporting. The internal control system was designed to provide reasonable assurance to management
and the board of directors regarding the reliability of financial reporting and preparation of
financial statements in accordance with generally accepted accounting principles.
Management assessed the effectiveness of the Company’s internal control over financial reporting as
of December 31, 2010. In making this assessment, management used the criteria set forth by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal
Control-Integrated Framework.
Based on our assessment and those criteria, management believes the Company’s internal control over
financial reporting is effective as of December 31, 2010.
The Company’s independent auditors have issued an attestation report on the Company’s internal
control over financial reporting. That report appears in this Form 10-K.
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Table of Contents
REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Internal Control Over Financial Reporting
To the Shareholders and Board of Directors of
Graco Inc.
Graco Inc.
We have audited the internal control over financial reporting of Graco Inc. and Subsidiaries (the
“Company”) as of December 31, 2010, based on criteria established in Internal Control — Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The
Company’s management is responsible for maintaining effective internal control over financial
reporting and for its assessment of the effectiveness of internal control over financial reporting,
included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our
responsibility is to express an opinion on the Company’s internal control over financial reporting
based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether effective internal control over financial reporting was
maintained in all material respects. Our audit included obtaining an understanding of internal
control over financial reporting, assessing the risk that a material weakness exists, testing and
evaluating the design and operating effectiveness of internal control based on the assessed risk,
and performing such other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed by, or under the
supervision of, the company’s principal executive and principal financial officers, or persons
performing similar functions, and effected by the company’s board of directors, management, and
other personnel to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance with generally
accepted accounting principles. A company’s internal control over financial reporting includes
those policies and procedures that (1) pertain to the maintenance of records that, in reasonable
detail, accurately and fairly reflect the transactions and dispositions of the assets of the
company; (2) provide reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted accounting principles,
and that receipts and expenditures of the company are being made only in accordance with
authorizations of management and directors of the company; and (3) provide reasonable assurance
regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the
company’s assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial reporting, including the
possibility of collusion or improper management override of controls, material misstatements due to
error or fraud may not be prevented or detected on a timely basis. Also, projections of any
evaluation of the effectiveness of the internal control over financial reporting to future periods
are subject to the risk that the controls may become inadequate because of changes in conditions,
or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective internal control over
financial reporting as of December 31, 2010, based on the criteria established in Internal Control
— Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States), the consolidated financial statements and financial statement schedule as of
and for the year ended December 31, 2010, of the Company and our report dated February 22, 2011,
expressed an unqualified opinion on those consolidated financial statements and financial statement schedule.
DELOITTE & TOUCHE LLP
Minneapolis, Minnesota
February 22, 2011
February 22, 2011
27
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Consolidated Financial Statements
To the Shareholders and Board of Directors of
Graco Inc.
Graco Inc.
We have audited the accompanying consolidated balance sheets of Graco Inc. and Subsidiaries (the
“Company”) as of December 31, 2010 and December 25, 2009, and the related consolidated statements
of earnings, comprehensive income, shareholders’ equity, and cash flows for each of the three years
in the period ended December 31, 2010. Our audits also included the financial statement schedule
listed in the Index at Item 15. These financial statements and financial statement schedule are
the responsibility of the Company’s management. Our responsibility is to express an opinion on the
financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects,
the financial position of Graco Inc. and Subsidiaries as of December 31, 2010 and December 25,
2009, and the results of their operations and their cash flows for each of the three years in the
period ended December 31, 2010, in conformity with accounting principles generally accepted in the
United States of America. Also, in our opinion, such financial statement schedule, when considered
in relation to the basic consolidated financial statements taken as a whole, presents fairly, in
all material respects, the information set forth therein.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States), the Company’s internal control over financial reporting as of December 31,
2010, based on the criteria established in Internal Control—Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 22,
2011, expressed an unqualified opinion on the Company’s internal control over financial reporting.
DELOITTE & TOUCHE LLP
Minneapolis, Minnesota
February 22, 2011
February 22, 2011
28
Table of Contents
GRACO INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
(In thousands except per share amounts)
CONSOLIDATED STATEMENTS OF EARNINGS
(In thousands except per share amounts)
| Years Ended | ||||||||||||
| December 31, | December 25, | December 26, | ||||||||||
| 2010 | 2009 | 2008 | ||||||||||
Net Sales |
$ | 744,065 | $ | 579,212 | $ | 817,270 | ||||||
Cost of products sold |
340,620 | 286,396 | 385,093 | |||||||||
Gross Profit |
403,445 | 292,816 | 432,177 | |||||||||
Product development |
37,699 | 37,538 | 36,558 | |||||||||
Selling, marketing and distribution |
135,903 | 115,550 | 138,665 | |||||||||
General and administrative |
76,702 | 65,261 | 69,589 | |||||||||
Operating Earnings |
153,141 | 74,467 | 187,365 | |||||||||
Interest expense |
4,184 | 4,854 | 7,633 | |||||||||
Other expense, net |
417 | 946 | 1,153 | |||||||||
Earnings Before Income Taxes |
148,540 | 68,667 | 178,579 | |||||||||
Income taxes |
45,700 | 19,700 | 57,700 | |||||||||
Net Earnings |
$ | 102,840 | $ | 48,967 | $ | 120,879 | ||||||
Basic Net Earnings per Common Share |
$ | 1.71 | $ | 0.82 | $ | 2.01 | ||||||
Diluted Net Earnings per Common Share |
$ | 1.69 | $ | 0.81 | $ | 1.99 | ||||||
Cash Dividends Declared per Common Share |
$ | 0.81 | $ | 0.77 | $ | 0.75 | ||||||
See notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
(In thousands)
| Years Ended | ||||||||||||
| December 31, | December 25, | December 26, | ||||||||||
| 2010 | 2009 | 2008 | ||||||||||
Net Earnings |
$ | 102,840 | $ | 48,967 | $ | 120,879 | ||||||
Other comprehensive income (loss) |
||||||||||||
Cumulative translation adjustment |
— | 234 | (1,105 | ) | ||||||||
Pension and postretirement medical liability adjustment |
(4,297 | ) | 34,576 | (102,741 | ) | |||||||
Gain (loss) on interest rate hedge contracts |
3,268 | 1,214 | (3,236 | ) | ||||||||
Income taxes |
313 | (13,263 | ) | 39,290 | ||||||||
Other comprehensive income (loss) |
(716 | ) | 22,761 | (67,792 | ) | |||||||
Comprehensive Income |
$ | 102,124 | $ | 71,728 | $ | 53,087 | ||||||
See notes to consolidated financial statements.
29
Table of Contents
GRACO INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share amounts)
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share amounts)
| December 31, | December 25, | |||||||
| 2010 | 2009 | |||||||
ASSETS |
||||||||
Current Assets |
||||||||
Cash and cash equivalents |
$ | 9,591 | $ | 5,412 | ||||
Accounts receivable, less allowances of $5,600 and $6,500 |
124,593 | 100,824 | ||||||
Inventories |
91,620 | 58,658 | ||||||
Deferred income taxes |
18,647 | 20,380 | ||||||
Other current assets |
7,957 | 3,719 | ||||||
Total current assets |
252,408 | 188,993 | ||||||
Property, Plant and Equipment, net |
134,185 | 139,053 | ||||||
Goodwill |
91,740 | 91,740 | ||||||
Other Intangible Assets, net |
28,338 | 40,170 | ||||||
Deferred Income Taxes |
14,696 | 8,372 | ||||||
Other Assets |
9,107 | 8,106 | ||||||
Total Assets |
$ | 530,474 | $ | 476,434 | ||||
LIABILITIES AND SHAREHOLDERS’ EQUITY |
||||||||
Current Liabilities |
||||||||
Notes payable to banks |
$ | 8,183 | $ | 12,028 | ||||
Trade accounts payable |
19,669 | 17,983 | ||||||
Salaries and incentives |
34,907 | 14,428 | ||||||
Dividends payable |
12,610 | 12,003 | ||||||
Other current liabilities |
44,385 | 47,373 | ||||||
Total current liabilities |
119,754 | 103,815 | ||||||
Long-term Debt |
70,255 | 86,260 | ||||||
Retirement Benefits and Deferred Compensation |
76,351 | 73,705 | ||||||
Uncertain Tax Positions |
— | 3,000 | ||||||
Commitments and Contingencies (Note K) |
||||||||
Shareholders’ Equity |
||||||||
Common stock, $1 par value; 97,000,000 shares authorized;
60,047,955 and 59,999,158 shares outstanding in 2010 and 2009 |
60,048 | 59,999 | ||||||
Additional paid-in-capital |
212,073 | 190,261 | ||||||
Retained earnings |
44,436 | 11,121 | ||||||
Accumulated other comprehensive income (loss) |
(52,443 | ) | (51,727 | ) | ||||
Total shareholders’ equity |
264,114 | 209,654 | ||||||
Total Liabilities and Shareholders’ Equity |
$ | 530,474 | $ | 476,434 | ||||
See notes to consolidated financial statements.
