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GRACO INC - Quarter Report: 2016 March (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 March 25, 2016
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 - 11th 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 (or for such shorter period that the registrant was required to file such reports), 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 for 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    

55,614,000 shares of the Registrant’s Common Stock, $1.00 par value, were outstanding as of April 13, 2016.



INDEX 
 
 
 
 
Page
PART I - FINANCIAL INFORMATION
 
 
 
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
 
 
 
 
Item 3.
 
 
 
 
 
 
 
Item 4.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
PART II - OTHER INFORMATION
 
 
 
 
 
 
 
Item 1A.
 
 
 
 
 
 
 
Item 2.
 
 
 
 
 
 
 
Item 6.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
EXHIBITS
 

2

Table of Contents

PART I     Item 1.
GRACO INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
(Unaudited) (In thousands except per share amounts)

 
Thirteen Weeks Ended
 
March 25,
2016
 
March 27,
2015
Net Sales
$
304,912

 
$
306,453

Cost of products sold
143,116

 
144,324

Gross Profit
161,796

 
162,129

Product development
14,686

 
15,290

Selling, marketing and distribution
52,701

 
51,424

General and administrative
33,460

 
30,184

Operating Earnings
60,949

 
65,231

Interest expense
4,493

 
5,303

Held separate investment (income), net

 
(29,523
)
Other expense (income), net
(1,146
)
 
710

Earnings Before Income Taxes
57,602

 
88,741

Income taxes
18,050

 
19,900

Net Earnings
$
39,552

 
$
68,841

Per Common Share
 
 
 
Basic net earnings
$
0.71

 
$
1.17

Diluted net earnings
$
0.70

 
$
1.14

Cash dividends declared
$
0.33

 
$
0.30

See notes to consolidated financial statements.


CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited) (In thousands)

 
Thirteen Weeks Ended
 
March 25,
2016
 
March 27,
2015
Net Earnings
$
39,552

 
$
68,841

Components of other comprehensive income (loss)
 
 
 
Cumulative translation adjustment
(2,402
)
 
(3,011
)
Pension and postretirement medical liability adjustment
1,473

 
2,438

Income taxes - pension and postretirement medical liability adjustment
(569
)
 
(902
)
Other comprehensive income (loss)
(1,498
)
 
(1,475
)
Comprehensive Income
$
38,054

 
$
67,366

See notes to consolidated financial statements.

3

Table of Contents

GRACO INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited) (In thousands)
 
March 25,
2016
 
December 25,
2015
ASSETS
 
 
 
Current Assets
 
 
 
Cash and cash equivalents
$
36,490

 
$
52,295

Accounts receivable, less allowances of $11,400 and $10,400
226,030

 
225,509

Inventories
212,331

 
202,136

Other current assets
20,993

 
29,077

Total current assets
495,844

 
509,017

Property, Plant and Equipment
 
 
 
Cost
469,381

 
461,173

Accumulated depreciation
(285,170
)
 
(282,736
)
Property, plant and equipment, net
184,211

 
178,437

Goodwill
419,447

 
394,488

Other Intangible Assets, net
248,827

 
227,987

Deferred Income Taxes
58,674

 
56,976

Other Assets
23,995

 
24,447

Total Assets
$
1,430,998

 
$
1,391,352

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Current Liabilities
 
 
 
Notes payable to banks
$
14,508

 
$
15,901

Trade accounts payable
40,329

 
40,505

Salaries and incentives
27,886

 
44,673

Dividends payable
18,150

 
18,447

Other current liabilities
60,884

 
75,090

Total current liabilities
161,757

 
194,616

Long-term Debt
457,670

 
392,695

Retirement Benefits and Deferred Compensation
137,356

 
137,457

Deferred Income Taxes
28,577

 
22,303

Other Non-current Liabilities
8,730

 
8,730

Shareholders’ Equity
 
 
 
Common stock
55,566

 
55,766

Additional paid-in-capital
422,436

 
398,774

Retained earnings
264,901

 
285,508

Accumulated other comprehensive income (loss)
(105,995
)
 
(104,497
)
Total shareholders’ equity
636,908

 
635,551

Total Liabilities and Shareholders’ Equity
$
1,430,998

 
$
1,391,352

See notes to consolidated financial statements.

