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 September 28, 2012
Commission File Number: 001-09249
GRACO INC.
(Exact name of registrant as specified in its charter)
88 - 11th Avenue N.E.
Minneapolis, Minnesota
(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.
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).
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.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
60,673,000 shares of the Registrant’s Common Stock, $1.00 par value, were outstanding as of October 18, 2012.
INDEX
PART I
FINANCIAL INFORMATION
Item 1.
Item 2.
Item 3.
Quantitative and Qualitative Disclosures About
Market Risk
Item 4.
Item 1A.
Item 6.
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GRACO INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
(Unaudited) (In thousands except per share amounts)
Net Sales
Cost of products sold
Gross Profit
Product development
Selling, marketing and distribution
General and administrative
Operating Earnings
Interest expense
Other expense (income), net
Earnings Before Income Taxes
Income taxes
Net Earnings
Per Common Share
Basic net earnings
Diluted net earnings
Cash dividends declared
See notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited) (In thousands)
Other comprehensive income (loss)
Cumulative translation adjustment
Pension and postretirement medical liability adjustment
Gain (loss) on interest rate hedge contracts
Comprehensive Income
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CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands)
ASSETS
Current Assets
Cash and cash equivalents
Accounts receivable, less allowances of $5,900 and $5,500
Inventories
Deferred income taxes
Investment in businesses held separate
Other current assets
Total current assets
Property, Plant and Equipment
Cost
Accumulated depreciation
Property, plant and equipment, net
Goodwill
Other Intangible Assets, net
Deferred Income Taxes
Other Assets
Total Assets
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities
Notes payable to banks
Trade accounts payable
Salaries and incentives
Dividends payable
Other current liabilities
Total current liabilities
Long-term Debt
Retirement Benefits and Deferred Compensation
Shareholders’ Equity
Common stock
Additional paid-in-capital
Retained earnings
Accumulated other comprehensive income (loss)
Total shareholders’ equity
Total Liabilities and Shareholders’ Equity
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CONSOLIDATED STATEMENTS OF CASH FLOWS
Cash Flows From Operating Activities
Adjustments to reconcile net earnings to net cash provided by operating activities
Depreciation and amortization
Share-based compensation
Excess tax benefit related to share-based payment arrangements
Change in
Accounts receivable
Retirement benefits and deferred compensation
Other accrued liabilities
Other
Net cash provided by operating activities
Cash Flows From Investing Activities
Property, plant and equipment additions
Proceeds from sale of property, plant and equipment
Acquisition of businesses, net of cash acquired
Investment in life insurance
Capitalized software and other intangible asset additions
Net cash used in investing activities
Cash Flows From Financing Activities
Borrowings on short-term lines of credit
Payments on short-term lines of credit
Borrowings on long-term notes and line of credit
Payments on long-term line of credit
Payments of debt issuance costs
Common stock issued
Common stock repurchased
Cash dividends paid
Net cash provided by (used in) financing activities
Effect of exchange rate changes on cash
Net increase (decrease) in cash and cash equivalents
Beginning of year
End of period
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 Graco Inc. and Subsidiaries as of September 28, 2012, 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 2011 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.
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Net earnings available to common shareholders
Weighted average shares outstanding for basic earnings per share
Dilutive effect of stock options computed using the treasury stock method and the average market price
Weighted average shares outstanding for diluted earnings per share
Basic earnings per share
Diluted earnings per share
Stock options to purchase 945,000 and 1,161,000 shares were not included in the September 28, 2012 and September 30, 2011 computations of diluted earnings per share, respectively, because they would have been anti-dilutive.
Outstanding, December 30, 2011
Granted
Exercised
Canceled
Outstanding, September 28, 2012
The Company recognized year-to-date share-based compensation of $10.0 million in 2012 and $8.8 million in 2011. As of September 28, 2012, there was $10.2 million of unrecognized compensation cost related to unvested options, expected to be recognized over a weighted average period of 1.9 years.