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GRACO INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
| Years Ended | ||||||||||||
| December 31, | December 25, | December 26, | ||||||||||
| 2010 | 2009 | 2008 | ||||||||||
Cash Flows From Operating Activities |
||||||||||||
Net earnings |
$ | 102,840 | $ | 48,967 | $ | 120,879 | ||||||
Adjustments to reconcile net earnings to
net cash provided by operating activities |
||||||||||||
Depreciation, amortization and impairment |
33,973 | 35,140 | 35,495 | |||||||||
Deferred income taxes |
(4,248 | ) | (69 | ) | (160 | ) | ||||||
Share-based compensation |
10,024 | 9,369 | 9,051 | |||||||||
Excess tax benefit related to share-based payment arrangements |
(1,988 | ) | (375 | ) | (2,873 | ) | ||||||
Change in |
||||||||||||
Accounts receivable |
(23,285 | ) | 28,420 | 14,965 | ||||||||
Inventories |
(32,997 | ) | 32,663 | (9,937 | ) | |||||||
Trade accounts payable |
1,670 | (701 | ) | (6,806 | ) | |||||||
Salaries and incentives |
20,453 | (2,893 | ) | (3,169 | ) | |||||||
Retirement benefits and deferred compensation |
(1,428 | ) | (848 | ) | (2,672 | ) | ||||||
Other accrued liabilities |
(18 | ) | (2,838 | ) | 5,658 | |||||||
Other |
(3,873 | ) | (303 | ) | 2,047 | |||||||
Net cash provided by operating activities |
101,123 | 146,532 | 162,478 | |||||||||
Cash Flows From Investing Activities |
||||||||||||
Property, plant and equipment additions |
(16,620 | ) | (11,463 | ) | (29,102 | ) | ||||||
Proceeds from sale of property, plant and equipment |
257 | 770 | 1,768 | |||||||||
Investment in life insurance |
(1,499 | ) | (1,499 | ) | (1,499 | ) | ||||||
Capitalized software and other intangible asset additions |
(907 | ) | (602 | ) | (1,327 | ) | ||||||
Acquisition of businesses, net of cash acquired |
— | — | (55,186 | ) | ||||||||
Net cash used in investing activities |
(18,769 | ) | (12,794 | ) | (85,346 | ) | ||||||
Cash Flows From Financing Activities |
||||||||||||
Borrowings on short-term lines of credit |
10,584 | 10,824 | 12,431 | |||||||||
Payments on short-term lines of credit |
(13,789 | ) | (17,209 | ) | (13,760 | ) | ||||||
Borrowings on long-term line of credit |
140,540 | 270,715 | 450,470 | |||||||||
Payments on long-term line of credit |
(156,545 | ) | (364,455 | ) | (377,530 | ) | ||||||
Excess tax benefit related to share-based payment arrangements |
1,988 | 375 | 2,873 | |||||||||
Common stock issued |
12,794 | 6,571 | 13,701 | |||||||||
Common stock repurchased |
(24,218 | ) | (187 | ) | (114,836 | ) | ||||||
Cash dividends paid |
(48,146 | ) | (45,444 | ) | (44,702 | ) | ||||||
Net cash used in financing activities |
(76,792 | ) | (138,810 | ) | (71,353 | ) | ||||||
Effect of exchange rate changes on cash |
(1,383 | ) | (1,635 | ) | 1,418 | |||||||
Net increase (decrease) in cash and cash equivalents |
4,179 | (6,707 | ) | 7,197 | ||||||||
Cash and Cash Equivalents |
||||||||||||
Beginning of year |
5,412 | 12,119 | 4,922 | |||||||||
End of year |
$ | 9,591 | $ | 5,412 | $ | 12,119 | ||||||
See notes to consolidated financial statements.
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GRACO INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(In thousands)
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(In thousands)
| Accumulated | ||||||||||||||||||||
| Other | ||||||||||||||||||||
| Additional | Compre- | |||||||||||||||||||
| Common | Paid-In | Retained | hensive | |||||||||||||||||
| Stock | Capital | Earnings | Income (Loss) | Total | ||||||||||||||||
Balance December 28, 2007 |
$ | 61,964 | $ | 156,420 | $ | 32,986 | $ | (6,696 | ) | $ | 244,674 | |||||||||
Shares issued |
645 | 13,056 | — | — | 13,701 | |||||||||||||||
Shares repurchased |
(3,093 | ) | (8,093 | ) | (100,881 | ) | — | (112,067 | ) | |||||||||||
Stock compensation cost |
— | 9,051 | — | — | 9,051 | |||||||||||||||
Tax benefit related to stock
options exercised |
— | 3,473 | — | — | 3,473 | |||||||||||||||
Restricted stock cancelled |
— | 254 | — | — | 254 | |||||||||||||||
Net earnings |
— | — | 120,879 | — | 120,879 | |||||||||||||||
Dividends declared |
— | — | (44,539 | ) | — | (44,539 | ) | |||||||||||||
Other comprehensive income (loss) |
— | — | — | (67,792 | ) | (67,792 | ) | |||||||||||||
Balance December 26, 2008 |
59,516 | 174,161 | 8,445 | (74,488 | ) | 167,634 | ||||||||||||||
Shares issued |
491 | 6,080 | — | — | 6,571 | |||||||||||||||
Shares repurchased |
(8 | ) | (23 | ) | (156 | ) | — | (187 | ) | |||||||||||
Stock compensation cost |
— | 9,369 | — | — | 9,369 | |||||||||||||||
Tax benefit related to stock
options exercised |
— | 674 | — | — | 674 | |||||||||||||||
Net earnings |
— | — | 48,967 | — | 48,967 | |||||||||||||||
Dividends declared |
— | — | (46,135 | ) | — | (46,135 | ) | |||||||||||||
Other comprehensive income (loss) |
— | — | — | 22,761 | 22,761 | |||||||||||||||
Balance December 25, 2009 |
59,999 | 190,261 | 11,121 | (51,727 | ) | 209,654 | ||||||||||||||
Shares issued |
875 | 11,919 | — | — | 12,794 | |||||||||||||||
Shares repurchased |
(826 | ) | (2,619 | ) | (20,773 | ) | — | (24,218 | ) | |||||||||||
Stock compensation cost |
— | 10,024 | — | — | 10,024 | |||||||||||||||
Tax benefit related to stock
options exercised |
— | 2,488 | — | — | 2,488 | |||||||||||||||
Net earnings |
— | — | 102,840 | — | 102,840 | |||||||||||||||
Dividends declared |
— | — | (48,752 | ) | — | (48,752 | ) | |||||||||||||
Other comprehensive income (loss) |
— | — | — | (716 | ) | (716 | ) | |||||||||||||
Balance December 31, 2010 |
$ | 60,048 | $ | 212,073 | $ | 44,436 | $ | (52,443 | ) | $ | 264,114 | |||||||||
See notes to consolidated financial statements.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Graco Inc. and Subsidiaries
Years Ended December 31, 2010, December 25, 2009 and December 26, 2008
Years Ended December 31, 2010, December 25, 2009 and December 26, 2008
A. Summary of Significant Accounting Policies
Fiscal Year. The fiscal year of Graco Inc. and Subsidiaries (the Company) is 52 or 53 weeks,
ending on the last Friday in December. The year ended December 31, 2010, was a 53-week year.
Years ended December 25, 2009 and December 26, 2008, were 52-week years.
Basis of Statement Presentation. The consolidated financial statements include the accounts of the
parent company and its subsidiaries after elimination of all significant intercompany balances and
transactions. As of December 31, 2010, all subsidiaries are 100 percent owned.
Foreign Currency Translation. The U.S. dollar is the functional currency for all foreign
subsidiaries. Accordingly, gains and losses from the translation of foreign currency balances and
transactions of those subsidiaries are included in other expense, net.
Accounting Estimates. The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities
at the date of the financial statements. Such estimates and assumptions also affect the reported
amounts of revenues and expenses during the reporting period. Actual results could differ from
those estimates.
Cash Equivalents. All highly liquid investments with a maturity of three months or less at the
date of purchase are considered to be cash equivalents.
Inventory Valuation. Inventories are stated at the lower of cost or market. The last-in, first-out
(LIFO) cost method is used for valuing most U.S. inventories. Inventories of foreign subsidiaries
are valued using the first-in, first-out (FIFO) cost method.
Other Current Assets. Amounts included in other current assets were (in thousands):
| 2010 | 2009 | |||||||
Prepaid income taxes |
$ | 5,879 | $ | 1,928 | ||||
Prepaid expenses and other |
2,078 | 1,791 | ||||||
Total |
$ | 7,957 | $ | 3,719 | ||||
Property, Plant and Equipment. For financial reporting purposes, plant and equipment are
depreciated over their estimated useful lives, primarily by using the straight-line method as
follows:
Buildings and improvements
|
10 to 30 years | |
Leasehold improvements
|
lesser of 5 to 10 years or life of lease | |
Manufacturing equipment
|
lesser of 5 to 10 years or life of equipment | |
Office, warehouse and automotive equipment
|
3 to 10 years |
Intangible Assets. Goodwill has been assigned to reporting units, which are the Company’s
divisions. The amounts of goodwill for each reportable segment were (in thousands):
| 2010 | 2009 | |||||||
Industrial |
$ | 59,511 | $ | 59,511 | ||||
Contractor |
12,732 | 12,732 | ||||||
Lubrication |
19,497 | 19,497 | ||||||
Total |
$ | 91,740 | $ | 91,740 | ||||
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Components of other intangible assets were (dollars in thousands):
| Estimated | Foreign | |||||||||||||||||||
| Life | Accumulated | Currency | Book | |||||||||||||||||
| (years) | Cost | Amortization | Translation | Value | ||||||||||||||||
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 | ||||||||||
December 25, 2009 |
||||||||||||||||||||
Customer relationships |
3 - 8 | $ | 41,075 | $ | (18,655 | ) | $ | (181 | ) | $ | 22,239 | |||||||||
Patents, proprietary technology
and product documentation |
3 - 10 | 22,862 | (13,708 | ) | (87 | ) | 9,067 | |||||||||||||
Trademarks, trade names and other |
3 - 10 | 8,154 | (2,470 | ) | — | 5,684 | ||||||||||||||
| 72,091 | (34,833 | ) | (268 | ) | 36,990 | |||||||||||||||
Not Subject to Amortization
Brand names |
3,180 | — | — | 3,180 | ||||||||||||||||
Total |
$ | 75,271 | $ | (34,833 | ) | $ | (268 | ) | $ | 40,170 | ||||||||||
Amortization of intangibles was $11.8 million in 2010 and $12.3 million in 2009. Estimated future
annual amortization is as follows: $10.7 million in 2011, $8.8 million in 2012, $4.1 million in
2013, $0.9 million in 2014 and $0.7 million thereafter.
In 2009, the useful life of certain brand names was determined to be no longer indefinite. After
impairment charges totaling $0.5 million, reflected above as a reduction of cost, the remaining
cost of such brand names, totaling $6.1 million, is being amortized over a three-year period. In
2008, the Company recorded impairment charges totaling $3.6 million, primarily due to reduced
expectations with respect to future sales of certain branded products within the industrial
segment.
Other Assets. Components of other assets were (in thousands):
| 2010 | 2009 | |||||||
Cash surrender value of life insurance |
$ | 6,185 | $ | 4,409 | ||||
Capitalized software |
1,050 | 945 | ||||||
Deposits and other |
1,872 | 2,752 | ||||||
Total |
$ | 9,107 | $ | 8,106 | ||||
The Company paid $1.5 million in 2010 for contracts insuring the lives of certain employees who are
eligible to participate in certain non-qualified pension and deferred compensation plans. These
insurance contracts will be used to fund the non-qualified pension and deferred compensation
arrangements. The insurance contracts are held in a trust and are available to general creditors
in the event of the Company’s insolvency. Changes in cash surrender value are recorded in
operating expense and were not significant in 2010, 2009 and 2008.
Capitalized software is amortized over its estimated useful life (generally 2 to 5 years) beginning
at date of implementation.
Impairment of Long-Lived Assets. The Company evaluates long-lived assets (including property and
equipment, goodwill and other intangible assets) for impairment whenever events or changes in
business circumstances indicate the carrying value of the assets may not be recoverable. Goodwill
and other intangible assets not subject to amortization are also reviewed for impairment annually
in the fourth quarter. Except for the impairment of certain intangibles noted above, there have
been no significant write-downs of any long-lived assets in the periods presented.
