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GGG > SEC Filings for GGG > Form 10-K on 18-Feb-2014All Recent SEC Filings

Show all filings for GRACO INC

Form 10-K for GRACO INC


18-Feb-2014

Annual Report


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

Acquisition

Results of Operations

Segment Results

Financial Condition and Cash Flow

Critical Accounting Estimates

Recent Accounting Pronouncements

Overview

Graco designs, manufactures and markets systems and equipment to pump, meter, mix and dispense a wide variety of fluids and coatings. 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.

Graco's key strategies include developing and marketing new products, leveraging products and technologies into additional, growing end user markets, expanding distribution globally and completing strategic acquisitions that provide additional channel and technologies. Long-term financial growth targets accompany these strategies, including our expectation of 10 percent revenue growth and 12 percent consolidated net earnings growth. In 2013, the Process division was created within the Industrial segment to provide specific focus on development of product and channel related to industrial in-plant applications. In addition, a regional management team was formed to focus on building commercial resources in South and Central America. We continued to develop new products in each division including products that are expected to drive incremental sales growth, such as the development of equipment for packaging applications as well as continued refresh and upgrades of existing product lines. We acquired EcoQuip and QED, with combined annual revenues of approximately $30 million. Both acquisitions were completed in December 2013, although the QED acquisition closed subsequent to fiscal year end.

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 Switzerland, and our primary distribution facilities are located in the United States, Belgium, Switzerland, P.R.C., Japan, Korea and Australia.

Finishing Brands Acquisition

On April 2, 2012, we completed the Finishing Brands acquisition, including Powder Finishing operations and Liquid Finishing operations. Results of the Powder Finishing business have been included in the Industrial segment since the date of acquisition. Pursuant to the hold separate order issued by the FTC, the Liquid Finishing business is being held separate from the rest of Graco's businesses until the FTC has issued its final order and the divestiture of the Liquid Finishing business is completed.

We have retained the services of an investment bank to help us market the Liquid Finishing businesses and identify potential buyers. While we seek a buyer, we must continue to hold the Liquid Finishing business assets separate from our other businesses and maintain them as viable and competitive. In accordance with the hold separate order, the Liquid Finishing businesses are managed independently by experienced Liquid Finishing business managers, under the supervision of a trustee appointed by the FTC, who reports directly to the FTC.

Under terms of the hold separate order, the Company does not have the power to direct the activities of the Liquid Finishing businesses that most significantly impact the economic performance of those businesses. Therefore, we have determined that the Liquid Finishing businesses are variable interest entities for which the Company is not the primary beneficiary and that they should not be consolidated. Furthermore, the Company does not have a controlling interest in the Liquid Finishing businesses, nor is it able to exert significant influence over the Liquid Finishing businesses. Consequently, our investment in the shares of the Liquid Finishing businesses has been reflected as a cost-method investment on our Consolidated Balance Sheets as of December 27, 2013 and December 28, 2012, and their results of operations have not been consolidated with those of the Company. As a cost-method investment, income is recognized based on dividends received from current earnings of Liquid Finishing. Dividends of $28 million


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and $12 million received in 2013 and 2012, respectively, are included in other expense (income) on the Consolidated Statements of Earnings. We evaluate our cost-method investment for other-than-temporary impairment at each reporting period. As of December 27, 2013, we evaluated our investment in Liquid Finishing and determined that there was no impairment.

Results of Operations

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

                                           2013            2012            2011
Net Sales                                $   1,104       $   1,012       $    895
Operating Earnings                             280             225            220
Net Earnings                                   211             149            142
Diluted Net Earnings per Common Share    $    3.36       $    2.42       $   2.32

2013 Summary:

Net sales grew by 9 percent, including increases of 11 percent in the Americas, 10 percent in EMEA and 3 percent in Asia Pacific. Sales in the Industrial segment grew by 8 percent, sales in the Contractor segment grew by 15 percent and sales in the Lubrication segment decreased by 1 percent.

First quarter 2013 sales from acquired Powder Finishing operations contributed approximately 3 percentage points to 2013 sales growth.

Changes in currency translation rates did not have a significant impact on sales or earnings in 2013.

Gross profit margin as a percentage of sales increased to 55 percent from 54 percent. The effects of realized price increases and higher production volume offset the unfavorable effect of changes in product mix, including the effect of increased Powder Finishing equipment and Contractor segment sales. In 2012, non-recurring purchase accounting effects reduced gross margin for the year by approximately 1 percentage point.

Investment in new product development was $51 million or 5 percent of sales in 2013.

Total operating expenses increased $2 million over 2012, with increases in product development and selling and marketing activities largely offset by decreases in general and administrative expenses, including a $14 million decrease in acquisition and divestiture costs.

