NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1.
Basis of Presentation
The consolidated balance sheet of Graco Inc. and Subsidiaries (the “Company”) as of
June 24, 2016
and the related statements of earnings for the thirteen and
twenty-six weeks
ended
June 24, 2016
and
June 26, 2015
, and cash flows for the
twenty-six weeks
ended
June 24, 2016
and
June 26, 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
June 24, 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
|
|
Twenty-six Weeks Ended
|
|
June 24,
2016
|
|
June 26,
2015
|
|
June 24,
2016
|
|
June 26,
2015
|
Net earnings available to common shareholders
|
$
|
50,947
|
|
|
$
|
172,637
|
|
|
$
|
90,499
|
|
|
$
|
241,478
|
|
Weighted average shares outstanding for basic earnings per share
|
55,634
|
|
|
58,235
|
|
|
55,514
|
|
|
58,608
|
|
Dilutive effect of stock options computed using the treasury stock method and the average market price
|
1,406
|
|
|
1,387
|
|
|
1,361
|
|
|
1,436
|
|
Weighted average shares outstanding for diluted earnings per share
|
57,040
|
|
|
59,622
|
|
|
56,875
|
|
|
60,044
|
|
Basic earnings per share
|
$
|
0.92
|
|
|
$
|
2.96
|
|
|
$
|
1.63
|
|
|
$
|
4.12
|
|
Diluted earnings per share
|
$
|
0.89
|
|
|
$
|
2.90
|
|
|
$
|
1.59
|
|
|
$
|
4.02
|
|
Stock options to purchase
509,000
and
1,357,000
shares were not included in the
June 24, 2016
and
June 26, 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
|
700
|
|
|
72.24
|
|
|
|
|
|
Exercised
|
(568
|
)
|
|
38.40
|
|
|
|
|
|
Canceled
|
(13
|
)
|
|
69.16
|
|
|
|
|
|
Outstanding, June 24, 2016
|
5,284
|
|
|
$
|
52.35
|
|
|
3,517
|
|
|
$
|
42.14
|
|
The Company recognized year-to-date share-based compensation of
$12.7 million
in
2016
and
$11.0 million
in
2015
. As of
June 24, 2016
, there was
$12.5 million
of unrecognized compensation cost related to unvested options, expected to be recognized over a weighted average period of
2.1 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
|
|
June 24,
2016
|
|
June 26,
2015
|
Expected life in years
|
7.0
|
|
|
6.5
|
|
Interest rate
|
1.4
|
%
|
|
1.7
|
%
|
Volatility
|
30.1
|
%
|
|
35.1
|
%
|
Dividend yield
|
1.8
|
%
|
|
1.6
|
%
|
Weighted average fair value per share
|
$
|
19.00
|
|
|
$
|
23.22
|
|
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:
|
|
|
|
|
|
|
|
|
|
Twenty-six Weeks Ended
|
|
June 24,
2016
|
|
June 26,
2015
|
Expected life in years
|
1.0
|
|
|
1.0
|
|
Interest rate
|
0.7
|
%
|
|
0.2
|
%
|
Volatility
|
24.6
|
%
|
|
18.9
|
%
|
Dividend yield
|
1.7
|
%
|
|
1.6
|
%
|
Weighted average fair value per share
|
$
|
19.14
|
|
|
$
|
16.51
|
|
4.