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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:
Expected life in years
Interest rate
Volatility
Dividend yield
Weighted average fair value per share
Under the Company’s Employee Stock Purchase Plan, the Company issued 239,000 shares in 2012 and 313,000 shares in 2011. 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:
In May 2012, the Company granted 6,000 Restricted Share Units to a key employee that will vest on the third anniversary of the date of grant. The market value of the units at the date of grant will be charged to operations over the vesting period. The expense related to this arrangement is not significant.
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Pension Benefits
Service cost
Interest cost
Expected return on assets
Amortization and other
Net periodic benefit cost
Postretirement Medical
Amortization
Total
The functional currency of certain subsidiaries related to businesses acquired in April 2012, is the local currency. Accordingly, adjustments resulting from the translation of those subsidiaries’ financial statements into U.S. dollars are charged or credited to accumulated other comprehensive income (loss).
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Industrial
Contractor
Lubrication
Unallocated corporate (expense)
Unallocated corporate includes acquisition-related expenses of $4 million for the quarter and $15 million year-to-date in 2012 and $3 million for the quarter and $6 million year-to-date in 2011.
Assets by segment were as follows (in thousands):
Unallocated corporate
Unallocated corporate in 2012 includes $427 million of investment in businesses held separate (see note 12).
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Geographic information follows (in thousands):
Net sales
(based on customer location)
United States
Other countries
Long-lived assets
Finished products and components
Products and components in various stages of completion
Raw materials and purchased components
Reduction to LIFO cost
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September 28, 2012
Customer relationships
Patents, proprietary technology and product documentation
Trademarks, trade names and other
Not Subject to Amortization:
Brand names
December 30, 2011
Amortization of intangibles for the quarter was $4.1 million in 2012 and $2.6 million in 2011, and for the year-to-date was $11.0 million in 2012 and $8.4 million in 2011. Estimated annual amortization expense is as follows: $15.0 million in 2012, $12.4 million in 2013, $9.1 million in 2014, $8.6 million in 2015, $8.3 million in 2016 and $71.7 million thereafter.
Changes in the carrying amount of goodwill in 2012 were as follows (in thousands):
Beginning balance
Additions from business acquisitions
Foreign currency translation
Ending balance
See note 12 for information on a significant business acquisition that added goodwill and other identifiable intangible assets to the Industrial segment in 2012.
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Accrued self-insurance retentions
Accrued warranty and service liabilities
Accrued trade promotions
Payable for employee stock purchases
Customer advances and deferred revenue
Income taxes payable
Total other current liabilities
Increases in customer advances and deferred revenue and in other are related to business acquisitions (see note 12).
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, beginning of year
Assumed in business acquisition
Charged to expense
Margin on parts sales reversed
Reductions for claims settled
Balance, end of period
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.
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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 September 28, 2012 totaled $26 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 to value the derivative instruments used to hedge interest rate volatility 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):
Gain (loss) on foreign currency forward contracts
Gains
Losses
Net
Loans denominated in U.S. Dollars bear interest, at the Company’s option, at either a base rate or a LIBOR-based rate. Loans denominated in currencies other than U.S. Dollars bear interest at a LIBOR-based rate. The base rate is an annual rate equal to a margin ranging from 0% to 1%, depending on the Company’s cash flow leverage ratio (debt to earnings before interest, taxes, depreciation, amortization and extraordinary, non-operating or non-cash charges and expenses), plus the highest of (i) the bank’s prime rate, (ii) the federal funds rate plus 0.5% or (iii) one-month LIBOR plus 1.5%. In general, LIBOR-based loans bear interest at LIBOR plus 1% to 2%, depending on the Company’s cash flow leverage ratio. The Company is also required to pay a fee on the undrawn amount of the loan commitment at an annual rate ranging from 0.15 percent to 0.40 percent, depending on the Company’s cash flow leverage ratio.