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Table of Contents
Other Current Liabilities. Components of other current liabilities were (in thousands):
| 2010 | 2009 | |||||||
Accrued self-insurance retentions |
$ | 6,675 | $ | 7,785 | ||||
Accrued warranty and service liabilities |
6,862 | 7,437 | ||||||
Accrued trade promotions |
5,947 | 2,953 | ||||||
Payable for employee stock purchases |
5,655 | 5,115 | ||||||
Income taxes payable |
733 | 1,550 | ||||||
Other |
18,513 | 22,533 | ||||||
Total |
$ | 44,385 | $ | 47,373 | ||||
Self-Insurance. The Company is self-insured for certain losses and costs relating to product
liability, workers’ compensation and employee medical benefits claims. The Company has purchased
stop-loss coverage in order to limit its exposure to significant claims. Accrued self-insured
retentions are based on claims filed and estimates of claims incurred but not reported.
Product Warranties. 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):
| 2010 | 2009 | |||||||
Balance, beginning of year |
$ | 7,437 | $ | 8,033 | ||||
Charged to expense |
3,484 | 4,548 | ||||||
Margin on parts sales reversed |
3,412 | 2,876 | ||||||
Reductions for claims settled |
(7,471 | ) | (8,020 | ) | ||||
Balance, end of year |
$ | 6,862 | $ | 7,437 | ||||
Revenue Recognition. Sales are recognized when revenue is realized or realizable and has been
earned. The Company’s policy is to recognize revenue when risk and title passes to the customer.
This is generally on the date of shipment, however certain sales have terms requiring recognition
when received by the customer. In cases where there are specific customer acceptance provisions,
revenue is recognized at the later of customer acceptance or shipment (subject to shipping terms).
Payment terms are established based on the type of product, distributor capabilities and
competitive market conditions. Rights of return are typically contractually limited, amounts are
estimable, and the Company records provisions for anticipated returns and warranty claims at the
time revenue is recognized. Historically, sales returns have been approximately 2 percent of
sales. Provisions for sales returns are recorded as a reduction of net sales, and provisions for
warranty claims are recorded in selling, marketing and distribution expenses. From time to time,
the Company may promote the sale of new products by agreeing to accept returns of superseded
products. In such cases, provisions for estimated returns are recorded as a reduction of net
sales.
Trade promotions are offered to distributors and end users through various programs, generally with
terms of one year or less. Such promotions include cooperative advertising arrangements, rebates
based on annual purchases, coupons and reimbursement for competitive products. Payment of
incentives may take the form of cash, trade credit, promotional merchandise or free product. Under
cooperative advertising arrangements, the Company reimburses the distributor for a portion of its
advertising costs related to the Company’s products; estimated costs are accrued at the time of
sale and classified as selling, marketing and distribution expense. Rebates are accrued based on
the program rates and progress toward the estimated annual sales amount, and are recorded as a
reduction of sales (cash, trade credit) or cost of products sold (free goods). The estimated costs
related to coupon programs are accrued at the time of sale and classified as selling, marketing and
distribution expense or cost of products sold, depending on the type of incentive offered.
Earnings Per Common Share. Basic net earnings per share is computed by dividing earnings available
to common shareholders by the weighted average number of shares outstanding during the year.
Diluted net earnings per share is computed after giving effect to the exercise of all dilutive
outstanding option grants.
Comprehensive Income. Comprehensive income is a measure of all changes in shareholders’ equity
except those resulting from investments by and distributions to owners, and includes such items as
net earnings, certain foreign currency translation items, changes in the value of qualifying hedges
and pension liability adjustments.
35
Table of Contents
Derivative Instruments and Hedging Activities. The Company accounts for all derivatives, including
those embedded in other contracts, as either assets or liabilities and measures those financial
instruments at fair value. The accounting for changes in the fair value of derivatives depends on
their intended use and designation.
As part of its risk management program, the Company may periodically use forward exchange contracts
and interest rate swaps to manage known market exposures. Terms of derivative instruments are
structured to match the terms of the risk being managed and are generally held to maturity. The
Company does not hold or issue derivative financial instruments for trading purposes. All other
contracts that contain provisions meeting the definition of a derivative also meet the requirements
of, and have been designated as, normal purchases or sales. The Company’s policy is to not enter
into contracts with terms that cannot be designated as normal purchases or sales.
In 2007, the Company entered into interest rate swap contracts that effectively fix the rates paid
on a total of $80 million of variable rate borrowings. One contract fixed the rate on $40 million
of borrowings at 4.7 percent plus the applicable spread (depending on cash flow leverage ratio)
until December 2010. The second contract fixed an additional $40 million of borrowings at 4.6
percent plus the applicable spread until January 2011. Both contracts were designated as cash flow
hedges against interest rate volatility. Consequently, changes in the fair market value were
recorded in accumulated other comprehensive income (loss) (AOCI). Amounts included in AOCI were
reclassified to earnings as interest rates varied and as the swap contracts approached expiration
dates. Net amounts paid or payable under terms of the contracts were charged to interest expense
and totaled $3.5 million in 2010 and $3.0 million in 2009.
The Company periodically evaluates its monetary asset and liability positions denominated in
foreign currencies. The Company enters into forward contracts or options, or borrows in various
currencies, in order to hedge its net monetary positions. These instruments are recorded at current
market values and the gains and losses are included in other expense, net. There were seven
contracts outstanding as of December 31, 2010, with notional amounts totaling $19 million. There
were 64 contracts outstanding during all or part of 2010, with net losses of $1.9 million
offsetting $1.3 million of exchange gains on net monetary positions, included in other expense,
net. The Company believes it uses strong financial counterparts in these transactions and that the
resulting credit risk under these hedging strategies is not significant.
The Company uses significant other observable inputs to value the derivative instruments used to
hedge interest rate volatility and net monetary positions, 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 | 2010 | 2009 | ||||||||
Gain (loss) on interest rate hedge contracts |
Other current liabilities | $ | (454 | ) | $ | (3,722 | ) | |||
Gain (loss) on foreign currency forward contracts |
||||||||||
Gains |
$ | 92 | $ | 207 | ||||||
Losses |
(284 | ) | (249 | ) | ||||||
Net |
Other current liabilities | $ | (192 | ) | $ | (42 | ) | |||
The Company may periodically hedge other anticipated transactions, generally with forward exchange
contracts, which are designated as cash flow hedges. Gains and losses representing effective
hedges are initially recorded as a component of other comprehensive income and are subsequently
reclassified into earnings when the hedged exposure affects earnings. There were no gains or
losses on such transactions in 2010, 2009 and 2008, and there were no such transactions outstanding
as of December 31, 2010, and December 25, 2009.
Cash flow presentation. In 2010, the Company changed its cash flow presentation of notes payable
activity, for all periods presented, to separately disclose borrowings and payments. In prior
years, such activity was disclosed on a net basis. 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. The effect of this change
was to increase both borrowings and payments on long-term line of credit by $193 million in 2009
and $208 million in 2008. These changes had no impact on net cash used in financing activities.
Recent Accounting Pronouncements. The Financial Accounting Standards Board (FASB) has issued
several Accounting Standards Updates (ASU) that will be effective for the Company in 2011. New
guidance on revenue recognition (ASU 2009-13 and 2009-14) and on goodwill impairment testing (ASU
2010-29) will not have a significant impact on the Company’s consolidated financial
36
Table of Contents
statements. New guidance on pro forma financial information for business combinations (ASU 2010-29)
will be considered for disclosures of future acquisitions.
B. Segment Information
The Company has three reportable segments: Industrial, Contractor and Lubrication. The Industrial
segment markets equipment and pre-engineered packages for moving and applying paints, coatings,
sealants, adhesives and other fluids. Markets served include
automotive and truck assembly and components plants, wood products, rail, marine, aerospace, farm,
construction, bus, recreational vehicles, and various other industries. The Contractor segment
markets sprayers for architectural coatings for painting, corrosion control, texture, and line
striping. The Lubrication segment markets products to move and dispense lubricants for fast oil
change facilities, service garages, fleet service centers, automobile dealerships, the mining
industry and industrial lubrication applications. All segments market parts and accessories for
their products.
The accounting policies of the segments are the same as those described in the summary of
significant accounting policies. The cost of manufacturing for each segment is based on product
cost, and expenses are based on actual costs incurred along with cost allocations of shared and
centralized functions based on activities performed, sales or space utilization. The Company began
identifying or allocating certain assets to segments in 2010. Depreciation expense is charged to
the manufacturing or operating cost center that utilizes the asset, and is then allocated to
segments on the same basis as other expenses within that cost center.
Reportable segments are defined by product. Segments are responsible for development,
manufacturing, marketing and sales of their products. This allows for focused marketing and
efficient product development. The segments share common purchasing, certain manufacturing,
distribution and administration functions.
| Reportable Segments (in thousands) | 2010 | 2009 | 2008 | |||||||||
Net Sales |
||||||||||||
Industrial |
$ | 409,569 | $ | 312,935 | $ | 462,941 | ||||||
Contractor |
256,588 | 208,544 | 266,772 | |||||||||
Lubrication |
77,908 | 57,733 | 87,557 | |||||||||
Total |
$ | 744,065 | $ | 579,212 | $ | 817,270 | ||||||
Operating Earnings |
||||||||||||
Industrial |
$ | 126,266 | $ | 68,310 | $ | 138,240 | ||||||
Contractor |
36,952 | 28,952 | 47,156 | |||||||||
Lubrication |
8,897 | (2,907 | ) | 12,475 | ||||||||
Unallocated corporate (expense) |
(18,974 | ) | (19,888 | ) | (10,506 | ) | ||||||
Total |
$ | 153,141 | $ | 74,467 | $ | 187,365 | ||||||
Assets |
||||||||||||
Industrial |
$ | 270,160 | ||||||||||
Contractor |
134,938 | |||||||||||
Lubrication |
81,746 | |||||||||||
Unallocated corporate |
43,630 | |||||||||||
Total |
$ | 530,474 | ||||||||||
Unallocated corporate (expense) is not included in management’s measurement of segment performance
and includes such items as stock compensation, bad debt expense, charitable contributions and
certain portions of pension expense. Unallocated assets include cash, allowances and valuation
reserves, deferred income taxes, certain capital items and other assets.
| Geographic Information (in thousands) | 2010 | 2009 | 2008 | |||||||||
Net sales (based on customer location) |
||||||||||||
United States |
$ | 341,009 | $ | 279,814 | $ | 384,221 | ||||||
Other countries |
403,056 | 299,398 | 433,049 | |||||||||
Total |
$ | 744,065 | $ | 579,212 | $ | 817,270 | ||||||
Long-lived assets |
||||||||||||
United States |
$ | 117,859 | $ | 122,035 | ||||||||
Other countries |
16,326 | 17,018 | ||||||||||
Total |
$ | 134,185 | $ | 139,053 | ||||||||
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Table of Contents
Sales to Major Customers
There were no customers that accounted for 10 percent or more of consolidated sales in 2010, 2009
or 2008.