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Table of Contents

GRACO INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited) (In thousands)
 
Thirteen Weeks Ended
 
March 25,
2016
 
March 27,
2015
Cash Flows From Operating Activities
 
 
 
Net Earnings
$
39,552

 
$
68,841

Adjustments to reconcile net earnings to net cash provided by operating activities
 
 
 
Depreciation and amortization
12,010

 
10,810

Deferred income taxes
(2,688
)
 
(4,044
)
Share-based compensation
6,093

 
5,033

Excess tax benefit related to share-based payment arrangements
(3,300
)
 
(300
)
Change in
 
 
 
Accounts receivable
3,100

 
(26,632
)
Inventories
(8,127
)
 
(13,545
)
Trade accounts payable
119

 
6,088

Salaries and incentives
(17,191
)
 
(16,910
)
Retirement benefits and deferred compensation
669

 
3,171

Other accrued liabilities
(3,233
)
 
4,947

Other
(1,426
)
 
9,762

Net cash provided by operating activities
25,578

 
47,221

Cash Flows From Investing Activities
 
 
 
Property, plant and equipment additions
(13,121
)
 
(9,796
)
Acquisition of businesses, net of cash acquired
(48,881
)
 
(182,904
)
Investment in restricted assets
876

 

Other
320

 
38

Net cash provided by (used in) investing activities
(60,806
)
 
(192,662
)
Cash Flows From Financing Activities
 
 
 
Borrowings (payments) on short-term lines of credit, net
(1,461
)
 
47,605

Borrowings on long-term line of credit
298,709

 
379,095

Payments on long-term line of credit
(233,734
)
 
(227,055
)
Excess tax benefit related to share-based payment arrangements
3,300

 
300

Common stock issued
20,111

 
12,746

Common stock repurchased
(48,050
)
 
(46,935
)
Cash dividends paid
(18,332
)
 
(17,730
)
Net cash provided by (used in) financing activities
20,543

 
148,026

Effect of exchange rate changes on cash
(1,120
)
 
1,437

Net increase (decrease) in cash and cash equivalents
(15,805
)
 
4,022

Cash and cash equivalents
 
 
 
Beginning of year
52,295

 
23,656

End of period
$
36,490

 
$
27,678

See notes to consolidated financial statements.

5

Table of Contents

GRACO INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1.Basis of Presentation

The consolidated balance sheet of Graco Inc. and Subsidiaries (the “Company”) as of March 25, 2016 and the related statements of earnings for the thirteen weeks ended March 25, 2016 and March 27, 2015, and cash flows for the thirteen weeks ended March 25, 2016 and March 27, 2015 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 March 25, 2016, 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 2015 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.Earnings per Share

The following table sets forth the computation of basic and diluted earnings per share (in thousands, except per share amounts):
 
Thirteen Weeks Ended
 
March 25,
2016
 
March 27,
2015
Net earnings available to common shareholders
$
39,552

 
$
68,841

Weighted average shares outstanding for basic earnings per share
55,394

 
58,981

Dilutive effect of stock options computed using the treasury stock method and the average market price
1,315

 
1,484

Weighted average shares outstanding for diluted earnings per share
56,709

 
60,465

Basic earnings per share
$
0.71

 
$
1.17

Diluted earnings per share
$
0.70

 
$
1.14


Stock options to purchase 1,909,000 and 1,186,000 shares were not included in the March 25, 2016 and March 27, 2015 computations of diluted earnings per share, respectively, because they would have been anti-dilutive.