In 2011, the Company entered into a note agreement and sold $300 million of unsecured notes with maturities ranging from 2018 to 2026. The notes have a carrying amount of $300 million and an estimated fair value of $330 million as of September 28, 2012. 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.
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The Company’s debt agreements require the Company to maintain certain financial ratios as to cash flow leverage and interest coverage. The Company is in compliance with all financial covenants of its debt agreements.
Sales of the ITW Finishing Group were $375 million in 2011, of which Powder Finishing contributed approximately one-third and Liquid Finishing contributed approximately two-thirds. Acquisition-related expenses are included in general and administrative expense in the Company’s consolidated statements of earnings, and totaled $8 million for the year 2011 and $15 million for 2012 year-to-date.
In December 2011, the United States Federal Trade Commission (“FTC”) filed a formal complaint to challenge the proposed acquisition on the grounds that the addition of the Liquid Finishing business to Graco would be anti-competitive, a position which Graco denied. In March 2012, the FTC issued an order (the “Hold Separate Order”) that allowed the acquisition to proceed to closing on April 2, 2012, subject to certain conditions, while it evaluated a settlement proposal from Graco. Pursuant to the Hold Separate Order, the Liquid Finishing business was to be held separate from the rest of Graco’s businesses until the FTC determined which portions of the Liquid Finishing business Graco must divest.
In May 2012, the FTC issued a proposed decision and order (the “Decision and Order”) which requires Graco to sell the Liquid Finishing business assets, including 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 business 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. In accordance with the Hold Separate Order, the Liquid Finishing business is managed independently by experienced Liquid Finishing business managers, under the supervision of a trustee appointed by the FTC, who reports directly to the FTC.
The Hold Separate Order requires the Company to provide sufficient resources to maintain the viability, competitiveness and marketability of the Liquid Finishing business, including general funds, capital, working capital and reimbursement of losses. To the extent that the Liquid Finishing business generates funds in excess of financial
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resources needed, the Company has access to such funds consistent with practices in place prior to the acquisition.
As a result of the Hold Separate Order, the Company does not have the power to direct the activities of the Liquid Finishing businesses that most significantly impact the economic performance of those businesses. Therefore, the Company has determined that the Liquid Finishing businesses are variable interest entities for which the Company is not the primary beneficiary, and that they should not be consolidated. Under terms of the Hold Separate Order, the Company does not have a controlling interest in the Liquid Finishing business, nor is it able to exert significant influence over the Liquid Finishing business. Consequently, the Company’s investment in the shares of the Liquid Finishing business, totaling $427 million, has been reflected as a cost-method investment on our Consolidated Balance Sheet as of September 28, 2012, and its results of operations have not been consolidated with those of the Company. The Company’s maximum exposure to loss as a result of its involvement with the Liquid Finishing business would include the entirety of its investment of $427 million and reimbursement of losses of the operations of the Liquid Finishing business in accordance with the Hold Separate Order, which cannot be quantified. The operating earnings of the Liquid Finishing business total $28 million since the date of acquisition, and no additional financial resources were required to be funded by the Company. As a cost-method investment, income is recognized based on dividends received from current earnings of Liquid Finishing. Dividends of $4 million received in the third quarter and $8 million received year-to-date are included in other expense (income) on the Consolidated Statements of Earnings for the periods ended September 28, 2012. The Company will evaluate its cost-method investment for other-than-temporary impairment at each reporting period. As of September 28, 2012, the Company evaluated its investment in Liquid Finishing and determined that there is no impairment.