Operating earnings were 25 percent of sales in 2013 as compared to 22 percent in 2012.

Other expense (income) included dividends received from the Liquid Finishing businesses that are held separate from the Company's other businesses. Dividends for 2013 and 2012 totaled $28 million and $12 million, respectively.

The effective tax rate was 27 percent, down from 31 percent in 2012. The lower rate for 2013 reflected the effects of higher after-tax dividend income received from the Liquid Finishing businesses and the federal R&D credit that was renewed in 2013, effective retroactive to the beginning of 2012. There was no R&D credit recognized in 2012.

Cash flows from operations grew to $243 million compared to $190 million in the prior year, with increases in working capital in line with volume growth.

Long-term debt was $408 million at December 27, 2013, compared to $556 million at December 28, 2012.

Dividends paid totaled $61 million in 2013.

The Company repurchased $68 million of its stock in 2013 compared to $1 million in 2012.

2012 Summary:

Our net sales grew by 13 percent, including increases of 13 percent in the Americas, 22 percent in EMEA and 5 percent in Asia Pacific. Sales in the Industrial segment grew by 20 percent, sales in the Contractor segment grew by 3 percent and sales in the Lubrication segment increased by 7 percent.

Sales from acquired Powder Finishing operations totaled $93 million since April 2012, or 10 percentage points of our total growth in 2012 sales, and included $19 million in the Americas, $52 million in EMEA and $22 million in Asia Pacific.

Foreign currency translation rates decreased sales by approximately $15 million and decreased earnings by approximately $5 million when compared to 2011 rates.

Operating earnings were 22 percent of sales in 2012 as compared to 25 percent in 2011.

Gross profit margin as a percentage of sales decreased 1 1/2 percentage points. Non-recurring purchase accounting effects related to acquired inventory totaled $7 million, reducing gross margin percentage for the year by approximately 1 percentage point. The effects of strong operational performance in legacy businesses offset the unfavorable effect of lower margin rates on acquired Powder Finishing operations.

Investment in new product development was $49 million or 5 percent of sales in 2012.

Total operating expenses were $45 million higher than 2011, including $25 million from Powder Finishing operations, an $8 million increase in acquisition and divestiture costs, $5 million from additional product development expenditures and an increase of $5 million in pension costs.


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The April purchase of Powder Finishing and Liquid Finishing operations had significant impacts on interest expense, an increase of $10 million for the year, and other expense (income), which included dividend income of $12 million received from the Liquid Finishing businesses held as a cost-method investment.

The effective tax rate was 31 percent as compared to 32 percent in 2011. The rate in 2012 was reduced by the effect of after-tax dividend income received from the Liquid Finishing investment.

Cash flows from operations grew to $190 million compared to $162 million in the prior year, with modest changes in working capital.

We paid $668 million to complete the Finishing Brands acquisition, which included the Powder Finishing operations that have been included in the Industrial segment since the date of acquisition and the Liquid Finishing operations that are held separate, using available cash and $350 million of borrowings on a new credit agreement.

Dividends paid totaled $54 million in 2012.

The following table presents net sales by geographic region (in millions):

                  2013            2012           2011
Americas1       $     595       $     536       $   476
EMEA2                 283             257           211
Asia Pacific          226             219           208

Total           $   1,104       $   1,012       $   895

1 North, South and Central America, including the United States. Sales in the United States were $498 million in 2013, $441 million in 2012 and $394 million in 2011.

2 Europe, Middle East and Africa

In 2013, sales in the Americas increased by 11 percent in total, with increases of 6 percent in the Industrial segment, 22 percent in the Contractor segment and flat in the Lubrication segment as compared to the prior year. The increase in the Americas was led by the Contractor segment, which benefited from growth in U.S. housing starts and construction spending. Increased sales in the Industrial segment were driven by improvement in a variety of general industrial, construction and process-related end-markets. Sales in the Lubrication segment reflected modest demand growth in vehicle service applications and a low rate of investment by industrial lubrication customers.

In 2013, sales in EMEA increased by 10 percent (8 percent at consistent translation rates). Sales in the Industrial segment increased by 12 percent (9 percent at consistent translation rates). Sales increased by 4 percent in the Contractor segment (2 percent at consistent translation rates) and increased by 14 percent in the Lubrication segment (12 percent at consistent translation rates). We continued to see growth during 2013 in the emerging markets of EMEA, though end-markets in many industries remained weak in Western Europe throughout much of the year.

