GRACO INC - Quarter Report: 2013 June (Form 10-Q)

Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

Quarterly Report Pursuant to Section 13 or 15 (d) of the

Securities Exchange Act of 1934

For the quarterly period ended June 28, 2013

Commission File Number: 001-09249

GRACO INC.


		(Exact name of registrant as specified in its charter)


Minnesota				41-0285640
(State of incorporation)				(I.R.S. Employer Identification Number)

88 - 11^th Avenue N.E.

Minneapolis, Minnesota

55413

(Address of principal executive offices)

(Zip Code)

(612) 623-6000


		(Registrant’s telephone number, including area code)

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, and (2) has been subject to such filing requirements for the past 90 days.

Yes X No

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 such shorter period that the registrant was required to submit and post such files).

Yes X No

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,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.


Large Accelerated Filer	X	Accelerated Filer
Non-accelerated Filer		Smaller reporting company

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes No X

61,364,000 shares of the Registrant’s Common Stock, $1.00 par value, were outstanding as of July 17, 2013.

INDEX

Page Number

PART I

FINANCIAL INFORMATION

Item 1.

Financial Statements

Consolidated Statements of Earnings

Consolidated Statements of Comprehensive Income

Consolidated Balance Sheets

Consolidated Statements of Cash Flows

Notes to Consolidated Financial Statements

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

Item 4.

Controls and Procedures

PART II

OTHER INFORMATION

Item 1A.

Risk Factors

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

Item 6.

Exhibits

SIGNATURES

EXHIBITS

Item 1. PART I

GRACO INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF EARNINGS

(Unaudited) (In thousands except per share amounts)


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

Net Sales	$	286,020		$	268,184		$	555,066		$	502,306
Cost of products sold		127,281			128,654			245,683			230,597

Gross Profit		158,739			139,530			309,383			271,709
Product development		12,467			12,502			24,888			24,140
Selling, marketing and distribution		44,556			42,547			87,910			80,573
General and administrative		26,499			32,006			49,871			56,552

Operating Earnings		75,217			52,475			146,714			110,444
Interest expense		4,625			5,359			9,387			9,048
Other expense (income), net		(10,851	)		(3,236	)		(15,246	)		(2,937	)

Earnings Before Income Taxes		81,443			50,352			152,573			104,333
Income taxes		23,600			16,000			42,600			34,600

Net Earnings	$	57,843		$	34,352		$	109,973		$	69,733


Per Common Share
Basic net earnings	$	0.94		$	0.57		$	1.80		$	1.16
Diluted net earnings	$	0.92		$	0.56		$	1.76		$	1.13
Cash dividends declared	$	0.25		$	0.23		$	0.50		$	0.45
See notes to consolidated financial statements. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited) (In thousands)

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

Net Earnings	$	57,843		$	34,352		$	109,973		$	69,733
Other comprehensive income (loss)
Cumulative translation adjustment		2,632			(9,458	)		(5,855	)		(9,458	)
Pension and postretirement medical liability adjustment		2,330			2,470			4,786			4,809
Income taxes
Pension and postretirement medical liability adjustment		(842	)		(888	)		(1,720	)		(1,731	)

Other comprehensive income (loss)		4,120			(7,876	)		(2,789	)		(6,380	)

Comprehensive Income	$	61,963		$	26,476		$	107,184		$	63,353

See notes to consolidated financial statements.

GRACO INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Unaudited)

(In thousands)


	Jun 28, 2013			Dec 28, 2012
ASSETS
Current Assets
Cash and cash equivalents	$	27,569		$	31,120
Accounts receivable, less allowances of $6,100 and $6,600		196,679			172,143
Inventories		133,304			121,549
Deferred income taxes		19,478			17,742
Investment in businesses held separate		425,978			426,813
Other current assets		7,568			7,629

Total current assets		810,576			776,996

Property, Plant and Equipment
Cost		396,313			389,067
Accumulated depreciation		(247,283	)		(237,523	)

Property, plant and equipment, net		149,030			151,544

Goodwill		178,211			181,228
Other Intangible Assets, net		141,521			151,773
Deferred Income Taxes		39,505			38,550
Other Assets		21,657			21,643