Sales and operating earnings of the Liquid Finishing business were as follows (in thousands):
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The Company transferred cash purchase consideration of $660 million to the seller on April 2, 2012. In July 2012, the Company transferred additional cash purchase consideration of $8 million, representing the difference between cash balances acquired and the amount estimated at the time of closing. The purchase consideration was allocated to assets acquired and liabilities assumed based on estimated fair values as follows (in thousands):
Property, plant and equipment
Other non-current assets
Identifiable intangible assets
Total assets acquired
Current liabilities assumed
Non-current liabilities assumed
Net assets acquired, Powder Finishing
Total purchase consideration
Identifiable intangible assets and estimated useful life are as follows (dollars in thousands):
Developed technology
Trade names
Total identifiable intangible assets
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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):
For the quarter, Powder Finishing sales of $30 million were included in net sales in 2012 and $38 million (approximately $35 million at consistent translation rates) were included in pro forma net sales in 2011.
Additional depreciation and amortization of $2 million per quarter are reflected in the pro forma results as if the acquisition of Powder Finishing had occurred at the beginning of 2011. Non-recurring acquisition expenses of $4 million for the third quarter and $15 million year-to-date were eliminated from the 2012 pro forma results, and $3 million for the quarter and $6 million for the year-to-date were eliminated from the 2011 pro forma results. Purchase accounting effects of $7 million related to inventory were removed from year-to-date 2012 and reflected in 2011.
To the extent that the Liquid Finishing business generates funds in excess of financial resources needed, the Company has access to such funds consistent with practices in place prior to the acquisition. Net earnings of the Liquid Finishing business, from which dividends could have been paid, subject to funds availability, were $12 million and $27 million for the quarter and year-to-date, respectively, in 2012, and $9 million and $24 million for the quarter and year-to-date, respectively, in 2011. For pro forma purposes, dividend income from Liquid Finishing of $4 million for the quarter and $8 million for the year-to-date was eliminated from other income in 2012.
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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, 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 Illinois Tool Works Inc. (the “Finishing Brands” acquisition), first announced in April 2011. The acquisition includes powder (“Powder Finishing”) and liquid (“Liquid Finishing”) equipment operations, technologies and brands. In Powder Finishing, Graco acquired the Gema® businesses. Gema is a global leader in powder coating technology, a market in which Graco had no previous product offerings. Results of the Powder Finishing business have been included in the Industrial segment since the date of acquisition. In Liquid Finishing, Graco acquired the Binks® spray finishing equipment businesses, DeVilbiss® spray guns and accessories businesses, Ransburg® electrostatic equipment and accessories businesses, and BGK curing technology.
In December 2011, the United States Federal Trade Commission (“FTC”) filed a formal complaint to challenge the proposed acquisition on the grounds that the addition of the Liquid Finishing business to Graco would be anti-competitive, a position which Graco denied. In March 2012, the FTC issued an order (the “Hold Separate Order”) that allowed the acquisition to proceed to closing on April 2, 2012, subject to certain conditions while it evaluated a settlement proposal from Graco. Pursuant to the Hold Separate Order, the Liquid Finishing business was to be held separate from the rest of Graco’s businesses until the FTC determined which portions, if any, of the Liquid Finishing business Graco must divest.
The Company has retained the services of an investment bank to help it market the Liquid Finishing business 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. In accordance with the Hold Separate Order, the Liquid Finishing business is managed independently by experienced Liquid Finishing business
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managers, under the supervision of a trustee appointed by the FTC, who reports directly to the FTC.
As a result of the Hold Separate Order, we have determined that the Liquid Finishing businesses are variable interest entities for which the Company is not the primary beneficiary, and that they should not be consolidated. Under terms of the Hold Separate Order, the Company does not have a controlling interest in the Liquid Finishing business, nor is it able to exert significant influence over the Liquid Finishing business. Consequently, the Company’s investment in the shares of the Liquid Finishing business has been reflected as a cost-method investment on our Consolidated Balance Sheet as of September 28, 2012, 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 $4 million received in the third quarter and $8 million received year-to-date are included in other expense (income) on the Consolidated Statements of Earnings for the periods ended September 28, 2012. The Company will evaluate its cost-method investment for other-than-temporary impairment at each reporting period. As of September 28, 2012, the Company evaluated its investment in Liquid Finishing and determined that there is no impairment.