Retirement Benefits
The components of net periodic benefit cost for retirement benefit plans were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Thirteen Weeks Ended
|
|
Twenty-six Weeks Ended
|
|
June 24,
2016
|
|
June 26,
2015
|
|
June 24,
2016
|
|
June 26,
2015
|
Pension Benefits
|
|
|
|
|
|
|
|
Service cost
|
$
|
1,915
|
|
|
$
|
1,907
|
|
|
$
|
3,912
|
|
|
$
|
4,003
|
|
Interest cost
|
3,846
|
|
|
3,605
|
|
|
7,863
|
|
|
7,380
|
|
Expected return on assets
|
(4,368
|
)
|
|
(4,659
|
)
|
|
(9,005
|
)
|
|
(9,576
|
)
|
Amortization and other
|
2,619
|
|
|
2,426
|
|
|
4,919
|
|
|
4,779
|
|
Net periodic benefit cost
|
$
|
4,012
|
|
|
$
|
3,279
|
|
|
$
|
7,689
|
|
|
$
|
6,586
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Postretirement Medical
|
|
|
|
|
|
|
|
Service cost
|
$
|
121
|
|
|
$
|
150
|
|
|
$
|
271
|
|
|
$
|
300
|
|
Interest cost
|
280
|
|
|
227
|
|
|
542
|
|
|
453
|
|
Amortization
|
(102
|
)
|
|
(101
|
)
|
|
(240
|
)
|
|
(202
|
)
|
Net periodic benefit cost
|
$
|
299
|
|
|
$
|
276
|
|
|
$
|
573
|
|
|
$
|
551
|
|
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, March 27, 2015
|
$
|
(75,048
|
)
|
|
$
|
(27,163
|
)
|
|
$
|
(102,211
|
)
|
Other comprehensive income before reclassifications
|
—
|
|
|
12,404
|
|
|
12,404
|
|
Amounts reclassified from accumulated other comprehensive income
|
1,180
|
|
|
—
|
|
|
1,180
|
|
Balance, June 26, 2015
|
$
|
(73,868
|
)
|
|
$
|
(14,759
|
)
|
|
$
|
(88,627
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, March 25, 2016
|
$
|
(69,018
|
)
|
|
$
|
(36,977
|
)
|
|
$
|
(105,995
|
)
|
Other comprehensive income before reclassifications
|
—
|
|
|
(7,635
|
)
|
|
(7,635
|
)
|
Amounts reclassified from accumulated other comprehensive income
|
1,142
|
|
|
—
|
|
|
1,142
|
|
Balance, June 24, 2016
|
$
|
(67,876
|
)
|
|
$
|
(44,612
|
)
|
|
$
|
(112,488
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 26, 2014
|
$
|
(76,584
|
)
|
|
$
|
(24,152
|
)
|
|
$
|
(100,736
|
)
|
Other comprehensive income before reclassifications
|
—
|
|
|
9,393
|
|
|
9,393
|
|
Reclassified from accumulated other comprehensive income
|
2,716
|
|
|
—
|
|
|
2,716
|
|
Balance, June 26, 2015
|
$
|
(73,868
|
)
|
|
$
|
(14,759
|
)
|
|
$
|
(88,627
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 25, 2015
|
$
|
(69,922
|
)
|
|
$
|
(34,575
|
)
|
|
$
|
(104,497
|
)
|
Other comprehensive income before reclassifications
|
—
|
|
|
(10,037
|
)
|
|
(10,037
|
)
|
Reclassified from accumulated other comprehensive income
|
2,046
|
|
|
—
|
|
|
2,046
|
|
Balance, June 24, 2016
|
$
|
(67,876
|
)
|
|
$
|
(44,612
|
)
|
|
$
|
(112,488
|
)
|
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
|
|
Twenty-six Weeks Ended
|
|
June 24,
2016
|
|
June 26,
2015
|
|
June 24,
2016
|
|
June 26,
2015
|
Cost of products sold
|
$
|
637
|
|
|
$
|
707
|
|
|
$
|
1,165
|
|
|
$
|
1,645
|
|
Product development
|
261
|
|
|
319
|
|
|
465
|
|
|
702
|
|
Selling, marketing and distribution
|
569
|
|
|
529
|
|
|
1,055
|
|
|
1,232
|
|
General and administrative
|
310
|
|
|
364
|
|
|
565
|
|
|
778
|
|
Total before tax
|
$
|
1,777
|
|
|
$
|
1,919
|
|
|
$
|
3,250
|
|
|
$
|
4,357
|
|
Income tax (benefit)
|
(635
|
)
|
|
(739
|
)
|
|
(1,204
|
)
|
|
(1,641
|
)
|
Total after tax
|
$
|
1,142
|
|
|
$
|
1,180
|
|
|
$
|
2,046
|
|
|
$
|
2,716
|
|
The Company has
three
reportable segments, Industrial, Process and Contractor. Sales and operating earnings by segment were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Thirteen Weeks Ended
