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GGG > SEC Filings for GGG > Form 10-Q on 23-Apr-2014All Recent SEC Filings

Show all filings for GRACO INC

Form 10-Q for GRACO INC


23-Apr-2014

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 in 2012

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 continues to work on resolving issues related to a proposed 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 totaled $4 million in the first quarter of 2014 and $4 million in the first quarter of 2013. Once the FTC issues its final decision and order, and the


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

The Company evaluates its cost-method investment for other-than-temporary impairment at each reporting period. As of March 28, 2014, 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
                                          March 28,         March 29,          %
                                            2014              2013          Change

Net Sales                               $       290.0     $       269.0          8%
Operating Earnings                      $        74.7     $        71.5          4%
Net Earnings                            $        50.7     $        52.1        (3)%
Diluted Net Earnings per Common Share   $        0.81     $        0.84        (4)%

Sales increased 8 percent, with increases in the Americas and EMEA and a decrease in Asia Pacific. Sales included $7 million (3 percentage points of growth) from operations acquired in the fourth quarter of 2013 and early in the first quarter of 2014.

Acquisition-related inventory charges, lower margins from acquired operations and changes in product mix contributed to a decrease in gross margin rate compared to the first quarter last year.

Operating earnings increased 4 percent, but a higher effective income tax rate led to a decrease in net earnings.

The following table presents components of changes in sales:

                                                                     Year-to-Date
                                               Segment                                      Region
                                                                                                          Asia
                            Industrial      Contractor       Lubrication       Americas       EMEA      Pacific      Total
Volume and Price                   2 %             9 %               7 %           11 %        3 %         (7)%        5 %
Acquisitions                       4 %             - %               - %            5 %        - %          1 %        3 %
Currency                           1 %             - %              (2)%           (1)%        4 %         (1)%        - %

Total                              7 %             9 %               5 %           15 %        7 %         (7)%        8 %


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

Thirteen Weeks Ended

                  March 28,           March 29,
                    2014                2013

Americas1      $        158.8      $        138.2
EMEA2                    73.4                68.8
Asia Pacific             57.8                62.0

Consolidated   $        290.0      $        269.0

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

2 Europe, Middle East and Africa

Sales increased 8 percent, including increases of 15 percent in the Americas and 7 percent in EMEA (3 percent at consistent translation rates). Sales decreased 7 percent in Asia Pacific (6 percent at consistent translation rates). Sales included $7 million (3 percentage points of growth) from operations acquired in the fourth quarter of 2013 and early in the first quarter of 2014.

Gross profit margin, expressed as a percentage of sales, was 55 percent, down from 56 percent last year. Non-recurring inventory-related purchase accounting effects of $1 million and lower margins in acquired operations accounted for more than half of the decrease. Changes in product mix also contributed to the decrease.

Total operating expenses of $85 million were 29 percent of sales, consistent with the first quarter last year. Operating expenses in 2014 included $1 million of acquisition and divestiture expenses. Such expenses were not significant in 2013.

Other expense (income) included dividends received from the Liquid Finishing businesses that are held separate from the Company's other businesses. Such dividends totaled $4 million for the first quarter in both 2014 and 2013.

The effective income tax rate of 31 percent was 4 percentage points higher than the comparable period last year because last year's rate included the $3.6 million 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 allowed in 2014.


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Segment Results

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

Industrial

                                                                  Thirteen Weeks Ended
                                                          March 28,                  March 29,
                                                             2014                      2013

Net sales (in millions)
Americas                                               $          78.5            $         66.2
EMEA                                                              54.4                      50.3
Asia Pacific                                                      43.5                      47.7

Total                                                  $         176.4            $        164.2


Operating earnings as a percentage of net sales                    31 %                      34 %

Industrial segment sales increased 7 percent, with increases of 19 percent in the Americas and 8 percent in EMEA (5 percent at consistent translation rates), partially offset by a 9 percent decrease in Asia Pacific (8 percent at consistent translation rates). Acquired operations contributed $7 million to sales of this segment (4 percentage points of growth). Operating margin rate for the Industrial segment decreased compared to last year due to lower margins on acquired operations, including the impact of non-recurring acquisition-related inventory valuation adjustments, and other investments in regional and product expansion.

Contractor

                                                                 Thirteen Weeks Ended
                                                          March 28,                 March 29,
                                                            2014                      2013

Net sales (in millions)
Americas                                               $         58.5            $         51.5
EMEA                                                             16.4                      16.1
Asia Pacific                                                     10.0                      10.0

Total                                                  $         84.9            $         77.6


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

Contractor segment sales for the quarter increased 9 percent, including a 14 percent increase in the Americas, with strong growth in both paint store and home center channels. Sales were flat in EMEA and Asia Pacific. Operating margin rates in the Contractor segment were consistent with last year's first quarter. Unfavorable effects of product mix offset the favorable effects of higher sales volume and expense leverage.


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Lubrication

                                                            Thirteen Weeks Ended
                                                   March 28,                    March 29,
                                                     2014                         2013

Net sales (in millions)
Americas                                        $         21.7               $         20.5
EMEA                                                       2.5                          2.5
Asia Pacific                                               4.4                          4.2

Total                                           $         28.6               $         27.2


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

Lubrication segment sales for the quarter increased 5 percent, mostly from increases in the Americas. Higher sales volume, improved gross margin rate and expense leverage led to a higher operating margin rate in the Lubrication segment.

Liquidity and Capital Resources

Net cash provided by operating activities was $28 million in 2014 and $39 million in 2013. The first quarter increase in accounts receivable was $9 million higher in 2014 than in 2013. Accounts receivable and inventory balances have increased since the end of 2013 due to increases in business activity. Significant uses of cash in the first quarter of 2014 included $65 million for a business acquisition, $48 million for purchases of Company common stock and $17 million of dividends paid to shareholders.

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 continues to work on resolving issues related to a proposed 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. Since the date of acquisition, the Company received $44 million of dividends from current earnings of the Liquid Finishing businesses, including $4 million in the first quarter of 2014.

At March 28, 2014, the Company had various lines of credit totaling $503 million, of which $290 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 2014, including the needs of the Liquid Finishing businesses acquired in April 2012.


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Outlook

Our outlook for 2014 has not changed, and we remain confident about achieving full year growth in all segments and regions. While U.S. housing starts began 2014 slower than anticipated, we continue to expect strong full year growth in the residential construction market to drive low double-digit growth in our Contractor segment in the Americas. Although certain emerging economies of EMEA are facing geopolitical and currency headwinds, and capital equipment demand in China remains uneven, we expect to benefit from the improving macro environment in developed economies around the world.

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 2013 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; our Company's growth strategies, which include making acquisitions, investing in new products, expanding geographically and targeting new industries; whether we are able to effectively complete a divestiture of the acquired Liquid Finishing businesses, which has not been completed and remains subject to FTC approval; political instability; new entrants who copy our products or infringe on our intellectual property; supply interruptions or delays; risks incident to conducting business internationally; the ability to meet our customers' needs and changes in product demand; 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; variations in activity in the construction and automotive industries; security breaches and natural disasters. Please refer to Item 1A of our Annual Report on Form 10-K for fiscal year 2013 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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