3.Share-Based Awards

Options on common shares granted and outstanding, as well as the weighted average exercise price, are shown below (in thousands, except exercise prices):
 
Option Shares
 
Weighted Average Exercise Price
 
Options Exercisable
 
Weighted Average Exercise Price
Outstanding, December 25, 2015
5,165

 
$
48.16

 
3,583

 
$
38.49

Granted
642

 
71.54

 
 
 
 
Exercised
(465
)
 
37.78

 
 
 
 
Canceled
(6
)
 
67.46

 
 
 
 
Outstanding, March 25, 2016
5,336

 
$
51.86

 
3,575

 
$
41.83


6

Table of Contents

The Company recognized year-to-date share-based compensation of $6.1 million in 2016 and $5.0 million in 2015. As of March 25, 2016, there was $17.0 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:
 
Thirteen Weeks Ended
 
March 25,
2016
 
March 27,
2015
Expected life in years
7.0

 
6.5

Interest rate
1.4
%
 
1.7
%
Volatility
30.3
%
 
35.3
%
Dividend yield
1.9
%
 
1.6
%
Weighted average fair value per share
$
18.89

 
$
23.42


Under the Company’s Employee Stock Purchase Plan, the Company issued 170,000 shares in 2016 and 166,000 shares in 2015. 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:
 
Thirteen Weeks Ended
 
March 25,
2016
 
March 27,
2015
Expected life in years
1.0

 
1.0

Interest rate
0.7
%
 
0.2
%
Volatility
19.3
%
 
18.9
%
Dividend yield
1.7
%
 
1.6
%
Weighted average fair value per share
$
17.49

 
$
16.51


4.Retirement Benefits

The components of net periodic benefit cost for retirement benefit plans were as follows (in thousands):
 
Thirteen Weeks Ended
 
March 25,
2016
 
March 27,
2015
Pension Benefits
 
 
 
Service cost
$
1,997

 
$
2,096

Interest cost
4,017

 
3,775

Expected return on assets
(4,637
)
 
(4,917
)
Amortization and other
2,300

 
2,353

Net periodic benefit cost
$
3,677

 
$
3,307

Postretirement Medical
 
 
 
Service cost
$
150

 
$
150

Interest cost
262

 
226

Amortization
(138
)
 
(101
)
Net periodic benefit cost
$
274

 
$
275



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5.Shareholders’ Equity

Changes in components of accumulated other comprehensive income (loss), net of tax were (in thousands):
 
Pension and Post-
retirement Medical
 
Cumulative
Translation
Adjustment
 
Total
Balance, December 26, 2014
$
(76,584
)
 
$
(24,152
)
 
$
(100,736
)
Other comprehensive income before reclassifications

 
(3,011
)
 
(3,011
)
Amounts reclassified from accumulated other comprehensive income
1,536

 

 
1,536

Balance, March 27, 2015
$
(75,048
)
 
$
(27,163
)
 
$
(102,211
)
Balance, December 25, 2015
$
(69,922
)
 
$
(34,575
)
 
$
(104,497
)
Other comprehensive income before reclassifications

 
(2,402
)
 
(2,402
)
Amounts reclassified from accumulated other comprehensive income
904

 

 
904

Balance, March 25, 2016
$
(69,018
)
 
$
(36,977
)
 
$
(105,995
)
.
 
 
 
 
 
.
 
 
 
 
 
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
 
March 25,
2016
 
March 27,
2015
Cost of products sold
$
528

 
$
938

Product development
204

 
383

Selling, marketing and distribution
486

 
703

General and administrative
255

 
414

Total before tax
$
1,473

 
$
2,438

Income tax (benefit)
(569
)
 
(902
)
Total after tax
$
904

 
$
1,536



8

Table of Contents

6.
Segment Information

The Company has three reportable segments, Industrial, Process and Contractor. Sales and operating earnings by segment were as follows (in thousands): 
 
Thirteen Weeks Ended
 
March 25,
2016
 
March 27,
2015
Net Sales
 
 
 