Total Assets	$	1,340,500		$	1,321,734

LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities
Notes payable to banks	$	7,798		$	8,133
Trade accounts payable		34,312			28,938
Salaries and incentives		28,668			34,001
Dividends payable		15,416			15,206
Other current liabilities		68,677			65,393

Total current liabilities		154,871			151,671

Long-term Debt		465,790			556,480
Retirement Benefits and Deferred Compensation		138,764			137,779
Deferred Income Taxes		20,958			21,690

Shareholders’ Equity
Common stock		61,390			60,767
Additional paid-in-capital		323,317			287,795
Retained earnings		261,944			189,297
Accumulated other comprehensive income (loss)		(86,534	)		(83,745	)

Total shareholders’ equity		560,117			454,114

Total Liabilities and Shareholders’ Equity	$	1,340,500		$	1,321,734

See notes to consolidated financial statements.

GRACO INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited) (In thousands)


	Twenty-six Weeks Ended
	Jun 28, 2013			Jun 29, 2012
Cash Flows From Operating Activities
Net Earnings	$	109,973		$	69,733
Adjustments to reconcile net earnings to net cash provided by operating activities
Depreciation and amortization		18,637			18,381
Deferred income taxes		(5,073	)		(8,074	)
Share-based compensation		7,762			6,936
Excess tax benefit related to share-based payment arrangements		(3,300	)		(2,000	)
Change in
Accounts receivable		(27,349	)		(25,312	)
Inventories		(12,393	)		1,794
Trade accounts payable		4,541			2,146
Salaries and incentives		(5,635	)		(11,832	)
Retirement benefits and deferred compensation		6,113			7,296
Other accrued liabilities		7,646			4,527
Other		(761	)		1,072

Net cash provided by operating activities		100,161			64,667

Cash Flows From Investing Activities
Property, plant and equipment additions		(9,423	)		(10,177	)
Acquisition of businesses, net of cash acquired		-			(227,323	)
Investment in businesses held separate		835			(426,813	)
Proceeds from sale of assets		1,600			-
Other		(112	)		(1,783	)

Net cash used in investing activities		(7,100	)		(666,096	)

Cash Flows From Financing Activities
Borrowings (payments) on short-term lines of credit, net		(172	)		(2,247	)
Borrowings on long-term line of credit		198,645			452,695
Payments on long-term line of credit		(289,335	)		(125,515	)
Payments of debt issuance costs		-			(1,921	)
Excess tax benefit related to share-based payment arrangements		3,300			2,000
Common stock issued		25,975			23,386
Common stock repurchased		(6,334	)		(272	)
Cash dividends paid		(30,504	)		(27,043	)

Net cash provided by (used in) financing activities		(98,425	)		321,083

Effect of exchange rate changes on cash		1,813			284

Net increase (decrease) in cash and cash equivalents		(3,551	)		(280,062	)
Cash and cash equivalents
Beginning of year		31,120			303,150

End of period	$	27,569		$	23,088

See notes to consolidated financial statements.

GRACO INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The consolidated balance sheet of Graco Inc. and Subsidiaries (the “Company”) as of June 28, 2013 and the related statements of earnings for the thirteen and twenty-six weeks ended June 28, 2013 and June 29, 2012, and cash flows for the twenty-six weeks ended June 28, 2013 and June 29, 2012 have been prepared by the Company and have not been audited.

In the opinion of management, these consolidated financial statements reflect all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the financial position of the Company as of June 28, 2013, and the results of operations and cash flows for all periods presented.

Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. Therefore, these statements should be read in conjunction with the financial statements and notes thereto included in the Company’s 2012 Annual Report on Form 10-K.

The results of operations for interim periods are not necessarily indicative of results that will be realized for the full fiscal year.