C. Inventories
Major components of inventories were as follows (in thousands):
| 2010 | 2009 | |||||||
Finished products and components |
$ | 48,670 | $ | 36,665 | ||||
Products and components in various stages of
completion |
31,275 | 22,646 | ||||||
Raw materials and purchased components |
46,693 | 31,826 | ||||||
| 126,638 | 91,137 | |||||||
Reduction to LIFO cost |
(35,018 | ) | (32,479 | ) | ||||
Total |
$ | 91,620 | $ | 58,658 | ||||
Inventories valued under the LIFO method were $63.3 million for 2010 and $36.7 million for 2009.
All other inventory was valued on the FIFO method.
Certain inventory quantities were reduced in 2009, resulting in liquidation of LIFO inventory
quantities carried at lower costs from prior years. The effect on net earnings was not
significant.
D. Property, Plant and Equipment
Property, plant and equipment were as follows (in thousands):
| 2010 | 2009 | |||||||
Land and improvements |
$ | 10,305 | $ | 10,303 | ||||
Buildings and improvements |
102,667 | 102,222 | ||||||
Manufacturing equipment |
189,741 | 188,225 | ||||||
Office, warehouse and automotive equipment |
32,043 | 31,442 | ||||||
Additions in progress |
10,098 | 2,248 | ||||||
Total property, plant and equipment |
344,854 | 334,440 | ||||||
Accumulated depreciation |
(210,669 | ) | (195,387 | ) | ||||
Net property, plant and equipment |
$ | 134,185 | $ | 139,053 | ||||
Depreciation expense was $21.2 million in 2010, $21.7 million in 2009 and $20.9 million in 2008.
E. Income Taxes
Earnings before income tax expense consist of (in thousands):
| 2010 | 2009 | 2008 | ||||||||||
Domestic |
$ | 137,213 | $ | 55,749 | $ | 159,972 | ||||||
Foreign |
11,327 | 12,918 | 18,607 | |||||||||
Total |
$ | 148,540 | $ | 68,667 | $ | 178,579 | ||||||
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Income tax expense consists of (in thousands):
| 2010 | 2009 | 2008 | ||||||||||
Current |
||||||||||||
Domestic |
||||||||||||
Federal |
$ | 43,580 | $ | 17,002 | $ | 50,483 | ||||||
State and local |
2,200 | (133 | ) | 2,300 | ||||||||
Foreign |
4,151 | 2,953 | 4,741 | |||||||||
| 49,931 | 19,822 | 57,524 | ||||||||||
Deferred |
||||||||||||
Domestic |
(2,364 | ) | (448 | ) | (436 | ) | ||||||
Foreign |
(1,867 | ) | 326 | 612 | ||||||||
| (4,231 | ) | (122 | ) | 176 | ||||||||
Total |
$ | 45,700 | $ | 19,700 | $ | 57,700 | ||||||
Income taxes paid were $55.7 million, $15.3 million and $55.8 million in 2010, 2009 and 2008.
A reconciliation between the U.S. federal statutory tax rate and the effective tax rate follows:
| 2010 | 2009 | 2008 | ||||||||||
Statutory tax rate |
35 | % | 35 | % | 35 | % | ||||||
Tax effect of international operations |
1 | (1 | ) | (1 | ) | |||||||
State taxes, net of federal effect |
1 | — | 1 | |||||||||
U.S. general business tax credits |
(2 | ) | (3 | ) | (1 | ) | ||||||
Domestic production deduction |
(3 | ) | (2 | ) | (2 | ) | ||||||
Change in unrecognized tax benefits |
(2 | ) | — | — | ||||||||
Other |
1 | — | — | |||||||||
Effective tax rate |
31 | % | 29 | % | 32 | % | ||||||
Deferred income taxes are provided for temporary differences between the financial reporting and
the tax basis of assets and liabilities. The deferred tax assets (liabilities) resulting from these
differences are as follows (in thousands):
| 2010 | 2009 | |||||||
Inventory valuations |
$ | 8,848 | $ | 7,532 | ||||
Self-insurance retention accruals |
2,168 | 2,403 | ||||||
Warranty reserves |
2,177 | 2,370 | ||||||
Vacation accruals |
2,299 | 2,025 | ||||||
Bad debt reserves |
1,624 | 1,730 | ||||||
Stock compensation |
— | 2,000 | ||||||
Interest rate swaps |
168 | 1,397 | ||||||
Other |
1,363 | 923 | ||||||
Total Current |
18,647 | 20,380 | ||||||
Unremitted earnings of consolidated foreign subsidiaries |
(3,100 | ) | (1,800 | ) | ||||
Excess of tax over book depreciation |
(19,518 | ) | (22,114 | ) | ||||
Pension liability |
17,686 | 16,951 | ||||||
Postretirement medical |
7,790 | 7,587 | ||||||
Stock compensation |
10,194 | 5,947 | ||||||
Deferred compensation |
877 | 833 | ||||||
Other |
767 | 968 | ||||||
Total Non-current |
14,696 | 8,372 | ||||||
Net deferred tax assets |
$ | 33,343 | $ | 28,752 | ||||
Total deferred tax assets were $70.2 million and $65.1 million, and total deferred tax liabilities
were $36.9 million and $36.3 million on December 31, 2010, and December 25, 2009.
39
Table of Contents
The Company files income tax returns in the U.S. federal jurisdiction, and various states and
foreign jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal,
state and local, or non-U.S. income tax examinations by tax authorities for years before 2004.
The Company records penalties and accrued interest related to uncertain tax positions in income tax
expense. Total reserves for uncertain tax positions were not material.
F. Debt
In July 2007, the Company entered into an agreement with a syndicate of lenders providing an
unsecured credit facility for 5 years. This credit facility provides $250 million of committed
credit, available for general corporate purposes, working capital needs, share repurchases and
acquisitions. The Company may borrow up to $25 million under the swingline portion of the facility
for daily working capital needs. Borrowings under the facility bear interest at either the bank’s
prime rate, the federal funds rate plus 0.5 percent or the London Interbank Offered Rate plus a
spread of between 0.23 percent and 0.57 percent, depending on the Company’s cash flow leverage
ratio (debt to earnings before interest, taxes, depreciation and amortization). The weighted
average interest rate on borrowings against the credit facility was 0.5 percent as of December 31,
2010 and 0.6 percent as of December 25, 2009. The Company is also required to pay a facility fee
on the full amount of the loan commitment at an annual rate ranging from 0.07 percent to 0.15
percent, depending on the Company’s cash flow leverage ratio. The agreement requires the Company to
maintain certain financial ratios as to cash flow leverage and interest coverage.
On December 31, 2010, the Company had $270 million in lines of credit, including the $250 million
in committed credit facilities described above and $20 million with foreign banks. The unused
portion of committed credit lines was $194 million as of December 31, 2010. In addition, the
Company has unused, uncommitted lines of credit with foreign banks totaling $11 million. Borrowing
rates under these credit lines vary with the prime rate, rates on domestic certificates of deposit
and the London Interbank market. The weighted average cost of borrowing (including the effect of
interest rate swaps) was 4.6 percent, 3.3 percent and 3.9 percent for the years ended December 31,
2010, December 25, 2009 and December 26, 2008. The Company pays facility fees of up to 0.15
percent per annum on certain of these lines. No compensating balances are required.
The Company is in compliance with all financial covenants of its debt agreements.
Interest paid on debt during 2010, 2009 and 2008 was $4.4 million, $4.8 million and $8.1 million
Subsequent Event. The Company has agreed in principle to financing through a series of senior
notes totaling $300 million, with terms ranging from 7 years to 15 years and fixed interest rates
ranging from 4 percent to 51/2 percent.
G. Shareholders’ Equity
At December 31, 2010, the Company had 22,549 authorized, but not issued, cumulative preferred
shares, $100 par value. The Company also has authorized, but not issued, a separate class of 3
million shares of preferred stock, $1 par value.
The Company maintains a plan in which one preferred share purchase right (Right) exists for each
common share of the Company. Each Right will entitle its holder to purchase one one-thousandth of a
share of a new series of junior participating preferred stock at an exercise price of $150, subject
to adjustment. The Rights are exercisable only if a person or group acquires beneficial ownership
of 15 percent or more of the Company’s outstanding common stock. The Rights expire in March 2020
and may be redeemed earlier by the Board of Directors for $.001 per Right.
Components of accumulated other comprehensive income (loss) were (in thousands):
| 2010 | 2009 | |||||||
Pension and postretirement medical liability adjustment |
$ | (51,334 | ) | $ | (48,560 | ) | ||
Gain (loss) on interest rate hedge contracts |
(286 | ) | (2,344 | ) | ||||
Cumulative translation adjustment |
(823 | ) | (823 | ) | ||||
Total |
$ | (52,443 | ) | $ | (51,727 | ) | ||
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Table of Contents
H. Share-Based Awards, Purchase Plans and Compensation Cost
Stock Option and Award Plan. The Company has a stock incentive plan under which it grants stock
options and share awards to directors, officers and other employees. Option price is the market
price on the date of grant. Options become exercisable at such time, generally over three or four
years, and in such installments as set by the Company, and expire ten years from the date of grant.
Restricted share awards have been made to certain key employees under the plan. The market value
of restricted stock at the date of grant is charged to operations over the vesting period.
Compensation cost charged to operations for restricted share awards was $263,000 in 2010, $287,000
in 2009 and $280,000 in 2008. Individual nonemployee directors of the Company may elect to
receive, either currently or deferred, all or part of their annual retainer, and/or payment for
attendance at Board or Committee meetings, in the form of shares of the Company’s common stock
instead of cash. Under this arrangement, the Company issued 10,104 shares in 2010, 14,952 shares in
2009 and 10,228 shares in 2008. The expense related to this arrangement is not significant.