Industrial
$
147,088

 
$
143,266

Process
64,285

 
67,681

Contractor
93,539

 
95,506

Total
$
304,912

 
$
306,453

Operating Earnings
 
 
 
Industrial
$
45,794

 
$
42,940

Process
7,277

 
10,498

Contractor
16,743

 
19,375

Unallocated corporate (expense)
(8,865
)
 
(7,582
)
Total
$
60,949

 
$
65,231


Assets by segment were as follows (in thousands): 
 
March 25,
2016
 
December 25,
2015
Industrial
$
562,702

 
$
558,799

Process
532,447

 
481,677

Contractor
216,170

 
205,632

Unallocated corporate
119,679

 
145,244

Total
$
1,430,998

 
$
1,391,352


Geographic information follows (in thousands):
 
Thirteen Weeks Ended
 
March 25,
2016
 
March 27,
2015
Net sales (based on customer location)
 
 
 
United States
$
153,001

 
$
159,328

Other countries
151,911

 
147,125

Total
$
304,912

 
$
306,453

 
March 25,
2016
 
December 25,
2015
Long-lived assets
 
 
 
United States
$
148,058

 
$
144,571

Other countries
36,153

 
33,866

Total
$
184,211

 
$
178,437



9

Table of Contents

7.Inventories

Major components of inventories were as follows (in thousands):
 
March 25,
2016
 
December 25,
2015
Finished products and components
$
117,180

 
$
112,267

Products and components in various stages of completion
55,136

 
51,033

Raw materials and purchased components
84,556

 
82,894

 
256,872

 
246,194

Reduction to LIFO cost
(44,541
)
 
(44,058
)
Total
$
212,331

 
$
202,136


8.Intangible Assets

Information related to other intangible assets follows (dollars in thousands):
 
Estimated Life
(years)
 
Cost      
 
Accumulated
Amortization
 
Foreign
Currency Translation  
 
Book
Value
March 25, 2016
 
 
 
 
 
 
 
 
 
Customer relationships
3 - 14
 
$
218,227

 
$
(41,010
)
 
$
(9,306
)
 
$
167,911

Patents, proprietary technology and product documentation
3 - 11
 
22,222

 
(9,514
)
 
(576
)
 
12,132

Trademarks, trade names and other
5
 
595

 
(156
)
 
(79
)
 
360

 
 
 
241,044

 
(50,680
)
 
(9,961
)
 
180,403

Not Subject to Amortization:
 
 
 
 
 
 
 
 
 
Brand names
 
 
72,128

 

 
(3,704
)
 
68,424

Total
 
 
$
313,172

 
$
(50,680
)
 
$
(13,665
)
 
$
248,827

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 25, 2015
 
 
 
 
 
 
 
 
 
Customer relationships
3 - 14
 
$
197,900

 
$
(36,852
)
 
$
(9,738
)
 
$
151,310

Patents, proprietary technology and product documentation
3 - 11
 
20,400

 
(8,952
)
 
(658
)
 
10,790

Trademarks, trade names and other
5
 
495

 
(132
)
 
(94
)
 
269

 
 
 
218,795

 
(45,936
)
 
(10,490
)
 
162,369

Not Subject to Amortization:
 
 
 
 
 
 
 
 
 
Brand names
 
 
69,514

 

 
(3,896
)
 
65,618

Total
 
 
$
288,309

 
$
(45,936
)
 
$
(14,386
)
 
$
227,987


Amortization of intangibles for the quarter was $4.8 million in 2016 and $4.1 million in 2015. Estimated annual amortization expense is as follows: $19.0 million in 2016, $18.8 million in 2017 $18.5 million in 2018, $18.3 million in 2019, $18.2 million in 2020, and $92.4 million thereafter.

