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GGG > SEC Filings for GGG > Form 10-Q on 23-Oct-2013All Recent SEC Filings

Show all filings for GRACO INC

Form 10-Q for GRACO INC


23-Oct-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 after-tax earnings of Liquid Finishing and included in other expense (income) on the Consolidated Statements of Earnings. Dividends received in 2013 totaled $9 million in the third quarter and $24 million year-to-date. Dividends received in 2012 totaled $4 million in the third quarter and $8 million year-to-date (starting in the second quarter). Once the FTC issues its final decision


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

Also in 2013, ITW reimbursed Graco approximately $4.5 million for payments 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 September 27, 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                            Thirty-nine Weeks Ended
                             Sep 27,          Sep 28,            %             Sep 27,          Sep 28,            %
                              2013             2012            Change           2013             2012            Change

Net Sales                  $    277.0       $    256.5              8%       $    832.1       $    758.8             10%
Net Earnings               $     56.1       $     37.1             51%       $    166.1       $    106.9             55%
Diluted Net Earnings
per Common Share           $     0.89       $     0.60             48%       $     2.65       $     1.73             53%

Sales for the quarter increased 8 percent from last year, driven by strong sales in the Contractor segment, along with modest increases in the Industrial and Lubrication segments. Year-to-date sales increased 10 percent, including 4 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 consolidated operating results, but had a more notable impact on regional results. Favorable effects of rate changes in EMEA were offset by unfavorable effects in Asia Pacific.


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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 %              24 %                3 %            15 %          4 %          (6)%         8 %
Currency                             - %               - %              (1) %             - %          4 %          (3)%         - %

Total                                1 %              24 %                2 %            15 %          8 %          (9)%         8 %


                                                                           Year-to-Date
                                                  Segment                                          Region
                                                                                                                   Asia
                              Industrial        Contractor        Lubrication        Americas        EMEA        Pacific       Total
Volume and Price                     - %              17 %                - %            11 %          1 %          (3)%         6 %
Acquisitions                         8 %               - %                - %             2 %          8 %            5%         4 %
Currency                            (1)%               1 %                - %             - %          2 %          (2)%         - %

Total                                7 %              18 %                - %            13 %         11 %           - %         10%

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

                 Thirteen Weeks Ended          Thirty-nine Weeks Ended
                 Sep 27,        Sep 28,        Sep 27,           Sep 28,
                  2013            2012           2013             2012

Americas1      $    156.1       $ 135.8      $     455.0        $  402.4
EMEA2                70.3          65.2            210.1           189.3
Asia Pacific         50.6          55.5            167.0           167.1

Consolidated   $    277.0       $ 256.5      $     832.1        $  758.8

1 North and South America, including the U.S. 2 Europe, Middle East and Africa

Sales for the quarter increased 8 percent, including increases of 15 percent in the Americas and 8 percent in EMEA (4 percent at consistent translation rates). Sales for the quarter decreased 9 percent in Asia Pacific (6 percent at consistent translation rates). Year-to-date sales increased 10 percent, including increases of 13 percent in the Americas and 11 percent in EMEA (9 percent at consistent translation rates). Year-to-date sales were flat in Asia Pacific (up 2 percent at consistent translation rates). The first quarter impact of the Powder Finishing operations acquired in April 2012 contributed approximately 4 percentage points of the total year-to-date growth and accounted for most of the growth in EMEA (at consistent translation rates).

Gross profit margin, expressed as a percentage of sales, was 54 1/2 percent for the quarter, consistent with the comparable period last year. Year-to-date gross profit margin rate was 55 percent, up 1 percentage point from last year. Non-recurring inventory-related purchase accounting effects totaling $7 million reduced last year's year-to-date gross margin rate by approximately 1 percentage point.


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Total operating expenses for the quarter and year-to-date were slightly lower than the comparable periods last year. Volume-related increases in selling, marketing and distribution expenses were more than offset by decreases in general and administrative expenses, including acquisition and divestiture cost decreases of $3 million for the quarter and $14 million year-to-date.

Other expense (income) included after-tax dividends received from the Liquid Finishing businesses that are held separate from the Company's other businesses. Such dividends totaled $9 million for the quarter and $24 million year-to-date, up from $4 million for the quarter and $8 million year-to-date received in the comparable periods last year. On a fully-diluted per share basis, dividends in 2013 were $0.14 for the quarter and $0.38 year-to-date, compared to $0.06 for the quarter and $0.13 year-to-date last year.