Options on common shares granted and outstanding, as well as the weighted average exercise price,
are shown below (in thousands, except per share amounts):
| Weighted | Weighted | |||||||||||||||||
| Average | Average | |||||||||||||||||
| Option | Exercise | Options | Exercise | |||||||||||||||
| Shares | Price | Exercisable | Price | |||||||||||||||
Outstanding, December 28, 2007 |
3,779 | $ | 28.63 | 2,228 | $ | 21.41 | ||||||||||||
Granted |
819 | 35.56 | ||||||||||||||||
Exercised |
(419 | ) | 16.60 | |||||||||||||||
Canceled |
(224 | ) | 38.81 | |||||||||||||||
Outstanding, December 26, 2008 |
3,955 | 30.77 | 2,186 | 24.98 | ||||||||||||||
Granted |
1,180 | 20.74 | ||||||||||||||||
Exercised |
(164 | ) | 10.59 | |||||||||||||||
Canceled |
(158 | ) | 31.57 | |||||||||||||||
Outstanding, December 25, 2009 |
4,813 | 28.98 | 2,445 | 28.38 | ||||||||||||||
Granted |
1,201 | 30.66 | ||||||||||||||||
Exercised |
(429 | ) | 14.45 | |||||||||||||||
Canceled |
(76 | ) | 33.04 | |||||||||||||||
Outstanding, December 31, 2010 |
5,509 | $ | 30.42 | 2,980 | $ | 31.99 | ||||||||||||
The following table summarizes information for options outstanding and exercisable at December 31,
2010 (in thousands, except per share and contractual term amounts):
| Options | ||||||||||||||||||||
| Outstanding | ||||||||||||||||||||
| Weighted Avg. | Options | Options | ||||||||||||||||||
| Remaining | Outstanding | Exercisable | ||||||||||||||||||
| Range of | Options | Contractual Term | Weighted Avg. | Options | Weighted Avg. | |||||||||||||||
| Prices | Outstanding | in Years | Exercise Price | Exercisable | Exercise Price | |||||||||||||||
$ 11—20
|
489 | 1 | $ | 16.50 | 485 | $ | 16.50 | |||||||||||||
20—30
|
2,236 | 8 | 24.07 | 641 | 25.00 | |||||||||||||||
30—40
|
1,911 | 7 | 36.48 | 1,085 | 36.47 | |||||||||||||||
40—49
|
873 | 5 | 41.23 | 769 | 41.23 | |||||||||||||||
$ 11—49
|
5,509 | 6 | $ | 30.42 | 2,980 | $ | 31.99 | |||||||||||||
|
|
||||||||||||||||||||
The aggregate intrinsic value of exercisable option shares was $23.6 million as of December 31,
2010, with a weighted average contractual term of 4.8 years. There were approximately 5.4 million
vested share options and share options expected to vest as of December 31, 2010, with an aggregate
intrinsic value of $50.7 million, a weighted average exercise price of $30.40 and a weighted
average contractual term of 6.4 years.
41
Table of Contents
Information related to options exercised follows (in thousands):
| 2010 | 2009 | 2008 | ||||||||||
Cash received |
$ | 6,203 | $ | 1,733 | $ | 6,950 | ||||||
Aggregate intrinsic value |
7,747 | 2,173 | 8,734 | |||||||||
Tax benefit realized |
2,800 | 800 | 3,100 | |||||||||
Stock Purchase Plan. Under the Company’s Employee Stock Purchase Plan, the purchase price of the
shares is the lesser of 85 percent of the fair market value on the first day or the last day of
the plan year. The Company issued 435,684 shares under this Plan in 2010, 312,424 shares in 2009
and 216,047 shares in 2008.
Authorized Shares. Shares authorized for issuance under the stock option and purchase plans are
shown below (in thousands):
| Available for Future | ||||||||
| Total Shares | Issuance as of | |||||||
| Authorized | December 31, 2010 | |||||||
Stock Incentive Plan (2010) |
5,100 | 4,627 | ||||||
Employee Stock Purchase Plan (2006) |
2,000 | 1,036 | ||||||
Total |
7,100 | 5,663 | ||||||
Amounts available for future issuance exclude outstanding options. Options outstanding as of
December 31, 2010, include options granted under four plans that were replaced by subsequent Plans.
No shares are available for future grants under those plans.
Share-based Compensation. The Company recognized share-based compensation cost of $10.0 million in
2010, $9.4 million in 2009 and $9.1 million in 2008, which reduced net income by $7.4 million, or
$0.12 per weighted common share in 2010, $7.3 million, or $0.12 per weighted common share in 2009
and $6.7 million, or $0.11 per weighted common share in 2008. As of December 31, 2010, there was
$8.5 million of unrecognized compensation cost related to unvested options, expected to be
recognized over a weighted average period of approximately two 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:
| 2010 | 2009 | 2008 | ||||||||||
Expected life in years |
5.7 | 6.0 | 6.0 | |||||||||
Interest rate |
2.4 | % | 2.1 | % | 3.2 | % | ||||||
Volatility |
34.8 | % | 30.1 | % | 25.1 | % | ||||||
Dividend yield |
2.7 | % | 3.7 | % | 2.1 | % | ||||||
Weighted average fair value per share |
$ | 8.26 | $ | 4.27 | $ | 8.28 | ||||||
Expected life is estimated based on vesting terms and exercise and termination history. Interest
rate is based on the U.S Treasury rate on zero-coupon issues with a remaining term equal to the
expected life of the option. Expected volatility is based on historical volatility over a period
commensurate with the expected life of options.
The fair value of employees’ purchase rights under the Employee Stock Purchase 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:
| 2010 | 2009 | 2008 | ||||||||||
Expected life in years |
1.0 | 1.0 | 1.0 | |||||||||
Interest rate |
0.3 | % | 0.7 | % | 1.5 | % | ||||||
Volatility |
42.8 | % | 51.5 | % | 27.1 | % | ||||||
Dividend yield |
2.9 | % | 4.5 | % | 2.1 | % | ||||||
Weighted average fair value per share |
$ | 8.48 | $ | 5.60 | $ | 8.14 | ||||||
42
Table of Contents
I. Earnings per Share
The following table sets forth the computation of basic and diluted earnings per share (in
thousands, except per share amounts):
| 2010 | 2009 | 2008 | ||||||||||
Net earnings available to common shareholders |
$ | 102,840 | $ | 48,967 | $ | 120,879 | ||||||
Weighted average shares outstanding for basic earnings per share |
60,209 | 59,865 | 60,264 | |||||||||
Dilutive
effect of stock options computed based on the treasury stock method using the average market price |
594 | 364 | 571 | |||||||||
Weighted average shares outstanding for diluted earnings per share |
60,803 | 60,229 | 60,835 | |||||||||
Basic earnings per share |
$ | 1.71 | $ | 0.82 | $ | 2.01 | ||||||
Diluted earnings per share |
$ | 1.69 | $ | 0.81 | $ | 1.99 | ||||||
Stock options to purchase 1.7 million, 2.4 million and 2.9 million shares were not included in the
2010, 2009 and 2008 computations of diluted earnings per share, respectively, because they would
have been anti-dilutive.
J. Retirement Benefits
The Company has a defined contribution plan, under Section 401(k) of the Internal Revenue Code,
which provides retirement benefits to most U.S. employees. For all employees who choose to
participate, the Company matches employee contributions at a 100 percent rate, up to 3 percent of
the employee’s compensation. For employees not covered by a defined benefit plan, the Company
contributes an amount equal to 1.5 percent of the employee’s compensation. Employer contributions
totaled $3.7 million in 2010, $2.7 million in 2009 and $3.1 million in 2008.
The Company’s postretirement medical plan provides certain medical benefits for retired U.S.
employees. Employees hired before January 1, 2005, are eligible for these benefits upon retirement
and fulfillment of other eligibility requirements as specified by the plan.
The Company has both funded and unfunded noncontributory defined benefit pension plans that
together cover most U.S. employees hired before January 1, 2006, certain directors and some of the
employees of the Company’s non-U.S. subsidiaries. For U.S. plans, benefits are based on years of
service and the highest five consecutive years’ earnings in the ten years preceding retirement.
The Company funds annually in amounts consistent with minimum funding levels and maximum tax
deduction limits.
Investment policies and strategies of the funded pension plan are based on a long-term view of
economic growth and heavily weighted toward equity securities. The primary goal of the plan’s
investments is to ensure that the plan’s liabilities are met over time. In developing strategic
asset allocation guidelines, an emphasis is placed on the long-term characteristics of individual
asset classes, and the benefits of diversification among multiple asset classes. The plan invests
primarily in common stocks and bonds, including the Company’s common stock. Target allocations for
plan assets are 55 percent equity securities, 25 percent fixed income securities and 20 percent
real estate and alternative investments.
Plan assets are held in a trust for the benefit of plan participants and are invested in various
commingled funds, most of which are sponsored by the trustee. Plan assets are classified within
the fair value hierarchy as follows:
Level 1 — based on quoted prices in active markets for identical assets
Level 2 — based on significant observable inputs
Level 3 — based on significant unobservable inputs
In 2010, all plan assets were transferred to a new trust. In connection with the transfer, assets
invested in certain funds that were formerly classified as level 1 in the fair value hierarchy were
converted to funds sponsored by the new trustee that are now classified as level 2.
Even though the underlying assets held in the trustee-sponsored equity funds are classified by the
trustee as level 1, the plan classifies those funds as level 2 because the unit of fund measurement
is defined as its net asset value, which is not directly traded on an active exchange. Certain
trustee-sponsored funds allow redemptions monthly or quarterly, with 10 or 60 days advance notice,
while most of the funds allow redemptions daily.
Level 3 investments consist of real estate investment trusts whose assets are valued at least
annually by independent appraisal firms, using market, income and cost approaches.