Changes in the carrying amount of goodwill in 2016 were as follows (in thousands): 
 
Industrial    
 
Process    
 
Contractor    
 
Total    
Balance, December 25, 2015
$
153,283

 
$
228,473

 
$
12,732

 
$
394,488

Additions from business acquisitions

 
27,049

 

 
27,049

Foreign currency translation
1,585

 
(3,675
)
 

 
(2,090
)
Balance, March 25, 2016
$
154,868

 
$
251,847

 
$
12,732

 
$
419,447


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Goodwill is reviewed for impairment annually in the fourth quarter and whenever events or changes in business circumstances indicate the carrying value of the goodwill may not be recoverable. In completing the goodwill impairment analysis for 2015, the estimated fair value of all reporting units substantially exceeded carrying value except for our Oil and Natural Gas reporting unit, which exceeded its carrying value by 14 percent. In the first quarter of 2016, the Company considered the impact of continuing weakness in the oil and natural gas markets and concluded that further impairment analysis was not required, however prolonged or deepened weakness could subject assets to impairment in the future.

9.
Other Current Liabilities
Components of other current liabilities were (in thousands):
 
March 25,
2016
 
December 25,
2015
Accrued self-insurance retentions
$
6,953

 
$
6,908

Accrued warranty and service liabilities
7,913

 
7,870

Accrued trade promotions
5,869

 
8,522

Payable for employee stock purchases
1,845

 
8,825

Customer advances and deferred revenue
8,393

 
9,449

Income taxes payable
4,770

 
1,308

Other
25,141

 
32,208

Total
$
60,884

 
$
75,090


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):
Balance, December 25, 2015
$
7,870

Charged to expense
1,655

Margin on parts sales reversed
120

Reductions for claims settled
(1,732
)
Balance, March 25, 2016
$
7,913


The Company manages certain self-insured loss exposures through a wholly-owned captive insurance subsidiary established in 2015. At March 25, 2016, cash balances of $9 million were restricted to funding of the captive's loss reserves. Restricted cash is included within other current assets on the Company's Consolidated Balance Sheet.


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10.Fair Value

Assets and liabilities measured at fair value on a recurring basis and fair value measurement level were as follows (in thousands):
 
Level   
 
March 25,
2016
 
December 25,
2015
Assets
 
 
 
 
 
Cash surrender value of life insurance
2
 
$
12,749

 
$
12,856

Forward exchange contracts
2
 

 
107

Total assets at fair value
 
 
$
12,749

 
$
12,963

Liabilities
 
 
 
 
 
Contingent consideration
3
 
$
4,081

 
$
9,600

Deferred compensation
2
 
2,991

 
2,958

Forward exchange contracts
2
 
603

 

Total liabilities at fair value
 
 
$
7,675

 
$
12,558


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.

Contingent consideration liability represents the estimated value (using a probability-weighted expected return approach) of future payments to be made to previous owners of an acquired business based on future revenues.

Long-term notes payable with fixed interest rates have a carrying amount of $300 million and an estimated fair value of $330 million as of March 25, 2016 and $320 million as of December 25, 2015. The fair value of variable rate borrowings approximates carrying value. The Company uses significant other observable inputs to estimate fair value (level 2 of the fair value hierarchy) 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.Divestiture in 2015

Net earnings in the first quarter of 2015 included $30 million of net investment income from the Liquid Finishing businesses sold in the second quarter of 2015. The Liquid Finishing businesses were held as a cost method investment, and prior to the sale, income was recognized on dividends received from post-tax earnings of Liquid Finishing.

12.Recent Accounting Pronouncements

In February 2016, the Financial Accounting Standards Board (FASB) issued a final standard on accounting for leases. The new standard is effective for the Company in fiscal 2019 and requires most leases to be recorded on the balance sheet. The Company is evaluating the effect of the new standard on its consolidated financial statements and related disclosures and accounting systems.

In March 2016, FASB issued a new standard that changes the accounting for share-based payments. The standard is effective for the Company in fiscal 2017 and early adoption is permitted. It simplifies several aspects of accounting for share-based payments, including the accounting for income taxes, forfeitures, and classification in the statement of cash flows. Under the new standard, excess tax benefits on the exercise of stock options currently credited to equity will reduce the current tax provision, potentially creating volatility in the Company's effective tax rate. The Company is evaluating the effect of the new standard on its consolidated financial statements and related disclosures and is considering whether or not to early adopt.