Consolidated Results
Net sales, net earnings and earnings per share were as follows (in millions except per share amounts and percentages):
Diluted Net Earnings per Common Share
The addition of Powder Finishing was the main factor in sales increases over last year. For the quarter, Powder Finishing contributed $30 million of sales, accounting for all of the increase. Year-to-date sales increased 12 percent from last year, with 9 percentage points of the growth from the addition of Powder Finishing.
Changes in currency translation rates decreased sales by approximately $6 million for the quarter and $14 million year-to-date, and decreased net earnings by approximately $2 million for both the quarter and $5 million year-to-date.
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The following table presents components of changes in sales:
Volume and Price
Acquisitions
Currency
Sales by geographic area were as follows (in millions):
Americas1
Europe2
Asia Pacific
Consolidated
1 North and South America, including the U.S.
2 Europe, Africa and Middle East
Sales for the quarter included $30 million from Powder Finishing operations acquired at the beginning of April, including $7 million in the Americas, $16 million in Europe and $7 million in Asia Pacific. Year-to-date sales included $62 million from Powder Finishing, including $13 million in the Americas, $32 million in Europe and $17 million in Asia Pacific. For the quarter, sales at consistent translation rates and before acquisitions were up 5 percent in the Americas, up 4 percent in Europe and down 10 percent in Asia Pacific. On the same basis, year-to-date sales were up 7 percent in the Americas, up 3 percent in Europe and down 1 percent in Asia Pacific.
Gross profit margin, expressed as a percentage of sales, was 55 percent for the quarter and 54 percent year-to-date, down 1 percentage point from the third quarter last year and 2 percentage points lower than last year-to-date. For the quarter and year-to-date, the favorable effects of realized price increases were more than offset by the unfavorable effects of currency translation, higher material costs and lower margin rates on acquired Powder Finishing operations. Non-recurring purchase accounting effects totaling $7 million related to inventory reduced year-to-date gross margin percentage by approximately 1 percentage point.
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Total operating expenses for the quarter increased $14 million, including $8 million from Powder Finishing operations. Increases in product development and general and administrative costs were partially offset by changes in currency translation rates. Year-to-date operating expenses increased $34 million, including $16 million from Powder Finishing and a $9 million increase in acquisition and divestiture expenses.
Interest expense increased $2 million for the quarter and $9 million year-to-date due to higher borrowing levels. Other expense (income) includes dividends of $4 million for the quarter and $8 million year-to-date, received from the Liquid Finishing businesses that are required to be held separate from the Company’s other businesses and accounted for as a cost-method investment.
The effective income tax rates of 32 percent for the quarter and 33 percent for the year-to-date are consistent with the comparable periods last year. This year’s rate is reduced by the effect of the investment income from the Liquid Finishing businesses held separate. Last year’s rate was reduced by the effect of the federal R&D credit that is not available in 2012.
Segment Results
Certain measurements of segment operations compared to last year are summarized below:
Net sales (in millions)
Americas
Europe
Operating earnings as a percentage of net sales
Industrial segment sales increased 24 percent for the quarter and 19 percent year-to-date, mostly from the addition of Powder Finishing operations. Without the increase from Powder Finishing operations, sales for the quarter increased 12 percent in the Americas, decreased 7 percent in Europe (1 percent increase at consistent translation rates) and decreased 12 percent in Asia Pacific. On the same basis, year-to-date sales increased 10 percent in the Americas, decreased 2 percent in Europe (4 percent increase at consistent translation rates) and decreased 5 percent in Asia Pacific. Powder Finishing operations contributed to segment operating earnings in the third quarter, but at a lower rate on sales, which drove the decrease in the operating margin rate for this segment.