2.	The following table sets forth the computation of basic and diluted earnings per share (in thousands, except per share amounts):


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

Net earnings available to common shareholders	$	57,843	$	34,352	$	109,973	$	69,733

Weighted average shares outstanding for basic earnings per share		61,371		60,484		61,166		60,268

Dilutive effect of stock options computed using the treasury stock method and the average market price		1,470		1,319		1,458		1,303

Weighted average shares outstanding for diluted earnings per share		62,841		61,803		62,624		61,571

Basic earnings per share	$	0.94	$	0.57	$	1.80	$	1.16

Diluted earnings per share	$	0.92	$	0.56	$	1.76	$	1.13

Stock options to purchase 568,000 and 572,000 shares were not included in the June 28, 2013 and June 29, 2012 computations of diluted earnings per share, respectively, because they would have been anti-dilutive.

3.	Information on option shares outstanding and option activity for the twenty-six weeks ended June 28, 2013 is shown below (in thousands, except per share amounts):


	Option Shares			Weighted Average Exercise Price		Options Exercisable		Weighted Average Exercise Price

Outstanding, December 28, 2012		5,192		$	34.85		3,194	$	32.99
Granted		563			58.80
Exercised		(534	)		32.11
Canceled		(16	)		40.03

Outstanding, June 28, 2013		5,205		$	37.71		3,429	$	33.01

The Company recognized year-to-date share-based compensation of $7.8 million in 2013 and $6.9 million in 2012. As of June 28, 2013, there was $13.2 million of unrecognized compensation cost related to unvested options, expected to be recognized over a weighted average period of 1.9 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:


	Twenty-six Weeks Ended
	Jun 28, 2013		Jun 29, 2012
Expected life in years		6.5		6.5
Interest rate		1.2%		1.3%
Volatility		36.3%		36.6%
Dividend yield		1.7%		1.8%
Weighted average fair value per share	$	18.29	$	15.62

Under the Company’s Employee Stock Purchase Plan, the Company issued 197,000 shares in 2013 and 239,000 shares in 2012. The fair value of the employees’ purchase rights under this 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:


	Twenty-six Weeks Ended
	Jun 28, 2013		Jun 29, 2012
Expected life in years		1.0		1.0
Interest rate		0.2%		0.2%
Volatility		26.0%		40.6%
Dividend yield		1.7%		1.7%
Weighted average fair value per share	$	14.16	$	15.58

In the first quarter of 2013, the Company granted 4,000 Restricted Share Awards to certain key employees that will vest on the fourth anniversary of the date of grant. The Company also granted 1,700 Restricted Share Units to a key employee that will vest on the third anniversary of the date of grant. The market value of the awards and units at the date of grant will be charged to operations over the vesting periods. The expense related to these arrangements is not significant.

4.	The components of net periodic benefit cost for retirement benefit plans were as follows (in thousands):


	Thirteen Weeks Ended						Twenty-six Weeks Ended
	Jun 28, 2013			Jun 29, 2012			Jun 28, 2013			Jun 29, 2012
Pension Benefits
Service cost	$	1,789		$	1,724		$	3,590		$	3,014
Interest cost		3,429			3,567			6,998			6,798
Expected return on assets		(4,535	)		(3,859	)		(9,249	)		(7,684	)
Amortization and other		2,789			3,049			5,292			5,495

Net periodic benefit cost	$	3,472		$	4,481		$	6,631		$	7,623


Postretirement Medical
Service cost	$	155		$	125		$	310		$	275
Interest cost		247			237			493			500
Amortization		(50	)		(38	)		(102	)		(75	)

Net periodic benefit cost	$	352		$	324		$	701		$	700

5.	Changes in components of accumulated other comprehensive income (loss), net of tax were (in thousands):


	Pension and Post- retirement Medical			Cumulative Translation Adjustment			Total

Beginning balance	$	(79,716	)	$	(4,029	)	$	(83,745	)
Other comprehensive income before reclassifications		-			(5,855	)		(5,855	)
Amounts reclassified from accumulated other comprehensive income		3,066			-			3,066

Ending balance	$	(76,650	)	$	(9,884	)	$	(86,534	)

Amounts related to pension and postretirement medical adjustments are reclassified to pension cost, which is allocated to cost of products sold and operating expenses based on salaries and wages, approximately as follows (in thousands):