12

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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, Process and Contractor. 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. 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.

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 25,
2016
 
March 27,
2015
 
%
 Change 
Net Sales
$
304.9

 
$
306.5

 
(1
)%
Operating Earnings
60.9

 
65.2

 
(7
)%
Net Earnings
$
39.6

 
$
68.8

 
(43
)%
Diluted Net Earnings per Common Share
$
0.70

 
$
1.14

 
(39
)%

Net earnings in the first quarter of 2015 included $30 million ($0.49 per diluted share) of net investment income from the Liquid Finishing businesses sold in the second quarter of 2015. Results excluding Liquid Finishing investment income and expense provide a more consistent base of comparison to future results. A calculation of the non-GAAP measurement of net earnings excluding investment income and expense follows (in millions except per share amounts):
 
Thirteen Weeks Ended    
 
March 25,
2016
 
March 27,
2015
Net Earnings, as reported
$
39.6

 
$
68.8

Held separate investment (income), net

 
(29.5
)
Income tax effect

 
(0.2
)
Net Earnings, adjusted
$
39.6

 
$
39.1

Diluted earnings per share
 
 
 
As reported
$
0.70

 
$
1.14

Adjusted
$
0.70

 
$
0.65


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Table of Contents

The following table presents components of changes in sales:
 
Year-to-Date
 
Segment
 
Region
 
Total    
 
Industrial  
 
Process  
 
Contractor  
 
Americas(1)
 
EMEA(2)
 
Asia Pacific  
 
Volume and Price
3
 %
 
(11
)%
 
(1
)%
 
(7
)%
 
10
 %
 
6
 %
 
(1
)%
Acquisitions
2
 %
 
8
 %
 
 %
 
1
 %
 
3
 %
 
3
 %
 
2
 %
Currency
(2
)%
 
(2
)%
 
(1
)%
 
 %
 
(3
)%
 
(3
)%
 
(2
)%
Total
3
 %
 
(5
)%
 
(2
)%
 
(6
)%
 
10
 %
 
6
 %
 
(1
)%
(1) North and South America, including the United States
(2) Europe, Middle East and Africa

Sales by geographic area were as follows (in millions):
 
Thirteen Weeks Ended    
 
March 25,
2016
 
March 27,
2015
Americas
$
173.4

 
$
184.8

EMEA
75.7

 
68.8

Asia Pacific
55.8

 
52.9

Consolidated
$
304.9

 
$
306.5


Sales decreased 1 percent, though at consistent translation rates they increased 1 percent. Increases of 10 percent in EMEA (13 percent at consistent translation rates) and 6 percent in Asia Pacific (9 percent at consistent translation rates) were largely offset by a 6 percent decrease in the Americas. Incremental sales from operations acquired within the last 12 months totaled $7 million, contributing 2 percentage points of growth. Organic sales at consistent translation rates decreased 1 percent, with increases of 10 percent in EMEA, 6 percent in Asia Pacific and a decrease of 7 percent in the Americas.

Gross profit margin rates were consistent with the rates in the first quarter of last year. Favorable effects of realized pricing and reduced acquisition related purchase accounting effects offset the impact of lower factory volume and product mix.

Total operating expenses were $4 million (4 percent) higher than the first quarter last year. The increase included expenses of acquired operations totaling $3 million. Unallocated corporate expenses increased $1 million, mostly from increases in stock compensation and pension, partially offset by a decrease in divestiture costs.

The effective income tax rate was 31 percent, up from 22 percent last year. Post-tax dividend income reduced the effective rate in the first quarter of 2015. The effective rate in the first quarter of 2016 benefited from foreign earnings taxed at lower rates than the U.S. rate and the federal R&D credit that was not reinstated in the first quarter of 2015.