43
Table of Contents
Plan assets by category and fair value measurement level were as follows (in thousands):
| Total | Level 1 | Level 2 | Level 3 | |||||||||||||
December 31, 2010 |
||||||||||||||||
Equity |
||||||||||||||||
Graco common stock |
$ | 13,758 | $ | 13,758 | $ | — | $ | — | ||||||||
U.S. Large Cap |
58,296 | — | 58,296 | — | ||||||||||||
U.S. Small Cap |
12,698 | — | 12,698 | — | ||||||||||||
International |
47,793 | — | 47,793 | — | ||||||||||||
Total Equity |
132,545 | 13,758 | 118,787 | — | ||||||||||||
Fixed income |
48,490 | — | 48,490 | — | ||||||||||||
Real estate and other |
10,274 | 2,112 | — | 8,162 | ||||||||||||
Total |
$ | 191,309 | $ | 15,870 | $ | 167,277 | $ | 8,162 | ||||||||
| December 25, 2009 | ||||||||||||||||
Equity |
||||||||||||||||
Graco common stock |
$ | 10,448 | $ | 10,448 | $ | — | $ | — | ||||||||
U.S. Large Cap |
58,836 | 21,597 | 37,239 | — | ||||||||||||
U.S. Small Cap |
24,465 | 24,465 | — | — | ||||||||||||
International |
28,731 | 2,063 | 26,668 | — | ||||||||||||
Total Equity |
122,480 | 58,573 | 63,907 | — | ||||||||||||
Fixed income |
35,967 | 25,305 | 10,662 | — | ||||||||||||
Real estate and other |
7,642 | 956 | — | 6,686 | ||||||||||||
Total |
$ | 166,089 | $ | 84,834 | $ | 74,569 | $ | 6,686 | ||||||||
A reconciliation of the beginning and ending balances of level 3 plan assets follows:
| 2010 | ||||
Balance, beginning of year |
$ | 6,686 | ||
Purchases |
2,079 | |||
Redemptions |
(940 | ) | ||
Change in unrealized gains (losses) |
337 | |||
Balance, end of year |
$ | 8,162 | ||
44
Table of Contents
The Company uses a year-end measurement date for all of its plans. The following provides a
reconciliation of the changes in the plans’ benefit obligations and fair value of assets over the
periods ending December 31, 2010, and December 25, 2009, and a statement of the funded status as of
the same dates (in thousands):
| Pension Benefits | Postretirement Medical Benefits | |||||||||||||||
| 2010 | 2009 | 2010 | 2009 | |||||||||||||
Change in benefit obligation |
||||||||||||||||
Obligation, beginning of year |
$ | 218,197 | $ | 215,154 | $ | 22,726 | $ | 23,782 | ||||||||
Service cost |
4,225 | 4,718 | 550 | 565 | ||||||||||||
Interest cost |
12,769 | 12,305 | 1,239 | 1,313 | ||||||||||||
Actuarial loss (gain) |
20,257 | (4,961 | ) | 242 | (848 | ) | ||||||||||
Plan amendments |
(261 | ) | — | — | — | |||||||||||
Exchange rate changes |
(518 | ) | 210 | — | — | |||||||||||
Benefit payments |
(9,364 | ) | (9,229 | ) | (1,698 | ) | (2,086 | ) | ||||||||
Obligation, end of year |
$ | 245,305 | $ | 218,197 | $ | 23,059 | $ | 22,726 | ||||||||
Change in plan assets |
||||||||||||||||
Fair value, beginning of year |
$ | 166,089 | $ | 128,720 | $ | — | $ | — | ||||||||
Actual return on assets |
23,845 | 30,757 | — | — | ||||||||||||
Employer contributions |
10,739 | 15,841 | 1,698 | 2,086 | ||||||||||||
Benefit payments |
(9,364 | ) | (9,229 | ) | (1,698 | ) | (2,086 | ) | ||||||||
Fair value, end of year |
$ | 191,309 | $ | 166,089 | $ | — | $ | — | ||||||||
Funded status |
$ | (53,996 | ) | $ | (52,108 | ) | $ | (23,059 | ) | $ | (22,726 | ) | ||||
Amounts recognized in consolidated balance sheets |
||||||||||||||||
Current liabilities |
$ | 686 | $ | 672 | $ | 1,730 | $ | 2,006 | ||||||||
Non-current liabilities |
53,310 | 51,436 | 21,329 | 20,720 | ||||||||||||
Total liabilities |
$ | 53,996 | $ | 52,108 | $ | 23,059 | $ | 22,726 | ||||||||
The accumulated benefit obligation as of year-end for all defined benefit pension plans was $227
million for 2010 and $202 million for 2009. Information for plans with an accumulated benefit
obligation in excess of plan assets follows (in thousands):
| 2010 | 2009 | |||||||
Projected benefit obligation |
$ | 245,305 | $ | 218,197 | ||||
Accumulated benefit obligation |
226,959 | 201,628 | ||||||
Fair value of plan assets |
191,309 | 166,089 | ||||||
The components of net periodic benefit cost for the plans for 2010, 2009 and 2008 were as follows
(in thousands):
| Pension Benefits | Postretirement Medical Benefits | |||||||||||||||||||||||
| 2010 | 2009 | 2008 | 2010 | 2009 | 2008 | |||||||||||||||||||
Service cost-benefits earned during the period |
$ | 4,225 | $ | 4,718 | $ | 4,968 | $ | 550 | $ | 565 | $ | 557 | ||||||||||||
Interest cost on projected benefit obligation |
12,769 | 12,305 | 12,223 | 1,239 | 1,313 | 1,381 | ||||||||||||||||||
Expected return on assets |
(13,819 | ) | (10,857 | ) | (18,981 | ) | — | — | — | |||||||||||||||
Early retirement incentives |
— | — | 530 | — | — | 385 | ||||||||||||||||||
Amortization of prior service cost (credit) |
87 | 183 | 232 | (658 | ) | (658 | ) | (658 | ) | |||||||||||||||
Amortization of net loss (gain) |
5,964 | 8,757 | 176 | 465 | 598 | 641 | ||||||||||||||||||
Cost of pension plans which are not significant
and have not adopted SFAS No. 87 |
91 | 73 | 136 | N/A | N/A | N/A | ||||||||||||||||||
Net periodic benefit cost (credit) |
$ | 9,317 | $ | 15,179 | $ | (716 | ) | $ | 1,596 | $ | 1,818 | $ | 2,306 | |||||||||||
45
Table of Contents
Amounts recognized in other comprehensive (income) loss in 2010 and 2009 were as follows (in
thousands):
| Pension Benefits | Postretirement Medical Benefits | |||||||||||||||
| 2010 | 2009 | 2010 | 2009 | |||||||||||||
Prior service cost (credit) arising during the period |
$ | (261 | ) | $ | — | $ | — | $ | — | |||||||
Net loss (gain) arising during the period |
10,174 | (24,848 | ) | 242 | (848 | ) | ||||||||||
Amortization of prior service credit (cost) |
(87 | ) | (183 | ) | 658 | 658 | ||||||||||
Amortization of net gain (loss) |
(5,964 | ) | (8,757 | ) | (465 | ) | (598 | ) | ||||||||
Total |
$ | 3,862 | $ | (33,788 | ) | $ | 435 | $ | (788 | ) | ||||||
Amounts included in accumulated other comprehensive (income) loss as of December 31, 2010 and
December 25, 2009, that had not yet been recognized as components of net periodic benefit cost,
were as follows (in thousands):
| Pension Benefits | Postretirement Medical Benefits | |||||||||||||||
| 2010 | 2009 | 2010 | 2009 | |||||||||||||
Prior service cost (credit) |
$ | (133 | ) | $ | 251 | $ | (4,417 | ) | $ | (5,074 | ) | |||||
Net loss |
78,243 | 73,994 | 7,684 | 7,907 | ||||||||||||
Net before income taxes |
78,110 | 74,245 | 3,267 | 2,833 | ||||||||||||
Income taxes |
(28,834 | ) | (27,470 | ) | (1,209 | ) | (1,048 | ) | ||||||||
Net |
$ | 49,276 | $ | 46,775 | $ | 2,058 | $ | 1,785 | ||||||||
Amounts included in accumulated other comprehensive (income) loss that are expected to be
recognized as components of net periodic benefit cost in 2011 were as follows (in thousands):
| Postretirement | ||||||||
| Pension | Medical | |||||||
| Benefits | Benefits | |||||||
Prior service cost (credit) |
$ | (2 | ) | $ | (658 | ) | ||
Net loss (gain) |
5,757 | 546 | ||||||
Net before income taxes |
5,755 | (112 | ) | |||||
Income taxes |
(2,129 | ) | 41 | |||||
Net |
$ | 3,626 | $ | (71 | ) | |||
Assumptions used to determine the Company’s benefit obligations are shown below:
| Pension Benefits | Postretirement Medical Benefits | |||||||||||||||
| Weighted average assumptions | 2010 | 2009 | 2010 | 2009 | ||||||||||||
Discount rate |
5.5 | % | 6.0 | % | 5.5 | % | 6.0 | % | ||||||||
Rate of compensation increase |
3.8 | % | 3.8 | % | N/A | N/A | ||||||||||
Assumptions used to determine the Company’s net periodic benefit cost are shown below:
| Pension Benefits | Postretirement Medical Benefits | |||||||||||||||||||||||
| Weighted average assumptions | 2010 | 2009 | 2008 | 2010 | 2009 | 2008 | ||||||||||||||||||
Discount rate |
6.0 | % | 6.0 | % | 6.2 | % | 6.0 | % | 6.0 | % | 6.3 | % | ||||||||||||
Expected return on assets |
8.5 | % | 8.5 | % | 9.0 | % | N/A | N/A | N/A | |||||||||||||||
Rate of compensation increase |
3.8 | % | 3.8 | % | 3.8 | % | N/A | N/A | N/A | |||||||||||||||
Several sources of information are considered in determining the expected rate of return
assumption, including the allocation of plan assets, the input of actuaries and professional
investment advisors, and historical long-term returns. In setting the return assumption, the
Company recognizes that historical returns are not always indicative of future returns and also
considers the long-term nature of its pension obligations.
46
Table of Contents
The Company’s U.S. retirement medical plan limits the annual cost increase that will be paid by the
Company to 3 percent. In measuring the accumulated postretirement benefit obligation (APBO), the
annual trend rate for health care costs was assumed to be 8.6 percent for 2011, decreasing each
year to a constant rate of 4.5 percent for 2026 and thereafter, subject to the plan’s annual
increase limitation.
At December 31, 2010, a one percent change in assumed health care cost trend rates would not have a
significant impact on the service and interest cost components of net periodic postretirement
health care benefit cost or the APBO for health care benefits.
The Company expects to contribute $0.7 million to its unfunded pension plans and $1.7 million to
the postretirement medical plan in 2011. The Company expects that no contribution to the funded
pension plan will be required in 2011. Estimated future benefit payments are as follows (in
thousands):
| Postretirement | ||||||||
| Pension | Medical | |||||||
| Benefits | Benefits | |||||||
2011 |
$ | 10,350 | $ | 1,730 | ||||
2012 |
10,969 | 1,602 | ||||||
2013 |
11,717 | 1,546 | ||||||
2014 |
12,548 | 1,596 | ||||||
2015 |
13,075 | 1,654 | ||||||
Years 2016 - 2020 |
77,243 | 9,188 | ||||||
K. Commitments and Contingencies
Lease Commitments. Aggregate annual rental commitments under operating leases with noncancelable
terms of more than one year were $9.7 million at December 31, 2010, payable as follows (in
thousands):
| Vehicles & | ||||||||||||
| Buildings | Equipment | Total | ||||||||||
2011 |
$ | 1,570 | $ | 1,779 | $ | 3,349 | ||||||
2012 |
1,206 | 1,242 | 2,448 | |||||||||
2013 |
808 | 759 | 1,567 | |||||||||
2014 |
842 | 331 | 1,173 | |||||||||
2015 |
482 | 112 | 594 | |||||||||
Thereafter |
604 | — | 604 | |||||||||
Total |
$ | 5,512 | $ | 4,223 | $ | 9,735 | ||||||
Total rental expense was $2.3 million for 2010, $3.1 million for 2009 and $2.6 million for 2008.
