MANAGEMENTS 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 Companys 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 Managements Discussion and Analysis reviews significant factors affecting the
Companys 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 Gracos 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 Companys 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 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
17
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.
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.
18
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
|
|
|
|
|
|
|
Americas
1
|
|
$
|
160.7
|
|
|
$
|
140.6
|
|
|
$
|
298.9
|
|
|
$
|
266.6
|
|
EMEA
2
|
|
|
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
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1
North and South America, including the U.S.
2
Europe, 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 55
1
⁄
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 years gross margin rate by approximately 3 percentage points for the quarter and 1
1
⁄
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
19
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 Companys 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 years 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.
20
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.
21
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 FTCs 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.
22
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 Companys 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 Companys 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 Companys
website at www.graco.com/ir and the Securities and Exchange Commissions 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 Companys future results. It is not possible for management to identify each and every factor that may have an impact on the Companys operations in the future as new factors can develop from time to time.
23