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Table of Contents

Segment Results

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

Industrial
 
Thirteen Weeks Ended    
 
March 25,
2016
 
March 27,
2015
Net sales (in millions)
 
 
 
Americas
$
65.1

 
$
67.8

EMEA
44.2

 
41.0

Asia Pacific
37.8

 
34.5

Total
$
147.1

 
$
143.3

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

Industrial segment sales increased 3 percent (5 percent at consistent translation rates). A 4 percent decrease in the Americas was more than offset by increases of 8 percent in EMEA (11 percent at consistent translation rates) and 10 percent in Asia Pacific (12 percent at consistent translation rates). Operating margin rates for the Industrial segment were slightly higher than last year due to improved gross margin rates and expense leverage on higher sales volume.

Process
 
Thirteen Weeks Ended    
 
March 25,
2016
 
March 27,
2015
Net sales (in millions)
 
 
 
Americas
$
40.0

 
$
42.9

EMEA
13.9

 
13.9

Asia Pacific
10.4

 
10.9

Total
$
64.3

 
$
67.7

Operating earnings as a percentage of net sales
11
%
 
16
%

Process segment sales decreased 5 percent (3 percent at consistent translation rates), including decreases of 7 percent in the Americas and 5 percent in Asia Pacific (2 percent at consistent translation rates). Sales in EMEA were flat, and increased 4 percent at consistent translation rates. Operating margin rate decreased compared to last year with improvements in gross margin offset by unfavorable expense leverage.

Contractor
 
Thirteen Weeks Ended    
 
March 25,
2016
 
March 27,
2015
Net sales (in millions)
 
 
 
Americas
$
68.3

 
$
74.2

EMEA
17.6

 
13.9

Asia Pacific
7.6

 
7.4

Total
$
93.5

 
$
95.5

Operating earnings as a percentage of net sales
18
%
 
20
%


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Table of Contents

Contractor segment sales decreased 2 percent (1 percent at consistent translation rates), with an 8 percent decrease in the Americas partially offset by increases of 26 percent in EMEA (29 percent at consistent translation rates) and 3 percent in Asia Pacific (8 percent at consistent translation rates). Operating margin rate decreased due to unfavorable expense leverage on lower sales volume.

Liquidity and Capital Resources

Net cash provided by operating activities of $26 million decreased $22 million from the comparable period of 2015, mostly due to a decrease in net earnings. Net earnings in the first quarter of 2015 included $30 million of post-tax dividends from the Liquid Finishing businesses that were sold in the second quarter of 2015. In the first quarter of 2016, the Company used proceeds from borrowings under its revolving line of credit to complete acquisitions of two related businesses that were not material to the consolidated financial statements. Other significant uses of cash in the first quarter of 2016 included share repurchases of $48 million and cash dividends of $18 million.

At March 25, 2016, cash balances of $9 million were restricted to funding of certain self-insured loss reserves. Restricted cash is included within other current assets on the Company's Consolidated Balance Sheets.

At March 25, 2016, the Company had various lines of credit totaling $546 million, of which $376 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 2016.

Outlook

We maintain our outlook for the full year of low to mid single-digit organic constant currency growth for Graco worldwide and expect growth in every region and reportable segment. We expect the Americas to generate mid single-digit growth, and the EMEA and Asia Pacific regions to generate low single-digit growth. There is some risk in our Process segment outlook, reflecting continued headwinds in the oil and natural gas market, however we continue to believe this segment will achieve organic constant currency growth in 2016. While we are mindful of opportunities to reduce discretionary spending, our intent is to press forward with investments in our growth initiatives and we are confident these initiatives will provide a solid long-term return to our shareholders.

