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GGG > SEC Filings for GGG > Form 10-Q on 24-Jul-2013All Recent SEC Filings

Show all filings for GRACO INC

Form 10-Q for GRACO INC


24-Jul-2013

Quarterly Report


MANAGEMENT'S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

The Company designs, manufactures and markets systems and equipment to move, measure, control, dispense and spray fluid and coating materials. Management classifies the Company's business into three reportable segments: Industrial, Contractor and Lubrication. Key strategies include developing and marketing new products, expanding distribution globally, opening new markets with technology and channel expansion and completing strategic acquisitions.

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

Acquisition

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

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

In May 2012, the FTC issued a proposed decision and order which requires Graco to sell the Liquid Finishing business assets, including certain business activities related to the development, manufacture, and sale of products under the Binks®, DeVilbiss®, Ransburg® and BGK® brand names, no later than 180 days from the date the order becomes final. The FTC has not yet issued its final decision and order.

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

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

As a cost-method investment, income is recognized based on dividends received from current earnings of Liquid Finishing. Dividends of $11 million received in the second quarter of 2013 and $15 million received year-to-date, along with $4 million received in the second quarter of 2012, are included in other expense (income) on the Consolidated Statements of Earnings. Also in the first quarter of 2013, ITW reimbursed Graco approximately $1 million for payments


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of pre-acquisition tax liabilities paid by Liquid Finishing businesses after the acquisition date. This reimbursement was recorded as a reduction of the cost-method investment on the Consolidated Balance Sheet.

The Company evaluates its cost-method investment for other-than-temporary impairment at each reporting period. As of June 28, 2013, the Company evaluated its investment in Liquid Finishing and determined that there was no impairment.

Consolidated Results

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



                                          Thirteen Weeks Ended                    Twenty-six Weeks Ended
                                   Jun 28,       Jun 29,         %          Jun 28,       Jun 29,         %
                                    2013          2012         Change        2013          2012         Change

Net Sales                         $   286.0     $   268.2           7%     $   555.1     $   502.3          11%
Net Earnings                      $    57.8     $    34.4          68%     $   110.0     $    69.7          58%
Diluted Net Earnings per Common
Share                             $    0.92     $    0.56          64%     $    1.76     $    1.13          56%

Sales for the quarter increased 7 percent from last year, driven by strong sales in the Contractor segment. Year-to-date sales increased 11 percent, including 6 percentage points from the full-year impact of the Powder Finishing operations acquired in April 2012, and strong growth in Contractor segment sales.

Higher sales and strong gross margin rates, decreases in acquisition-related expenses, higher investment income from Liquid Finishing businesses held separate, and favorable changes in the income tax provision all contributed to significant growth in net earnings for both the quarter and the year-to-date.

Changes in currency translation rates did not have a significant effect on quarterly or year-to-date operating results.


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The following table presents components of changes in sales:

                                                                                 Quarter
                                               Segment                                                Region
                                                                                                                       Asia
                          Industrial          Contractor         Lubrication        Americas           EMEA           Pacific           Total
Volume and Price                    1%                20%                  -%             14%               1%            (5)%                7%
Currency                            -%                 -%                  -%              -%               1%            (1)%                -%

Total                               1%                20%                  -%             14%               2%            (6)%                7%


                                                                              Year-to-Date
                                               Segment                                                Region
                                                                                                                       Asia
                          Industrial          Contractor         Lubrication        Americas           EMEA           Pacific           Total
Volume and Price                    1%                14%                (1)%             10%             (1)%            (1)%                5%
Acquisitions                       10%                 -%                  -%              2%              13%              7%                6%
Currency                            -%                 -%                  -%              -%               1%            (2)%                -%

Total                              11%                14%                (1)%             12%              13%              4%               11%

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

                  Thirteen Weeks Ended           Twenty-six Weeks Ended
                 Jun 28,         Jun 29,        Jun 28,           Jun 29,
                  2013             2012          2013              2012

Americas1      $     160.7       $  140.6     $     298.9       $     266.6
EMEA2                 70.9           69.4           139.8             124.1
Asia Pacific          54.4           58.2           116.4             111.6

Consolidated   $     286.0       $  268.2     $     555.1       $     502.3

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

2 Europe, Middle East and Africa

Sales for the quarter increased 7 percent, including increases of 14 percent in the Americas and 2 percent in EMEA. Sales decreased 6 percent in Asia Pacific. Year-to-date sales increased 11 percent, including increases of 12 percent in the Americas, 13 percent in EMEA and 4 percent in Asia Pacific. The first quarter impact of the Powder Finishing operations acquired in April 2012 contributed approximately 6 percentage points of the total year-to-date growth and accounted for all of the growth in EMEA and Asia Pacific.