|
|
Twenty-six Weeks Ended
|
|
June 24,
2016
|
|
June 26,
2015
|
|
June 24,
2016
|
|
June 26,
2015
|
Net Sales
|
|
|
|
|
|
|
|
Industrial
|
$
|
156,997
|
|
|
$
|
153,502
|
|
|
$
|
304,085
|
|
|
$
|
296,768
|
|
Process
|
64,706
|
|
|
71,946
|
|
|
128,991
|
|
|
139,627
|
|
Contractor
|
126,423
|
|
|
110,041
|
|
|
219,962
|
|
|
205,547
|
|
Total
|
$
|
348,126
|
|
|
$
|
335,489
|
|
|
$
|
653,038
|
|
|
$
|
641,942
|
|
Operating Earnings
|
|
|
|
|
|
|
|
Industrial
|
$
|
51,052
|
|
|
$
|
50,738
|
|
|
$
|
96,846
|
|
|
$
|
93,678
|
|
Process
|
7,634
|
|
|
13,988
|
|
|
14,911
|
|
|
24,486
|
|
Contractor
|
29,364
|
|
|
27,040
|
|
|
46,107
|
|
|
46,415
|
|
Unallocated corporate (expense)
|
(9,708
|
)
|
|
(7,875
|
)
|
|
(18,573
|
)
|
|
(15,457
|
)
|
Total
|
$
|
78,342
|
|
|
$
|
83,891
|
|
|
$
|
139,291
|
|
|
$
|
149,122
|
|
Assets by segment were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
June 24,
2016
|
|
December 25,
2015
|
Industrial
|
$
|
563,914
|
|
|
$
|
558,799
|
|
Process
|
520,931
|
|
|
481,677
|
|
Contractor
|
228,587
|
|
|
205,632
|
|
Unallocated corporate
|
137,457
|
|
|
145,244
|
|
Total
|
$
|
1,450,889
|
|
|
$
|
1,391,352
|
|
Geographic information follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Thirteen Weeks Ended
|
|
Twenty-six Weeks Ended
|
|
June 24,
2016
|
|
June 26,
2015
|
|
June 24,
2016
|
|
June 26,
2015
|
Net sales
(based on customer location)
|
|
|
|
|
|
|
|
United States
|
$
|
186,284
|
|
|
$
|
170,921
|
|
|
$
|
339,285
|
|
|
$
|
330,249
|
|
Other countries
|
161,842
|
|
|
164,568
|
|
|
313,753
|
|
|
311,693
|
|
Total
|
$
|
348,126
|
|
|
$
|
335,489
|
|
|
$
|
653,038
|
|
|
$
|
641,942
|
|
|
|
|
|
|
|
|
|
|
|
June 24,
2016
|
|
December 25,
2015
|
Long-lived assets
|
|
|
|
United States
|
$
|
152,885
|
|
|
$
|
144,571
|
|
Other countries
|
36,784
|
|
|
33,866
|
|
Total
|
$
|
189,669
|
|
|
$
|
178,437
|
|
7.
Inventories
Major components of inventories were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
June 24,
2016
|
|
December 25,
2015
|
Finished products and components
|
$
|
112,402
|
|
|
$
|
112,267
|
|
Products and components in various stages of completion
|
53,886
|
|
|
51,033
|
|
Raw materials and purchased components
|
83,999
|
|
|
82,894
|
|
|
250,287
|
|
|
246,194
|
|
Reduction to LIFO cost
|
(44,943
|
)
|
|
(44,058
|
)
|
Total
|
$
|
205,344
|
|
|
$
|
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
|
June 24, 2016
|
|
|
|
|
|
|
|
|
|
Customer relationships
|
3 - 14
|
|
$
|
218,227
|
|
|
$
|
(45,238
|
)
|
|
$
|
(10,949
|
)
|
|
$
|
162,040
|
|
Patents, proprietary technology and product documentation
|
3 - 11
|
|
17,422
|
|
|
(5,287
|
)
|
|
(649
|
)
|
|
11,486
|
|
Trademarks, trade names and other
|
3 - 5
|
|
895
|
|
|
(232
|
)
|
|
(66
|
)
|
|
597
|
|
|
|
|
236,544
|
|
|
(50,757
|
)
|
|
(11,664
|
)
|
|
174,123
|
|
Not Subject to Amortization:
|
|
|
|
|
|
|
|
|
|
Brand names
|
|
|
70,528
|
|
|
—
|
|
|
(4,244
|
)
|
|
66,284
|
|
Total
|
|
|
$
|
307,072
|
|
|
$
|
(50,757
|
)
|
|
$
|
(15,908
|
)
|
|
$
|
240,407
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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
$4.9 million
in
2016
and
$4.4 million
in
2015
and for the year-to-date was
$9.6 million
in
2016
and
$8.5 million
in
2015
. Estimated annual amortization expense is as follows:
$18.8 million
in
2016
,
$18.7 million
in
2017
,
$18.5 million
in
2018
,
$18.2 million
in
2019
,