In 2013, sales in Asia Pacific grew by 3 percent (5 percent at consistent translation rates). Sales increased by 7 percent in the Industrial segment (10 percent at consistent translation rates). Sales in the Contractor segment decreased by 4 percent (3 percent at consistent translation rates) and sales in the Lubrication segment decreased by 13 percent (10 percent at consistent translation rates). Industrial project activity was strong in the fourth quarter, which brought the Industrial segment back to modest growth for the year. However, we continue to see lack of growth in a number of markets throughout Asia Pacific, including shipyards, container manufacturing, heavy machinery, manufacturing, housing, paint and mining, and we face an increased level of competition in the region.

In 2012, sales in the Americas increased by 13 percent, with increases of 19 percent in the Industrial segment, 5 percent in the Contractor segment and 13 percent in the Lubrication segment as compared to the prior year. Growth related to the acquired Powder Finishing business was 4 percentage points. The increase in the Americas reflected strength across a range of product lines with growth in a number of industrial end-markets as well as growth in the housing and construction industries.

In 2012, sales in EMEA increased by 22 percent (28 percent at consistent translation rates), primarily due to the sales from Powder Finishing of $52 million since the acquisition. Sales of legacy Graco products in the Industrial segment decreased by 2 percent during 2012 (increased by 3 percent at consistent translation rates). Sales decreased by 5 percent in the Contractor segment (flat at consistent translation rates) and increased by 2 percent in the Lubrication segment (7 percent at consistent translation rates). We continued to see growth during 2012 in the emerging markets of Eastern Europe and the Middle East, though end-markets in many industries remained weak in Western Europe.

In 2012, sales in Asia Pacific grew by 5 percent overall. Sales of Powder Finishing equipment were $22 million from the date of acquisition. Sales decreased by 7 percent in 2012 for legacy Graco products in the Industrial segment. Sales in the Contractor


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segment grew by 4 percent and sales in the Lubrication segment decreased by 10 percent. Activity levels in many end-markets remained challenging throughout the region and across product categories throughout 2012.

The following table presents components of net sales change:

                                                                                                     2013
                                                           Segment                                                     Region
                                      Industrial         Contractor         Lubrication             Americas          Europe         Asia Pacific            Consolidated
Volume and Price                              3 %               14 %                 - %                 10 %              2 %                1 %                     6 %
Acquisitions                                  5 %                - %                 - %                  1 %              6 %                4 %                     3 %
Currency                                      - %                1 %               (1) %                  - %              2 %              (2) %                     - %

Total                                         8 %               15 %               (1) %                 11 %             10 %                3 %                     9 %


                                                                                                     2012
                                                           Segment                                                     Region
                                      Industrial         Contractor         Lubrication             Americas          Europe         Asia Pacific           Consolidated
Volume and Price                              3 %                4 %                 8 %                  9 %              2 %              (5) %                     4 %
Acquisitions                                 19 %                - %                 - %                  4 %             26 %               10 %                    10 %
Currency                                    (2) %              (1) %               (1) %                  - %            (6) %                - %                   (1) %

Total                                        20 %                3 %                 7 %                 13 %             22 %                5 %                    13 %

The following table presents an overview of components of operating earnings as a percentage of net sales:

                                         2013            2012            2011
Net Sales                                100.0 %         100.0 %         100.0 %
Cost of products sold                     45.0            45.6            44.1

Gross profit                              55.0            54.4            55.9
Product development                        4.7             4.8             4.7
Selling, marketing and distribution       16.1            16.2            16.9
General and administrative                 8.9            11.2             9.8

Operating earnings                        25.3            22.2            24.5
Interest expense                           1.6             1.9             1.0
Other expense (income), net              (2.5)           (1.1)             0.1

Earnings before income taxes              26.2            21.4            23.4
Income taxes                               7.1             6.7             7.5

Net Earnings                              19.1 %          14.7 %          15.9 %

2013 Compared to 2012

Operating earnings as a percentage of sales were 25 percent in 2013 as compared to 22 percent in 2012. Expense leverage and reductions of acquisition and divestiture costs led to the improvements in operating earnings as a percentage of sales.

Gross profit margin as a percentage of sales was 55 percent in 2013 as compared to 54 percent in 2012. The favorable effect of realized price increases and higher production volume offset the unfavorable effect of changes in product mix, including increased sales of powder finishing equipment and Contractor segment sales. For 2012, non-recurring purchase accounting effects reduced the gross margin percentage by approximately 1 percentage point.

Operating expenses for the year increased $2 million over 2012 with business activity-related increases largely offset by decreases in acquisition and divestiture costs in 2013. Acquisition and divestiture costs were $2 million in 2013, as compared to $16 million in 2012. Overall, product development spending was 5 percent of sales in 2013, consistent with 2012.