Gross profit margin, expressed as a percentage of sales, was 55 1/2 percent for both the quarter and year-to date, up from 52 percent and 54 percent for the quarter and year-to-date last year, respectively. Non-recurring purchase accounting effects totaling $7 million related to inventory reduced last year's gross margin rate by approximately 3 percentage points for the quarter and 1 1/2 points year-to-date.

Total operating expenses for the quarter decreased by $4 million, including a $7 million drop in acquisition and divestiture costs. Year-to-date operating expenses were $1 million higher than last


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year, with higher expenses from acquired operations and other volume-related increases mostly offset by a $10 million decrease in acquisition and divestiture costs.

Other expense (income) included dividends of $11 million for the quarter and $15 million year-to-date received from the Liquid Finishing businesses that are held separate from the Company's other businesses. The Company received the first of such dividends in the second quarter of 2012, in the amount of $4 million.

The effective income tax rate of 29 percent for the quarter and the year-to-date rate of 28 percent were lower than the comparable periods last year. This year's rate includes the impact of the federal R&D credit that was renewed in the first quarter, effective retroactive to the beginning of 2012. There was no R&D credit recognized in 2012. The effective rate in 2013 also reflects the effect of higher after-tax dividend income received from the Liquid Finishing businesses held separate.

Segment Results

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

Industrial

                                            Thirteen Weeks Ended                 Twenty-six Weeks Ended
                                        Jun 28,             Jun 29,            Jun 28,            Jun 29,
                                          2013                2012              2013               2012
Net sales (in millions)
Americas                              $       70.2        $       65.6       $     136.4        $     125.0
EMEA                                          49.8                49.9             100.1               86.7
Asia Pacific                                  39.7                42.7              87.3               80.6

Total                                 $      159.7        $      158.2       $     323.8        $     292.3


Operating earnings as a
percentage of net sales                        32%                 27%               33%                31%

Industrial segment sales for the quarter increased 1 percent, with a 7 percent increase in the Americas mostly offset by a decrease in Asia Pacific. Year-to-date sales increased 11 percent, with 10 percentage points of the increase from Powder Finishing operations acquired in April 2012. Operating margin rate for the Industrial segment improved compared to last year, which included the effects of purchase accounting related to inventory that reduced the rate for the second quarter of 2012 by approximately 4 percentage points.


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Contractor



                                               Thirteen Weeks Ended              Twenty-six Weeks Ended
                                             Jun 28,           Jun 29,         Jun 28,            Jun 29,
                                              2013              2012             2013               2012

Net sales (in millions)
Americas                                   $     69.9        $     54.6      $     121.4        $     100.8
EMEA                                             18.0              17.2             34.1               33.2
Asia Pacific                                     10.6              10.3             20.6               20.1

Total                                      $     98.5        $     82.1      $     176.1        $     154.1


Operating earnings as a percentage of
net sales                                          25%               22%              23%                20%

Contractor segment sales for the quarter increased 20 percent, including increases of 28 percent in the Americas, 5 percent in EMEA and 2 percent in Asia Pacific. Year-to-date sales were up 14 percent, driven by increases in the Americas. Initial stocking of expanded product offerings in the home centers channel and the recovery in the U.S. housing market contributed to higher sales in this segment. Higher sales volume, improved gross margin rate and expense leverage led to higher operating margin rates in the Contractor segment.

Lubrication



                                               Thirteen Weeks Ended              Twenty-six Weeks Ended
                                             Jun 28,           Jun 29,         Jun 28,            Jun 29,
                                              2013              2012             2013               2012

Net sales (in millions)
Americas                                   $     20.6        $     20.5      $      41.1        $      40.8
EMEA                                              3.0               2.3              5.5                4.2
Asia Pacific                                      4.3               5.1              8.5               10.9

Total                                      $     27.9        $     27.9      $      55.1        $      55.9


Operating earnings as a percentage of
net sales                                          24%               20%              21%                21%

Lubrication segment sales were flat for the quarter and down 1 percent year-to-date. Increases in the Americas and EMEA were offset by a decrease in Asia Pacific, where several large industrial lubrication transactions in 2012 were not repeated in 2013. Improved manufacturing performance and limited spending increases led to higher operating margin rates in this segment.