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

Cost of products sold	$	844		$	1,753
Product development		370			763
Selling, marketing and distribution		658			1,324
General and administrative		458			946

Total before tax	$	2,330		$	4,786
Income tax (benefit)		(842	)		(1,720	)

Total after tax	$	1,488		$	3,066

6.	The Company has three reportable segments: Industrial (which aggregates four operating segments), Contractor and Lubrication. Sales and operating earnings by segment for the thirteen and twenty-six weeks ended June 28, 2013 and June 29, 2012 were as follows (in thousands):


	Thirteen Weeks Ended						Twenty-six Weeks Ended
	Jun 28, 2013			Jun 29, 2012			Jun 28, 2013			Jun 29, 2012
Net Sales
Industrial	$	159,671		$	158,220		$	323,846		$	292,323
Contractor		98,498			82,106			176,126			154,092
Lubrication		27,851			27,858			55,094			55,891

Total	$	286,020		$	268,184		$	555,066		$	502,306

Operating Earnings
Industrial	$	51,530		$	43,171		$	106,749		$	91,484
Contractor		24,479			17,965			40,911			30,504
Lubrication		6,647			5,543			11,788			11,632
Unallocated corporate (expense)		(7,439	)		(14,204	)		(12,734	)		(23,176	)

Total	$	75,217		$	52,475		$	146,714		$	110,444

Unallocated corporate expenses in 2012 included acquisition-related expenses of $7 million in the second quarter and $11 million for the year-to-date.

Assets by segment were as follows (in thousands):


	Jun 28, 2013		Dec 28, 2012

Industrial	$	566,743	$	567,879
Contractor		169,665		141,094
Lubrication		83,856		84,079
Unallocated corporate		520,236		528,682

Total	$	1,340,500	$	1,321,734

Geographic information follows (in thousands):


	Thirteen Weeks Ended				Twenty-six Weeks Ended
	Jun 28, 2013		Jun 29, 2012		Jun 28, 2013		Jun 29, 2012
Net sales (based on customer location)
United States	$	135,173	$	116,454	$	251,254	$	220,622
Other countries		150,847		151,730		303,812		281,684

Total	$	286,020	$	268,184	$	555,066	$	502,306


	Jun 28, 2013		Dec 28, 2012
Long-lived assets
United States	$	117,255	$	119,331
Other countries		31,775		32,213

Total	$	149,030	$	151,544

7.	Major components of inventories were as follows (in thousands):


	Jun 28, 2013			Dec 28, 2012

Finished products and components	$	65,146		$	58,703
Products and components in various stages of completion		43,629			44,001
Raw materials and purchased components		65,147			59,190

		173,922			161,894
Reduction to LIFO cost		(40,618	)		(40,345	)

Total	$	133,304		$	121,549

8.	Information related to other intangible assets follows (dollars in thousands):


	Estimated Life (years)		Cost		Accumulated Amortization			Foreign Currency Translation			Book Value
June 28, 2013
Customer relationships		3 - 14	$	122,995	$	(26,426	)	$	(3,733	)	$	92,836
Patents, proprietary technology and product documentation		3 - 11		15,585		(5,316	)		(397	)		9,872
Trademarks, trade names and other		1 - 5		75		(46	)		-			29


				138,655		(31,788	)		(4,130	)		102,737

Not Subject to Amortization:
Brand names				40,400		-			(1,616	)		38,784


Total			$	179,055	$	(31,788	)	$	(5,746	)	$	141,521


December 28, 2012
Customer relationships		2 - 14	$	132,245	$	(30,041	)	$	(1,510	)	$	100,694
Patents, proprietary technology and product documentation		3 - 11		20,830		(9,679	)		(147	)		11,004
Trademarks, trade names and other		1 - 5		85		(27	)		-			58


				153,160		(39,747	)		(1,657	)		111,756

Not Subject to Amortization:
Brand names				40,580		-			(563	)		40,017


Total			$	193,740	$	(39,747	)	$	(2,220	)	$	151,773

Amortization of intangibles for the quarter was $3.2 million in 2013 and $4.3 million in 2012, and for the year-to-date was $6.6 million in 2013 and $6.8 million in 2012. Estimated annual amortization expense is as follows: $12.4 million in 2013, $9.0 million in 2014, $8.5 million in 2015, $8.2 million in 2016, $8.0 million in 2017 and $63.2 million thereafter.