The effective income tax rates of 24 percent for the quarter and 27 percent year-to-date were lower than the comparable periods last year. This year's rates included 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 rates in 2013 also reflected the effect of higher after-tax dividend income received from the Liquid Finishing businesses held separate, and the effect of more foreign earnings that are taxed at lower rates than in the United States. The effective rate for the quarter also included the impact of additional benefit from U.S. business credits and deductions.

Segment Results

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

Industrial



                                        Thirteen Weeks Ended                    Thirty-nine Weeks Ended
                                   Sep 27,               Sep 28,             Sep 27,               Sep 28,
                                     2013                 2012                 2013                 2012
Net sales (in millions)
Americas                         $      69.0          $       67.0         $     205.4          $      192.0
EMEA                                    51.5                  47.0               151.6                 133.7
Asia Pacific                            36.2                  40.7               123.5                 121.3

Total                            $     156.7          $      154.7         $     480.5          $      447.0


Operating earnings as a
percentage of net sales                 32 %                  30 %                33 %                  31 %

Industrial segment sales for the quarter increased 1 percent, with increases of 3 percent in the Americas and 10 percent in EMEA (6 percent at consistent translation rates), mostly offset by an 11 percent decrease in Asia Pacific (9 percent at consistent translation rates). Year-to-date sales increased 7 percent, mostly from Powder Finishing operations acquired in April 2012. Operating margin rate for the Industrial segment increased compared to last year, driven by improved gross margin rates. The effects of purchase accounting related to inventory reduced the 2012 year-to-date operating margin rate by approximately 2 percentage points.


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Contractor



                                       Thirteen Weeks Ended                       Thirty-nine Weeks Ended
                                  Sep 27,                Sep 28,              Sep 27,                Sep 28,
                                    2013                  2012                  2013                  2012
Net sales (in millions)
Americas                        $      67.1           $       48.7          $     188.5           $      149.5
EMEA                                   16.6                   16.1                 50.8                   49.2
Asia Pacific                            9.2                   10.1                 29.8                   30.2

Total                           $      92.9           $       74.9          $     269.1           $      228.9

Operating earnings as a
percentage of net sales                 23 %                   17 %                 23 %                   19 %

Contractor segment sales for the quarter increased 24 percent, including increases of 38 percent in the Americas and 4 percent in EMEA (flat at consistent translation rates) and a decrease of 8 percent in Asia Pacific. Year-to-date sales were up 18 percent, driven by increases in the Americas. Higher sales volume and expense leverage led to higher operating margin rates in the Contractor segment.

Lubrication



                                       Thirteen Weeks Ended                     Thirty-nine Weeks Ended
                                   Sep 27,                Sep 28,            Sep 27,               Sep 28,
                                     2013                 2012                 2013                  2012
Net sales (in millions)
Americas                         $      20.0           $     20.0          $      61.1           $      60.8
EMEA                                     2.1                  2.2                  7.6                   6.4
Asia Pacific                             5.3                  4.7                 13.8                  15.6

Total                            $      27.4           $     26.9          $      82.5           $      82.8

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

Lubrication segment sales for the quarter increased 2 percent, mostly from increases in Asia Pacific. Year-to-date sales were flat, with increases in Europe offset by decreases in Asia Pacific. Operating margin rates were steady in this segment.


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Liquidity and Capital Resources

Net cash provided by operating activities was $181 million in 2013 and $132 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 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 $422 million, is not impaired.

Under terms of the FTC's hold separate order, the Company is required to provide sufficient resources to maintain the viability, competitiveness and marketability of the Liquid Finishing businesses, including general funds, capital, working capital and reimbursement of losses. To the extent that the Liquid Finishing businesses generate funds in excess of financial resources needed, the Company has access to such funds consistent with practices in place prior to the acquisition. In the first nine months of 2013, the Company received $24 million of dividends from current earnings of the Liquid Finishing businesses.

At September 27, 2013, the Company had various lines of credit totaling $502 million, of which $389 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 expect to achieve growth in every region in the fourth quarter of 2013. The housing recovery and a marginally favorable economic environment in the U.S. should continue to provide a tailwind for growth in our Contractor and Industrial segments in the Americas. We don't see a catalyst to advance the weak macroeconomic environments in Asia Pacific or EMEA in the near term, but we expect modest growth in the fourth quarter. As we finish out 2013 and look toward 2014, Graco's global team remains focused on our strategic growth initiatives of expanding our distribution channels, developing innovative new products, conversion of end users from manual painting techniques to using spray equipment, and continuing our efforts to expand into adjacent new markets.


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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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