Interest expense was $18 million in 2013, a decrease of $1 million from 2012. Other expense (income) included dividends received from the Liquid Finishing businesses that are held separate from the Company's other businesses. Dividends for the year totaled $28 million in 2013 and $12 million in 2012.


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The effective income tax rate was 27 percent for the year as compared to 31 percent in 2012. The lower rate for 2013 reflected the effects of higher after-tax dividend income received from the Liquid Finishing businesses and the federal R&D credit that was renewed in 2013, effective retroactive to the beginning of 2012. There was no R&D credit recognized in 2012.

2012 Compared to 2011

Operating earnings as a percentage of sales were 22 percent in 2012 as compared to 25 percent in 2011. The impact of purchase accounting related to the Powder Finishing acquisition, higher acquisition/divestiture costs and an increase in pension costs were partially offset by other operating improvements.

Gross profit margin as a percentage of sales was 54 percent in 2012 as compared to 56 percent in 2011. Non-recurring purchase accounting effects totaling $7 million related to acquired inventory with the Powder Finishing operations reduced the gross margin percentage by approximately 1 percentage point. Strong operating performance and cost management improved margins on the legacy Graco operations, partially offsetting the lower margin rates on acquired Powder Finishing operations.

Operating expenses for the year increased $45 million, including $25 million from Powder Finishing operations, an increase of $8 million for acquisition and divestiture costs, an increase of $5 million in product development spending and an increase of $5 million in pension expense. Overall, product development spending was 5 percent of sales in 2012, consistent with 2011.

The purchase of Powder Finishing and Liquid Finishing operations had significant impacts on interest expense (an increase of $10 million for the year) and other expense (income), which included dividend income of $12 million received from the Liquid Finishing businesses held as a cost-method investment.

The effective income tax rate was 31 percent for the year as compared to 32 percent in 2011. The 2012 effective tax rate was reduced by the effect of the investment income from the Liquid Finishing businesses held separate and the effect of a tax rate change on deferred liabilities related to a tax holiday received in a foreign jurisdiction.

Segment Results

The following table presents net sales and operating earnings by business
segment (in millions):



                           2013           2012          2011
Sales
Industrial              $     652      $     603      $   502
Contractor                    343            299          291
Lubrication                   109            110          102

Total                   $   1,104      $   1,012      $   895


Operating Earnings
Industrial              $     211      $     186      $   174
Contractor                     72             54           51
Lubrication                    23             23           19
Unallocated corporate         (26)           (38)         (24)

Total                   $     280      $     225      $   220

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.


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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):



                                                2013         2012         2011
Sales
Americas                                      $   276      $   261      $   220
EMEA                                              206          184          135
Asia Pacific                                      170          158          147

Total                                         $   652      $   603      $   502


Components of Net Sales Change
Volume and Price                                  3 %          3 %         20 %
Acquisitions                                      5 %         19 %          - %
Currency                                          - %        (2) %          3 %

Total                                             8 %         20 %         23 %


Operating Earnings as a Percentage of Sales      32 %         31 %         35 %

In 2013, sales in the Industrial segment totaled $652 million, an increase of 8 percent from the prior year. First quarter 2013 sales from the acquired Powder Finishing operations contributed approximately 5 percentage points to the 2013 sales growth. Overall for the Industrial segment, sales increased by 6 percent in the Americas, increased 12 percent in EMEA (9 percent at consistent translation rates) and increased 7 percent in Asia Pacific (10 percent at consistent translation rates).

Operating earnings as a percentage of sales were 32 percent in 2013 as compared to 31 percent in 2012. The effects of purchase accounting related to inventory reduced the operating margin rate for 2012 by approximately 1 percentage point.

In 2012, sales in the Industrial segment totaled $603 million, an increase of 20 percent from the prior year, including $93 million from Powder Finishing operations acquired in April 2012. Without Powder Finishing, sales increased by 10 percent in the Americas, decreased 2 percent in EMEA (3 percent increase at consistent translation rates) and decreased 7 percent in Asia Pacific.

Operating earnings as a percentage of sales were 31 percent in 2012 as compared to 35 percent in 2011. Powder Finishing operations contributed to segment earnings, but at a lower rate on sales, which drove the decrease in the operating margin for the Industrial segment.

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.


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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):



                                                2013          2012          2011
Sales
Americas                                      $    237      $    194      $    184
EMEA                                                67            64            68
Asia Pacific                                        39            41            39

Total                                         $    343      $    299      $    291


Components of Net Sales Change
Volume and Price                                  14 %           4 %          11 %
Currency                                           1 %         (1) %           2 %

Total                                             15 %           3 %          13 %


Operating Earnings as a Percentage of Sales       21 %          18 %          17 %

. . .

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