$18.0 million
in
2020
, and
$91.5 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
|
—
|
|
|
28,348
|
|
|
—
|
|
|
28,348
|
|
Foreign currency translation
|
1,430
|
|
|
(8,078
|
)
|
|
—
|
|
|
(6,648
|
)
|
Balance, June 24, 2016
|
$
|
154,713
|
|
|
$
|
248,743
|
|
|
$
|
12,732
|
|
|
$
|
416,188
|
|
Goodwill is reviewed for impairment annually or more frequently if events or changes in circumstances indicate that 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 second quarter of 2016, the Company considered the impact of continuing weakness in the oil and natural gas markets as well as the financial performance of the reporting unit when evaluating whether it is more likely than not the fair value of the reporting unit will be less than its carrying value. The Company concluded that further impairment analysis was not required. We continue to monitor operational performance measures of the reporting unit noting that prolonged or deepened weakness could subject the goodwill to impairment in the future. As of June 24, 2016, goodwill for the Oil and Natural Gas reporting unit was
$150 million
.
|
|
9.
|
Other Current Liabilities
|
Components of other current liabilities were (in thousands):
|
|
|
|
|
|
|
|
|
|
June 24,
2016
|
|
December 25,
2015
|
Accrued self-insurance retentions
|
$
|
6,998
|
|
|
$
|
6,908
|
|
Accrued warranty and service liabilities
|
8,051
|
|
|
7,870
|
|
Accrued trade promotions
|
5,724
|
|
|
8,522
|
|
Payable for employee stock purchases
|
4,619
|
|
|
8,825
|
|
Customer advances and deferred revenue
|
9,475
|
|
|
9,449
|
|
Income taxes payable
|
5,965
|
|
|
1,308
|
|
Other
|
24,646
|
|
|
32,208
|
|
Total
|
$
|
65,478
|
|
|
$
|
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
|
3,355
|
|
Margin on parts sales reversed
|
589
|
|
Reductions for claims settled
|
(3,763
|
)
|
Balance, June 24, 2016
|
$
|
8,051
|
|
The Company manages certain self-insured loss exposures through a wholly-owned captive insurance subsidiary established in 2015. At
June 24, 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.
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
|
|
June 24,
2016
|
|
December 25,
2015
|
Assets
|
|
|
|
|
|
Cash surrender value of life insurance
|
2
|
|
$
|
12,805
|
|
|
$
|
12,856
|
|
Forward exchange contracts
|
2
|
|
—
|
|
|
107
|
|
Total assets at fair value
|
|
|
$
|
12,805
|
|
|
$
|
12,963
|
|
Liabilities
|
|
|
|
|
|
Contingent consideration
|
3
|
|
$
|
4,081
|
|
|
$
|
9,600
|
|
Deferred compensation
|
2
|
|
3,176
|
|
|
2,958
|
|
Forward exchange contracts
|
2
|
|
374
|
|
|
—
|
|
Total liabilities at fair value
|
|
|
$
|
7,631
|
|
|
$
|
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
$335 million
as of
June 24, 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
In the second quarter of 2015, the Company sold the Liquid Finishing business assets that were held as a cost-method investment. The
$147 million
pre-tax gain, net of transaction and other related expenses, was included in investment income in the Company's consolidated statements of earnings. Prior to the sale, income was recognized on dividends received from after-tax earnings of Liquid Finishing and also included in investment income. Net earnings in 2015 included dividend income of
$12 million
for the quarter and
$42 million
for the year-to-date.
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 will adopt for fiscal 2017.
Item 2. GRACO INC. AND SUBSIDIARIES