Changes in the carrying amount of goodwill in 2013 were as follows (in thousands):


	Industrial			Contractor		Lubrication		Total
Beginning balance	$	148,999		$	12,732	$	19,497	$	181,228
Foreign currency translation		(2,132	)		-		-		(2,132	)
Other		(885	)		-		-		(885	)

Ending balance	$	145,982		$	12,732	$	19,497	$	178,211

9.	Components of other current liabilities were (in thousands):


	Jun 28, 2013		Dec 28, 2012

Accrued self-insurance retentions	$	6,593	$	6,952
Accrued warranty and service liabilities		7,670		7,943
Accrued trade promotions		5,073		5,669
Payable for employee stock purchases		3,591		7,203
Customer advances and deferred revenue		12,914		10,617
Income taxes payable		12,245		4,305
Other		20,591		22,704

Total other current liabilities	$	68,677	$	65,393

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):


	Twenty-six Weeks Ended Jun 28, 2013			Year Ended Dec 28, 2012

Balance, beginning of year	$	7,943		$	6,709
Assumed in business acquisition		-			1,121
Charged to expense		2,825			6,182
Margin on parts sales reversed		953			2,244
Reductions for claims settled		(4,051	)		(8,313	)

Balance, end of period	$	7,670		$	7,943

10.	Assets and liabilities measured at fair value on a recurring basis and fair value measurement level were as follows (in thousands):


	Level	Jun 28, 2013		Dec 28, 2012
Assets
Cash surrender value of life insurance	2	$	9,958	$	9,483
Forward exchange contracts	2		285		491

Total assets at fair value		$	10,243	$	9,974


Liabilities
Deferred compensation	2	$	3,371	$	3,016

Contracts insuring the lives of certain employees who are eligible to participate in certain non-qualified pension and deferred compensation plans are held in trust. Cash surrender value of the contracts is based on performance measurement funds that

shadow the deferral investment allocations made by participants in certain deferred compensation plans. The deferred compensation liability balances are valued based on amounts allocated by participants to the underlying performance measurement funds.

Long-term notes payable with fixed interest rates have a carrying amount of $300 million and an estimated fair value of $320 million as of June 28, 2013 and $330 million as of December 28, 2012. The fair value of variable rate borrowings approximates carrying value. The Company uses significant other observable inputs to estimate fair value based on the present value of future cash flows and rates that would be available for issuance of debt with similar terms and remaining maturities.

11.	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.

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 (income), net. The notional amount of contracts outstanding as of June 28, 2013 totaled $21 million. 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 (level 2 in the fair value hierarchy) to value the derivative instruments used to hedge 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	Jun 28, 2013			Dec 28, 2012
Gain (loss) on foreign currency forward contracts
Gains		$	436		$	553
Losses			(151	)		(62	)

Net	Accounts receivable	$	285		$	491

12.

On April 2, 2012, the Company completed the purchase of the finishing businesses of Illinois Tool Works Inc. (“ITW”). The acquisition included powder finishing and liquid finishing equipment operations, technologies and brands (separately, the “Powder Finishing” and “Liquid Finishing” businesses). Results of the Powder Finishing businesses have been included in the Industrial segment since the date of acquisition, including $62 million of sales and $9 million of operating earnings in the first half of 2013 and $31 million of sales and $0.2 million of net operating loss in the first half of 2012 (starting in the second quarter).

In May 2012, the United States Federal Trade Commission (“FTC”) issued a proposed decision and order which requires Graco to sell the Liquid Finishing business assets 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 hold the Liquid Finishing business assets separate from its other businesses and maintain them as viable and competitive.

The Company does not have a controlling interest in the Liquid Finishing businesses, nor is it able to exert significant 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 on the Consolidated Balance Sheets, and its 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 $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 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.