Other Commitments. The Company is committed to pay suppliers under the terms of open purchase
orders issued in the normal course of business totaling approximately $25 million at December 31,
2010. The Company also has commitments with certain suppliers to purchase minimum quantities, and
under the terms of certain agreements, the Company is committed for certain portions of the
supplier’s inventory. The Company does not purchase, or commit to purchase, quantities in excess
of normal usage or amounts that cannot be used within one year. The Company estimates that the
maximum commitment amount under such agreements does not exceed $17 million. In addition, the
Company could be obligated to perform under standby letters of credit totaling $2 million at
December 31, 2010. The Company has also guaranteed the debt of its subsidiaries for up to $32
million. All debt of subsidiaries is reflected in the consolidated balance sheets.
Contingencies. The Company is party to various legal proceedings arising in the normal course of
business. The Company is actively pursuing and defending these matters and has recorded an
estimate of the probable costs. Management does not expect that resolution of these matters will
have a material adverse effect on the Company, although the ultimate outcome cannot be determined
based on available information.
47
Table of Contents
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
None.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
As of the end of the fiscal year covered by this report, the Company carried out an evaluation of
the effectiveness of the design and operation of its disclosure controls and procedures. This
evaluation was done under the supervision and with the participation of the Company’s President and
Chief Executive Officer, the Chief Financial Officer and Treasurer, the Vice President and
Controller, and the Vice President, General Counsel and Secretary. Based upon that evaluation,
they concluded that the Company’s disclosure controls and procedures are effective.
Management’s Annual Report on Internal Control Over Financial Reporting
The information under the heading “Management’s Report on Internal Control Over Financial
Reporting” in Part II, Item 8, of this 2010 Annual Report on Form 10-K is incorporated herein by
reference.
Reports of Independent Registered Public Accounting Firm
The information under the heading “Reports of Independent Registered Public Accounting Firm:
Internal Control Over Financial Reporting” in Part II, Item 8, of this 2010 Annual Report on Form
10-K is incorporated herein by reference.
Changes in Internal Control Over Financial Reporting
During the fourth 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.
Item 9B. Other Information
Not applicable.
PART III
Item 10. Directors, Executive Officers and Corporate Governance
The information under the heading “Executive Officers of the Company” in Part I of this 2010 Annual
Report on Form 10-K and the information under the headings “Election of Directors,” and “Director
Qualifications and Selection Process” of our Company’s Proxy Statement for its 2011 Annual Meeting
of Shareholders, to be held on April 21, 2011 (the “Proxy Statement”), is incorporated herein by
reference.
Audit Committee Members and Audit Committee Financial Expert
The information under the heading “Committees of the Board of Directors” of our Company’s Proxy
Statement is incorporated herein by reference.
Corporate Governance Guidelines, Committee Charters and Code of Ethics
Our Company has adopted Corporate Governance Guidelines and Charters for the Audit, Governance, and
Management Organization and Compensation Committees of the Board of Directors. We have also issued
Code of Ethics and Business Conduct (Code of Ethics) that applies to our principal executive
officer, principal financial officer, principal accounting officer, all officers, directors, and
employees of Graco Inc. and all of its subsidiaries and branches worldwide. The Corporate
Governance Guidelines, Committee Charters, and Code of Ethics, with any amendments or waivers
thereto, may be accessed free of charge by visiting the Graco website at www.graco.com.
Our Company intends to post on the Graco website any amendment to, or waiver from, a provision of
the Code of Ethics that applies to our principal executive officer, principal financial officer,
principal accounting officer, controller and other persons performing similar functions within four
business days following the date of such amendment or waiver.
48
Table of Contents
Section 16(a) Reporting Compliance
The information under the heading “Section 16(a) Beneficial Ownership Reporting Compliance” of the
Company’s Proxy Statement is incorporated herein by reference.
Item 11. Executive Compensation
The information contained under the headings “Director Compensation,” “Executive Compensation,”
“Compensation Committee Interlocks and Insider Participation” and “Report of the Management
Organization and Compensation Committee” of the Proxy Statement is incorporated herein by
reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters
The information contained under the headings “Equity Compensation Plan Information” and “Beneficial
Ownership of Shares” of the Proxy Statement is incorporated herein by reference.
Item 13.
Certain Relationships and Related Transactions, and Director Independence
The information under the headings “Related Person Transaction Approval Policy” and “Director
Independence” of the Proxy Statement is incorporated herein by reference.
Item 14. Principal Accounting Fees and Services
The information under the headings “Independent Registered Public Accounting Firm Fees and
Services” and “Pre-Approval Policies” of the Proxy Statement is incorporated herein by reference.
49
Table of Contents
PART IV
Item 15. Exhibits, Financial Statement Schedule
| (a) | The following documents are filed as part of this report: |
(1)
|
Financial Statements | |||||
| See Part II | ||||||
(2)
|
Financial Statement Schedule | |||||
| Schedule II — Valuation and Qualifying Accounts | 51 | |||||
| All other schedules are omitted because they are not applicable, or are not required, or because the required information is included in the Consolidated Financial Statements or Notes thereto. | ||||||
(3)
|
Management Contract, Compensatory Plan or Arrangement. (See Exhibit Index) | 53 | ||||
| Those entries marked by an asterisk are Management Contracts, Compensatory Plans or Arrangements. |
50
Table of Contents
Schedule II — Valuation and Qualifying Accounts
Graco Inc. and Subsidiaries
(in thousands)
Graco Inc. and Subsidiaries
(in thousands)
| Additions | ||||||||||||||||||||
| Balance at | charged to | Deductions | Other | Balance at | ||||||||||||||||
| beginning | costs and | from | add | end | ||||||||||||||||
| of year | expenses | reserves 1 | (deduct)2 | of year | ||||||||||||||||
Year ended |
||||||||||||||||||||
December 31, 2010 |
||||||||||||||||||||
Allowance for doubtful accounts |
$ | 2,100 | $ | 1,400 | $ | 2,200 | $ | — | $ | 1,300 | ||||||||||
Allowance for returns and credits |
4,400 | 10,800 | 10,900 | — | 4,300 | |||||||||||||||
| $ | 6,500 | $ | 12,200 | $ | 13,100 | $ | — | $ | 5,600 | |||||||||||
December 25, 2009 |
||||||||||||||||||||
Allowance for doubtful accounts |
$ | 2,200 | $ | 900 | $ | 1,000 | $ | — | $ | 2,100 | ||||||||||
Allowance for returns and credits |
4,400 | 8,900 | 8,900 | — | 4,400 | |||||||||||||||
| $ | 6,600 | $ | 9,800 | $ | 9,900 | $ | — | $ | 6,500 | |||||||||||
December 26, 2008 |
||||||||||||||||||||
Allowance for doubtful accounts |
$ | 2,500 | $ | — | $ | 400 | $ | 100 | $ | 2,200 | ||||||||||
Allowance for returns and credits |
4,000 | 12,000 | 11,600 | — | 4,400 | |||||||||||||||
| $ | 6,500 | $ | 12,000 | $ | 12,000 | $ | 100 | $ | 6,600 | |||||||||||
| 1 | For doubtful accounts, represents amounts determined to be uncollectible and charged against reserve, net of collections on accounts previously charged against reserves. For returns and credits, represents amounts of credits issued and returns processed. | |
| 2 | Includes amounts assumed or established in connection with acquisitions and effects of foreign currency translation. |
51
Table of Contents
Signatures
Pursuant to the requirements of Section 13 or 15(d) 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. |
||
/s/ Patrick J. McHale
|
February 22, 2011 | |
Patrick J. McHale |
||
President and Chief Executive Officer |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by
the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
/s/ Patrick J. McHale
|
February 22, 2011 | |
President and Chief Executive Officer |
||
(Principal Executive Officer) |
||
/s/ James A. Graner
|
February 22, 2011 | |
Chief Financial Officer and Treasurer |
||
(Principal Financial Officer) |
||
/s/ Caroline M. Chambers
|
February 22, 2011 | |
Vice President and Controller |
||
(Principal Accounting Officer) |
Lee R. Mitau
|
Director, Chairman of the Board | ) | ||
William J. Carroll
|
Director | ) | ||
Eric P. Etchart
|
Director | ) | ||
Jack W. Eugster
|
Director | ) A majority of the Board of Directors | ||
Patrick J. McHale
|
Director | ) | ||
William G. Van Dyke
|
Director | ) | ||
R. William Van Sant
|
Director | ) |
Patrick J. McHale, by signing his name hereto, does hereby sign this document on behalf of himself
and each of the above named directors of the Registrant pursuant to powers of attorney duly
executed by such persons.