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, Form 10-Qs and Form 8-Ks, and other disclosures, including our 2015 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: our Company’s growth strategies, which include making acquisitions, investing in new products, expanding geographically and targeting new industries; economic conditions in the United States and other major world economies; changes in currency translation rates; changes in laws and regulations; compliance with anti-corruption laws; new entrants who copy our products or infringe on our intellectual property; risks incident to conducting business internationally; the ability to meet our customers’ needs and changes in product demand; supply interruptions or delays; security breaches; the possibility of asset impairments if acquired businesses do not meet performance expectations; political instability; results of and costs associated with, litigation, administrative proceedings and regulatory reviews incident to our business as well as indemnification claims under our asset purchase agreement with Carlisle Companies Incorporated, Carlisle Fluid Technologies, Inc., and Finishing Brands Holdings Inc.; the possibility of decline in purchases from few large customers of the Contractor segment; variations in activity in the construction, automotive, mining and oil and natural gas industries; our ability to attract, develop and retain qualified personnel; and catastrophic events. Please refer to Item 1A of our Annual Report on Form 10-K for fiscal year 2015 for a more comprehensive discussion of these and other risk

16

Table of Contents

factors. These reports are available on the Company’s website at www.graco.com 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 2015 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 and Treasurer, the Vice President, Controller and Information Systems, 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.

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Table of Contents

PART IIOTHER INFORMATION

Item 1A.Risk Factors

There have been no material changes to the Company’s risk factors from those disclosed in the Company’s 2015 Annual Report on Form 10-K.

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

Issuer Purchases of Equity Securities

On April 24, 2015, 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 is for an indefinite period of time or until terminated by the Board.

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 due upon exercise of options or vesting of restricted stock.

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)
December 26, 2015 - January 22, 2016
538,624

 
$
65.62

 
538,624

 
4,040,800

January 23, 2016 - February 19, 2016
188,433

 
$
67.42

 
188,433

 
3,852,367

February 20, 2016 - March 25, 2016

 

 

 



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Table of Contents

Item 6.Exhibits
3.1

 
Restated Articles of Incorporation as amended June 13, 2014. (Incorporated by reference to Exhibit 3.1 to the Company’s Report on Form 8-K filed June 16, 2014.)
 
 
 
3.2

 
Restated Bylaws as amended February 14, 2014. (Incorporated by reference to Exhibit 3.2 to the Company’s 2013 Annual Report on Form 10-K.)
 
 
 
10.1

 
Stock Option Agreement. Form of agreement used for award of non-incentive stock options to Chief Executive Officer under the Graco Inc. 2015 Stock Incentive Plan in 2016 .
 
 
 
10.2

 
Stock Option Agreement. Form of agreement used for award of non-incentive stock options to executive officers under the Graco Inc. 2015 Stock Incentive Plan in 2016.
 
 
 
31.1

 
Certification of President and Chief Executive Officer pursuant to Rule 13a-14(a).
 
 
 
31.2

 
Certification of Chief Financial Officer and Treasurer pursuant to Rule 13a-14(a).
 
 
 
32

 
Certification of President and Chief Executive Officer and Chief Financial Officer and Treasurer pursuant to Section 1350 of Title 18, U.S.C.
 
 
 
99.1

 
Press Release Reporting First Quarter Earnings dated April 20, 2016.
 
 
 
101

 
Interactive Data File.

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Table of Contents

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:
 
April 20, 2016
 
By:
 
/s/ Patrick J. McHale
 
 
 
 
 
 
Patrick J. McHale
 
 
 
 
 
 
President and Chief Executive Officer
 
 
 
 
 
 
(Principal Executive Officer)
 
 
 
 
Date:
 
April 20, 2016
 
By:
 
/s/ Christian E. Rothe
 
 
 
 
 
 
Christian E. Rothe
 
 
 
 
 
 
Chief Financial Officer and Treasurer
 
 
 
 
 
 
(Principal Financial Officer)
 
 
 
 
Date:
 
April 20, 2016
 
By:
 
/s/ Caroline M. Chambers
 
 
 
 
 
 
Caroline M. Chambers
 
 
 
 
 
 
Vice President, Corporate Controller
     and Information Systems
 
 
 
 
 
 
(Principal Accounting Officer)