Sales and operating earnings of the Liquid Finishing businesses were as follows (in thousands):


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

Net Sales	$	71,845	$	66,608	$	135,043	$	133,758
Operating Earnings		16,398		12,801		29,978		24,384

The following pro forma information reflects the combined results of Graco and Powder Finishing operations as if the acquisition had occurred at the beginning of 2011 (in thousands, except per share amounts):


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

Net Sales	$	286,020	$	268,184	$	555,066	$	532,551
Operating Earnings		75,217		66,896		146,714		131,089
Net Earnings		57,843		43,847		109,973		82,768
Basic earnings per share		0.94		0.72		1.80		1.37
Diluted earnings per share		0.92		0.71		1.76		1.34

Pro forma results for the 2012 year-to-date period reflect additional depreciation and amortization of $2 million, as if the acquisition of Powder Finishing had occurred at the beginning of 2011. Non-recurring acquisition expenses of $7 million for the second quarter and $11 million year-to-date were eliminated from the 2012 pro forma results. Purchase accounting effects of $7 million related to inventory were removed from the second quarter and year-to-date 2012 pro forma results.

Item 2. GRACO INC. AND SUBSIDIARIES

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.

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.

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, 2013		Jun 29, 2012		% Change		Jun 28, 2013		Jun 29, 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.

The following table presents components of changes in sales:


	Quarter
	Segment						Region
	Industrial		Contractor		Lubrication		Americas		EMEA		Asia 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
	Industrial		Contractor		Lubrication		Americas		EMEA		Asia 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, 2013		Jun 29, 2012		Jun 28, 2013		Jun 29, 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

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

²Europe, 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 55¹⁄₂ 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 1¹⁄₂ 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

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, 2013		Jun 29, 2012		Jun 28, 2013		Jun 29, 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.

Contractor


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

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.

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.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

There have been no material changes related to market risk from the disclosures made in the Company’s 2012 Annual Report on Form 10-K.

Item 4. Controls and Procedures

Evaluation of disclosure controls and procedures

As of the end of the fiscal quarter 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, 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.

Changes in internal controls

During the 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.

PART II OTHER INFORMATION

Item 1A. Risk Factors

There have been no material changes to the Company’s risk factors from those disclosed in the Company’s 2012 Annual Report on Form 10-K.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Issuer Purchases of Equity Securities

On September 14, 2012, 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, 2015.

In addition to shares purchased under the Board authorizations, 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 option exercises.

Information on issuer purchases of equity securities follows:


Period	Total Number of Shares Purchased		Average Price Paid per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs		Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs (at end of period)

Mar 30, 2013 – Apr 26, 2013		-		-		-		5,999,600

Apr 27, 2013 – May 24, 2013		-		-		-		5,999,600

May 25, 2013 – Jun 28, 2013		114,928		63.27		114,928		5,884,672

Item 6. Exhibits


3.1		Restated Articles of Incorporation as amended April 26, 2013. (Incorporated by reference to Exhibit 3.1 to the Company’s Report on Form 8-K filed April 30, 2013.)

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.)

31.1		Certification of President and Chief Executive Officer pursuant to Rule 13a-14(a).

31.2		Certification of Chief Financial Officer pursuant to Rule 13a-14(a).

32		Certification of President and Chief Executive Officer and Chief Financial Officer pursuant to Section 1350 of Title 18, U.S.C.

99.1		Press Release Reporting Second Quarter Earnings dated July 24, 2013.

101		Interactive Data File.

SIGNATURES

Pursuant to the requirements 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.

Date:	July 24, 2013	By:	/s/ Patrick J. McHale
			Patrick J. McHale
			President and Chief Executive Officer
			(Principal Executive Officer)

Date:	July 24, 2013	By:	/s/ James A. Graner
			James A. Graner
			Chief Financial Officer
			(Principal Financial Officer)

Date:	July 24, 2013	By:	/s/ Caroline M. Chambers
			Caroline M. Chambers
			Vice President and Corporate Controller
			(Principal Accounting Officer)

GRACO INC - Quarter Report: 2013 June (Form 10-Q)

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