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Contractor segment sales decreased 4 percent for the quarter and were flat year-to-date. Sales for the quarter decreased 5 percent in both the Americas and in Asia Pacific and increased 1 percent in Europe (9 percent at consistent translation rates). Year-to-date sales increased 1 percent in the Americas, decreased 6 percent in Europe (increased 1 percent at consistent translation rates) and increased 8 percent in Asia Pacific. Lower sales volume, product mix and higher marketing and general spending led to lower third quarter operating earnings in the Contractor segment. Year-to-date operating earnings as a percentage of sales are consistent with last year.
Lubrication segment sales increased 7 percent for the quarter and 11 percent year-to-date. Sales for the quarter increased 13 percent in the Americas, 8 percent in Europe (15 percent at consistent translation rates) and decreased 11 percent in Asia Pacific. Year-to-date sales increased 15 percent in the Americas, decreased 2 percent in Europe (3 percent increase at consistent translation rates) and increased 4 percent in Asia Pacific. Higher volume and leveraging of expenses led to improved operating earnings in the Lubrication segment.
Liquidity and Capital Resources
Net cash provided by operating activities was $132 million in 2012 and $109 million in 2011. Changes in receivable and inventory levels moderated in the first nine months of 2012 after increasing in 2011.
On March 27, 2012, the Company’s $250 million credit agreement was terminated in connection with the execution of a new unsecured revolving credit agreement. The new credit
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agreement is with a syndicate of lenders and expires in March 2017. It provides up to $450 million of committed credit, available for general corporate purposes, working capital needs, share repurchases and acquisitions. The Company may borrow up to $50 million under the swingline portion of the facility for daily working capital needs.
The agreement requires the Company to maintain certain financial ratios as to cash flow leverage and interest coverage. The Company is in compliance with all financial covenants of its debt agreements.
On April 2, 2012, the Company paid $660 million to complete the Finishing Brands acquisition, using available cash and $350 million of borrowings on the new credit agreement. In July 2012, the Company made an additional payment of $8 million, representing the difference between cash balances acquired and the amount estimated at the time of closing. Assets acquired in the acquisition included $18 million of cash, of which $6 million was available to Powder Finishing operations.
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 business, including general funds, capital, working capital and reimbursement of losses. To the extent that the Liquid Finishing business generates 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 second and third quarters, the Company received a total of $8 million of dividends from current earnings of the Liquid Finishing business.
While the FTC has not yet issued a final Decision and Order requiring the Company to divest the Liquid Finishing business, the Company has retained the services of an investment bank to help it market the business and identify potential buyers. The Company believes its investment in the Liquid Finishing business, carried at a cost of $427 million, is not impaired.
At September 28, 2012, the Company had various lines of credit totaling $469 million, of which $174 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 2012, including the needs of the Powder Finishing and Liquid Finishing businesses acquired in April 2012.
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Outlook
We are expecting macroeconomic crosscurrents to continue into the fourth quarter, with favorable conditions in the Americas and challenges in China, India and Western Europe. The investments we have made during the past few years to broaden our geographic coverage and diversify our product portfolio give us opportunities to outperform our end markets, while the nascent housing recovery in the U.S. should be a positive for our Contractor equipment business. We will forge ahead with new product development, expansion of our distribution channel, conversion of end users from manual painting to using equipment, and continue our efforts to expand into adjacent new markets.
SAFE HARBOR CAUTIONARY STATEMENT
A forward-looking statement is any statement made in this report and other reports that the Company files periodically with the Securities and Exchange Commission, as well as in press or earnings releases, analyst briefings, conference calls and the Company’s Overview report to shareholders, which reflects the Company’s current thinking on market trends and the Company’s future financial performance at the time they are made. All forecasts and projections are forward-looking statements. The Company undertakes no obligation to update these statements in light of new information or future events.