/s/ Patrick J. McHale
|
February 22, 2011 | |
Patrick J. McHale |
||
(For himself and as attorney-in-fact) |
52
Table of Contents
Exhibit Index
| Exhibit | ||
| Number | Description | |
3.1
|
Restated Articles of Incorporation as amended June 14, 2007. (Incorporated by reference to Exhibit 3.1 to the Company’s Report on Form 10-Q for the thirteen weeks ended June 29, 2007.) | |
3.2
|
Restated Bylaws as amended June 13, 2002. (Incorporated by reference to Exhibit 3 to the Company’s Report on Form 10-Q for the thirteen weeks ended June 28, 2002.) | |
3.3
|
Form of Articles of Amendment of Certificate of Designation, Preferences and Rights of Series A Junior Participating Preferred Shares. (Incorporated by reference to Exhibit 2 to the Company’s Registration Statement on Form 8-A filed on February 16, 2010.) | |
4.1
|
Rights Agreement, dated as of February 12, 2010, between the Company and Wells Fargo Bank, N.A., as Rights Agent. (Incorporated by reference to Exhibit 1 to the Company’s Registration Statement on Form 8-A dated February 16, 2010.) | |
4.2
|
Credit Agreement dated July 12, 2007, between the Company and U.S. Bank National Association, JPMorgan Chase Bank, N.A., Wells Fargo Bank, National Association, and Bank of America, N.A. (Incorporated by reference to Exhibit 10.1 to the Company’s Report on Form 8-K dated July 12, 2007.) | |
*10.1
|
Executive Officer Bonus Plan as amended and restated December 23, 2008. (Incorporated by reference to Exhibit 10.1 to the Company’s 2008 Annual Report on Form 10-K.) | |
*10.2
|
Executive Officer Annual Incentive Bonus Plan as amended and restated December 23, 2008. (Incorporated by reference to Exhibit 10.2 to the Company’s 2008 Annual Report on Form 10-K.) | |
*10.3
|
Graco Inc. Nonemployee Director Stock Option Plan, as amended and restated June 18, 2004. (Incorporated by reference to Exhibit 10.4 to the Company’s Report on Form 10-Q for the thirteen weeks ended April 1, 2005.) | |
*10.4
|
Long Term Stock Incentive Plan, as amended and restated June 18, 2004. (Incorporated by reference to Exhibit 10.1 to the Company’s Report on Form 10-Q for the thirteen weeks ended April 1, 2005.) | |
*10.5
|
Graco Inc. Stock Incentive Plan, dated May 1, 2001. (Incorporated by reference to Exhibit 10.1 to the Company’s Report on Form 10-Q for the thirteen weeks ended June 29, 2001.) | |
*10.6
|
Graco Inc. Amended and Restated Stock Incentive Plan (2006). (Incorporated by reference to Appendix A to the Company’s Definitive Proxy Statement on Schedule 14A filed March 14, 2006.) | |
10.7
|
Employee Stock Incentive Plan, as amended and restated June 18, 2004. (Incorporated by reference to Exhibit 10.3 to the Company’s Report on Form 10-Q for the thirteen weeks ended April 1, 2005.) | |
*10.8
|
Graco Inc. 2010 Stock Incentive Plan. (Incorporated by reference to Appendix A to the Company’s Definitive Proxy Statement on Schedule 14A filed March 11, 2010.) | |
*10.9
|
Deferred Compensation Plan Restated, effective December 1, 1992. (Incorporated by reference to Exhibit 2 to the Company’s Report on Form 8-K dated March 11, 1993.) First Amendment dated September 1, 1996. (Incorporated by reference to Exhibit 10.2 to the Company’s Report on Form 10-Q for the thirteen weeks ended June 27, 1997.) Second Amendment dated May 27, 2000. (Incorporated by reference to Exhibit 10.7 to the Company’s 2005 Annual Report on Form 10-K.) Third Amendment adopted on December 19, 2002. (Incorporated by reference to Exhibit 10.7 to the Company’s 2005 Annual Report on Form 10-K.) Fourth Amendment adopted June 14, 2007. (Incorporated by reference to Exhibit 10.2 to the Company’s Report on Form 10-Q for the thirteen weeks ended June 29, 2007.) | |
*10.10
|
Deferred Compensation Plan (2005 Statement) as amended and restated on April 4, 2005. (Incorporated by reference to Exhibit 10.1 of the Company’s Report on Form 10-Q for the thirteen weeks ended July 1, 2005.) Second Amendment dated November 1, 2005. (Incorporated by reference to Exhibit 10.8 to the Company’s 2005 Annual Report on Form 10-K.) Third Amendment adopted on December 29, 2008. (Incorporated by reference to Exhibit 10.8 to the Company’s 2008 Annual Report on Form 10-K.) |
53
Table of Contents
| Exhibit | ||
| Number | Description | |
*10.11
|
Retirement Plan for Nonemployee Directors. (Incorporated by reference to Attachment C to Item 5 to the Company’s Report on Form 10-Q for the thirteen weeks ended March 29, 1991.) First Amendment adopted on December 29, 2008. (Incorporated by reference to Exhibit 10.10 to the Company’s 2008 Annual Report on Form 10-K.) | |
*10.12
|
Graco Restoration Plan (2005 Statement). (Incorporated by reference to Exhibit 10.1 to the Company’s Report on Form 10-Q for the thirteen weeks ended September 29, 2006.) First Amendment adopted December 8, 2006. (Incorporated by reference to Exhibit 10.12 to the Company’s 2006 Annual Report on Form 10-K.) Second Amendment adopted August 15, 2007. (Incorporated by reference to Exhibit 10.1 to the Company’s Report on Form 10-Q for the thirteen weeks ended September 28, 2007.) Third Amendment adopted March 27, 2008. (Incorporated by reference to Exhibit 10.1 to the Company’s Report on Form 10-Q for the thirteen weeks ended March 28, 2008.) Fourth Amendment adopted December 29, 2008. (Incorporated by reference to Exhibit 10.11 to the Company’s 2008 Annual Report on Form 10-K.) Fifth Amendment adopted September 16, 2010. (Incorporated by reference to Exhibit 10.1 to the Company’s Report on Form 10-Q for the thirteen weeks ended September 24, 2010.) | |
*10.13
|
Stock Option Agreement. Form of agreement used for award of nonstatutory stock options to nonemployee directors under the Nonemployee Director Stock Option Plan. (Incorporated by reference to Exhibit 10.11 to the Company’s 2001 Annual Report on Form 10-K.) | |
*10.14
|
Stock Option Agreement. Form of agreement used for award of nonstatutory stock options to nonemployee directors under the Graco Inc. Stock Incentive Plan. (Incorporated by reference to Exhibit 10.22 to the Company’s 2002 Annual Report on Form 10-K.) Amended form of agreement for awards made to nonemployee directors. (Incorporated by reference to Exhibit 10.3 to the Company’s Report on Form 10-Q for the thirteen weeks ended March 26, 2004.) | |
*10.15
|
Stock Option Agreement. Form of agreement used for award of nonstatutory stock options to nonemployee directors under the Graco Inc. Amended and Restated Stock Incentive Plan (2006). (Incorporated by reference to Exhibit 10.3 to the Company’s Report on Form 10-Q for the thirteen weeks ended June 29, 2007.) Amended form of agreement for awards made to nonemployee directors in 2008. (Incorporated by reference to Exhibit 10.2 to the Company’s Report on Form 10-Q for the thirteen weeks ended June 27, 2008.) Amended and restated form of agreement for awards made to nonemployee directors in 2009. (Incorporated by reference to Exhibit 10.14 to the Company’s 2009 Annual Report on Form 10-K/A.) | |
*10.16
|
Stock Option Agreement. Form of agreement used for award of nonstatutory stock options to nonemployee directors under the Graco Inc. 2010 Stock Incentive Plan. | |
*10.17
|
Stock Option Agreement. Form of agreement used for award of non-incentive stock options to executive officers under the Long Term Stock Incentive Plan. (Incorporated by reference to Exhibit 10.12 to the Company’s 2001 Annual Report on Form 10-K.) | |
*10.18
|
Stock Option Agreement. Form of agreement used for award of non-incentive stock options to executive officers under the Graco Inc. Stock Incentive Plan. (Incorporated by reference to Exhibit 10.2 to the Company’s Report on Form 10-Q for the thirteen weeks ended March 29, 2002.) Amended form of agreement for awards made to Chief Executive Officer in 2001 and 2002. Amended form of agreement for awards made to executive officers in 2003. (Incorporated by reference to Exhibit 10.15 of the Company’s 2003 Annual Report on Form 10-K.) Amended form of agreement for awards made to executive officers in 2004, 2005 and 2006. Amended form of agreement for awards made to Chief Executive Officer in 2004, 2005 and 2006. (Incorporated by reference to Exhibit 10.2 and 10.4 to the Company’s Report on Form 10-Q for the thirteen weeks ended March 26, 2004.) | |
*10.19
|
Stock Option Agreement. Form of agreement used for award in 2007 of non-incentive stock options to executive officers under the Graco Inc. Amended and Restated Stock Incentive Plan (2006). (Incorporated by reference to Exhibit 10.1 to the Company’s Report on Form 10-Q for the thirteen weeks ended March 30, 2007.) Amended form of agreement for awards made to executive officers in 2008, 2009 and 2010. (Incorporated by reference to Exhibit 10.2 to the Company’s Report on Form 10-Q for the thirteen weeks ended March 28, 2008.) | |
*10.20
|
Stock Option Agreement. Form of agreement used for award in 2007 of non-incentive stock options to chief executive officer under the Graco Inc. Amended and Restated Stock Incentive Plan (2006). (Incorporated by reference to Exhibit 10.1 to the Company’s Report on Form 10-Q for the thirteen weeks ended March 30, 2007.) Amended form of agreement for awards made to chief executive officer in 2008, 2009 and 2010. (Incorporated by reference to Exhibit 10.2 to the Company’s Report on Form 10-Q for the thirteen weeks ended March 28, 2008.) | |
*10.21
|
Executive Officer Restricted Stock Agreement. Form of agreement used to award restricted stock to selected executive officers. (Incorporated by reference to Exhibit 10.20 to the Company’s 2007 Annual Report on Form 10-K.) |
54
Table of Contents
| Exhibit | ||
| Number | Description | |
*10.22
|
Nonemployee Director Stock and Deferred Stock Program. (Incorporated by reference to Exhibit 10.22 to the Company’s 2009 Annual Report on Form 10-K/A.) | |
*10.23
|
Key Employee Agreement. Form of agreement used with chief executive officer. (Incorporated by reference to Exhibit 10.24 to the Company’s 2007 Annual Report on Form 10-K.) | |
*10.24
|
Key Employee Agreement. Form of agreement used with executive officers other than the chief executive officer. (Incorporated by reference to Exhibit 10.25 to the Company’s 2007 Annual Report on Form 10-K.) | |
*10.25
|
Executive Group Long-Term Disability Policy as revised in 1995. (Incorporated by reference to Exhibit 10.23 to the Company’s 2004 Annual Report on Form 10-K.) As enhanced by Supplemental Income Protection Plan in 2004. (Incorporated by reference to Exhibit 10.28 to the Company’s 2007 Annual Report on Form 10-K.) | |
*10.26
|
Amendment to the 2003 through 2006 Nonstatutory Stock Option Agreements of one nonemployee director. (Incorporated by reference to Exhibit 10.27 to the Company’s 2009 Annual Report on Form 10-K/A.) | |
11
|
Statement of Computation of Earnings per share included in Note I on page 43. | |
21
|
Subsidiaries of the Registrant included herein on page 56. | |
23
|
Independent Registered Public Accounting Firm’s Consent included herein on page 57. | |
24
|
Power of Attorney included herein on page 58. | |
31.1
|
Certification of President and Chief Executive Officer pursuant to Rule 13a-14(a) included herein on page 59. | |
31.2
|
Certification of Chief Financial Officer and Treasurer pursuant to Rule 13a-14(a) included herein on page 60. | |
32
|
Certification of President and Chief Executive Officer and Chief Financial Officer and Treasurer pursuant to Section 1350 of Title 18, U.S.C. included herein on page 61. | |
99
|
Cautionary Statement Regarding Forward-Looking Statements included herein on page 62. | |
101
|
Interactive Data File. |
Except as otherwise noted, all documents incorporated by reference above relate to File No.
001-09249.
* Management Contracts, Compensatory Plans or Arrangements.
Pursuant to Item 601(b)(4)(iii) of Regulation S-K, copies of certain instruments defining the
rights of holders of certain long-term debt of the Company and its subsidiaries are not filed as
exhibits because the amount of debt authorized under any such instrument does not exceed 10 percent
of the total assets of the Company and its subsidiaries. The Company agrees to furnish copies
thereof to the Securities and Exchange Commission upon request.
55