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Liquidity and Capital Resources

Net cash provided by operating activities was $100 million in 2013 and $65 million in 2012. The increase mostly reflects the increase in net earnings. Accounts receivable and inventory balances have increased since the end of 2012 due to first half increases in business activity.

In May 2012, the FTC issued a proposed decision and order which requires Graco to sell the Liquid Finishing business assets, including certain business activities related to the development, manufacture, and sale of products under the Binks, DeVilbiss, Ransburg and BGK brand names, no later than 180 days from the date the order becomes final. The FTC has not yet issued its final decision and order.

The Company has retained the services of an investment bank to help it market the Liquid Finishing businesses and identify potential buyers. The Company believes its investment in the Liquid Finishing businesses, carried at a cost of $426 million, is not impaired.

Under terms of the FTC's hold separate order, the Company is required to provide sufficient resources to maintain the viability, competitiveness and marketability of the Liquid Finishing businesses, including general funds, capital, working capital and reimbursement of losses. To the extent that the Liquid Finishing businesses generate funds in excess of financial resources needed, the Company has access to such funds consistent with practices in place prior to the acquisition. In the first half of 2013, the Company received $15 million of dividends from current earnings of the Liquid Finishing businesses.

At June 28, 2013, the Company had various lines of credit totaling $500 million, of which $328 million was unused. Internally generated funds and unused financing sources are expected to provide the Company with the flexibility to meet its liquidity needs in 2013, including the needs of the Powder Finishing and Liquid Finishing businesses acquired in April 2012.

Outlook

We are well positioned for the remainder of the year and believe that our strategies will deliver full-year sales growth in every region. While macroeconomic conditions in EMEA and Asia Pacific are not expected to improve, comparables to the prior year are somewhat easier in these regions in the second half of 2013. When combined with our strategic initiatives, we continue to expect modest full-year growth from the EMEA and Asia Pacific regions. In the United States, the continued housing recovery should result in a sustained tailwind.


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SAFE HARBOR CAUTIONARY STATEMENT

The Company desires to take advantage of the "safe harbor" provisions regarding forward-looking statements of the Private Securities Litigation Reform Act of 1995 and is filing this Cautionary Statement in order to do so. From time to time various forms filed by our Company with the Securities and Exchange Commission, including our Form 10-K, our Form 10-Qs and Form 8-Ks, and other disclosures, including our 2012 Overview report, press releases, earnings releases, analyst briefings, conference calls and other written documents or oral statements released by our Company, may contain forward-looking statements. Forward-looking statements generally use words such as "expect," "foresee," "anticipate," "believe," "project," "should," "estimate," "will," and similar expressions, and reflect our Company's expectations concerning the future. All forecasts and projections are forward-looking statements. Forward-looking statements are based upon currently available information, but various risks and uncertainties may cause our Company's actual results to differ materially from those expressed in these statements. The Company undertakes no obligation to update these statements in light of new information or future events.

Future results could differ materially from those expressed, due to the impact of changes in various factors. These risk factors include, but are not limited to: changes in laws and regulations; economic conditions in the United States and other major world economies; whether we are able to locate, complete and effectively integrate acquisitions; whether we are able to effectively and timely complete a divestiture of the acquired Liquid Finishing businesses, which has not been completed and remains subject to FTC approval; risks incident to conducting business internationally, including currency fluctuations and political instability; supply interruptions or delays; the ability to meet our customers' needs, and changes in product demand; new entrants who copy our products or infringe on our intellectual property; results of and costs associated with, litigation, administrative proceedings and regulatory reviews incident to our business; compliance with anti-corruption laws; the possibility of decline in purchases from few large customers of the Contractor segment; fluctuations in new construction and remodeling activity; natural disasters; and security breaches. Please refer to Item 1A of our Annual Report on Form 10-K for fiscal year 2012 for a more comprehensive discussion of these and other risk factors. These reports are available on the Company's website at www.graco.com/ir and the Securities and Exchange Commission's website at www.sec.gov. Shareholders, potential investors and other readers are urged to consider these factors in evaluating forward-looking statements and are cautioned not to place undue reliance on such forward-looking statements.

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


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