The Company desires to take advantage of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995 by making cautionary statements concerning any forward-looking statements made by or on behalf of the Company. The Company cannot give any assurance that the results forecasted in any forward-looking statement will actually be achieved. 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: economic conditions in the United States and other major world economies, currency fluctuations, political instability, changes in laws and regulations, and changes in product demand. In addition, risk factors related to the Company’s acquisition of the finishing businesses from ITW and proposed divestiture of the Liquid Finishing equipment operations include: to what extent or when the required regulatory approvals will be obtained, whether and when the Company will be able to realize the expected financial results and accretive effect of the transaction, how customers, competitors, suppliers and employees will react to the transaction, economic changes in global markets, the extent of the acquired businesses required to be divested, whether the Company will be able to find a suitable purchaser(s) and structure the divestiture on acceptable terms, and whether the Company will be able to complete a divestiture in a time frame that is satisfactory to the Federal Trade Commission. Please refer to Item 1A of, and Exhibit 99 to, the Company’s Annual Report on Form 10-K for fiscal year 2011 and Item 1A of this Quarterly Report on Form 10-Q for a more comprehensive discussion of these and other risk factors.
Investors should realize that factors other than those identified above and in Item 1A and Exhibit 99 might prove important to the Company’s future results. It is not possible for management to identify each and every factor that may have an impact on the Company’s operations in the future as new factors can develop from time to time.
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There have been no material changes related to market risk from the disclosures made in the Company’s 2011 Annual Report on Form 10-K.
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.
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PART II OTHER INFORMATION
There have been no material changes to the Company’s risk factors from those disclosed in the Company’s 2011 Annual Report on Form 10-K, except for changes in the status of the previously proposed (now completed) acquisition, as described below:
Acquisition - Our acquisition of the finishing business operations of Illinois Tool Works Inc. is subject to regulatory approvals and the expected benefits from the acquisition may not be fully realized.
On April 2, 2012, the Company closed on its $650 million acquisition of the Illinois Tool Works Inc. finishing businesses. The acquisition added Gema®, a global leader in powder coating technology, which represented approximately one-third of the purchase. The remaining two-thirds of the acquisition is a collection of industrial liquid finishing businesses, which the United States Federal Trade Commission (“FTC”) has ordered to be held separate from Gema and other Graco businesses while the FTC investigates and considers a settlement proposal from Graco. In compliance with the FTC’s order, the industrial liquid finishing businesses are being run independently by existing management under the supervision of a trustee who reports directly to the FTC.
In May 2012, the FTC issued a proposed decision and order (the “Decision and Order”), subject to a 30-day comment period, which requires Graco to sell the Liquid Finishing business assets, including 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 business 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 Hold Separate Order requires the Company to provide sufficient resources to maintain the viability, competitiveness and marketability of the Liquid Finishing business, including general funds, capital, working capital and reimbursement of losses.
We cannot predict to what extent or when the required regulatory approvals will be obtained. Additional risk factors include: the extent of the acquired businesses required to be divested, whether the Company will be able to find a suitable purchaser(s) and structure the divestiture on acceptable terms, and whether the Company will be able to complete a divestiture in a time frame that is satisfactory to the FTC.
Significant changes to our financial condition as a result of global economic changes or difficulties in the integration or addition of the newly acquired businesses, including how customers, competitors, suppliers and employees react to the transaction, may affect our ability to obtain the expected benefits from the transaction or to satisfy the financial covenants included in the terms of the financing arrangements.
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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
On September 18, 2009, 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. This authorization expired on September 30, 2012.
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 new 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
Jun 30, 2012 – Jul 27, 2012
Jul 28, 2012 – Aug 24, 2012
Aug 25, 2012 – Sep 28, 2012
1Authorization for purchases of up to 3,981,850 shares expired on September 30, 2012.
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3.1
3.2
3.3
4.1
31.1
31.2
32
99.1
101
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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.
Date:
October 24, 2012
/s/ Patrick J. McHale
/s/ James A. Graner
/s/ Caroline M. Chambers