GRACO INC — Interim / Quarterly Report 2019

Jul 24, 2019

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

☒ Quarterly Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934

For the quarterly period ended June 28, 2019

☐ Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from to

Commission File Number: 001-09249

GRACO INC.
(Exact name of registrant as specified in its charter)

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

88 - 11th Avenue N.E. — Minneapolis,	55413
(Address of principal executive offices)	(Zip Code)

(612)
(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock, par value $1.00 per share	GGG	The New York Stock Exchange

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 ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer	☒
Emerging growth company	☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) 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).

Yes ☐ No ☒

166,805,000 shares of the Registrant’s Common Stock, $1.00 par value, were outstanding as of July 17, 2019 .

TABLE OF CONTENTS

		Page
PART I - FINANCIAL INFORMATION
Item 1.	Financial Statements
	Consolidated Statements of Earnings	3
	Consolidated Statements of Comprehensive Income	3
	Consolidated Balance Sheets	4
	Consolidated Statements of Cash Flows	5
	Consolidated Statements of Shareholders' Equity	6
	Notes to Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	14
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	20
Item 4.	Controls and Procedures	20
PART II - OTHER INFORMATION
Item 1A.	Risk Factors	21
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	21
Item 6.	Exhibits	22
SIGNATURES
EXHIBITS

2

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PART I Item 1.

GRACO INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF EARNINGS

(Unaudited) (In thousands except per share amounts)

	Three Months Ended — June 28, 2019	June 29, 2018	Six Months Ended — June 28, 2019	June 29, 2018
Net Sales	$ 428,328	$ 424,570	$ 833,198	$ 830,918
Cost of products sold	201,374	194,667	390,202	378,594
Gross Profit	226,954	229,903	442,996	452,324
Product development	17,324	16,112	33,893	31,401
Selling, marketing and distribution	60,441	62,949	121,258	125,471
General and administrative	36,828	37,464	70,957	70,378
Operating Earnings	112,361	113,378	216,888	225,074
Interest expense	3,431	3,891	6,966	7,124
Other expense, net	1,119	4,251	1,388	5,286
Earnings Before Income Taxes	107,811	105,236	208,534	212,664
Income taxes	19,674	16,096	33,648	38,014
Net Earnings	$ 88,137	$ 89,140	$ 174,886	$ 174,650
Net Earnings per Common Share
Basic	$ 0.53	$ 0.53	$ 1.05	$ 1.04
Diluted	$ 0.51	$ 0.51	$ 1.02	$ 1.00

See notes to consolidated financial statements.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited) (In thousands)

	Three Months Ended — June 28, 2019		June 29, 2018		Six Months Ended — June 28, 2019		June 29, 2018
Net Earnings	$ 88,137		$ 89,140		$ 174,886		$ 174,650
Components of other comprehensive income (loss)
Cumulative translation adjustment	1,232		( 15,112	)	2,401		( 6,366	)
Pension and postretirement medical liability adjustment	1,910		2,705		4,037		4,531
Income taxes - pension and postretirement medical liability adjustment	( 423	)	( 596	)	( 893	)	( 997	)
Other comprehensive income	2,719		( 13,003	)	5,545		( 2,832	)
Comprehensive Income	$ 90,856		$ 76,137		$ 180,431		$ 171,818

See notes to consolidated financial statements.

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GRACO INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Unaudited) (In thousands)

	June 28, 2019		December 28, 2018
ASSETS
Current Assets
Cash and cash equivalents	$ 180,883		$ 132,118
Accounts receivable, less allowances of $5,200 and $5,300	291,008		274,608
Inventories	297,545		283,982
Other current assets	29,457		32,508
Total current assets	798,893		723,216
Property, Plant and Equipment, net	286,521		229,295
Goodwill	296,273		293,846
Other Intangible Assets, net	163,564		166,310
Operating Lease Assets	32,170		—
Deferred Income Taxes	32,691		32,055
Other Assets	30,435		28,019
Total Assets	$ 1,640,547		$ 1,472,741
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities
Notes payable to banks	$ 7,284		$ 11,083
Current portion of long term debt	75,000		—
Trade accounts payable	61,958		56,902
Salaries and incentives	47,109		62,297
Dividends payable	26,716		26,480
Other current liabilities	141,535		143,041
Total current liabilities	359,602		299,803
Long-term Debt	179,081		266,391
Retirement Benefits and Deferred Compensation	135,209		133,388
Operating Lease Liabilities	25,734		—
Deferred Income Taxes	14,963		16,586
Other Non-current Liabilities	—		4,700
Shareholders’ Equity
Common stock	166,792		165,171
Additional paid-in-capital	556,170		510,825
Retained earnings	342,308		220,734
Accumulated other comprehensive income (loss)	( 139,312	)	( 144,857	)
Total shareholders’ equity	925,958		751,873
Total Liabilities and Shareholders’ Equity	$ 1,640,547		$ 1,472,741

See notes to consolidated financial statements.

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GRACO INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited) (In thousands)

	Six Months Ended — June 28, 2019		June 29, 2018
Cash Flows From Operating Activities
Net Earnings	$ 174,886		$ 174,650
Adjustments to reconcile net earnings to net cash provided by operating activities
Depreciation and amortization	24,087		23,755
Deferred income taxes	( 3,881	)	355
Share-based compensation	17,548		15,832
Change in
Accounts receivable	( 16,051	)	( 26,100	)
Inventories	( 13,157	)	( 17,700	)
Trade accounts payable	4,603		2,298
Salaries and incentives	( 18,514	)	( 13,231	)
Retirement benefits and deferred compensation	5,780		6,627
Other accrued liabilities	( 10,789	)	6,493
Other	( 690	)	( 2,202	)
Net cash provided by operating activities	163,822		170,777
Cash Flows From Investing Activities
Property, plant and equipment additions	( 70,186	)	( 27,443	)
Acquisition of businesses, net of cash acquired	( 6,176	)	( 10,519	)
Other	( 828	)	( 65	)
Net cash provided by (used in) investing activities	( 77,190	)	( 38,027	)
Cash Flows From Financing Activities
Borrowings (payments) on short-term lines of credit, net	( 3,767	)	112
Borrowings on long-term lines of credit	23,944		389,340
Payments on long-term debt and lines of credit	( 36,453	)	( 320,603	)
Common stock issued	33,954		20,052
Common stock repurchased	( 2,438	)	( 155,601	)
Taxes paid related to net share settlement of equity awards	( 1,268	)	( 16,151	)
Cash dividends paid	( 53,075	)	( 44,650	)
Net cash provided by (used in) financing activities	( 39,103	)	( 127,501	)
Effect of exchange rate changes on cash	1,236		448
Net increase (decrease) in cash and cash equivalents	48,765		5,697
Cash, Cash Equivalents and Restricted Cash
Beginning of year	132,118		112,904
End of period	$ 180,883		$ 118,601
Reconciliation to Consolidated Balance Sheets
Cash and cash equivalents	$ 180,883		$ 109,854
Restricted cash included in other current assets	—		8,747
Cash, cash equivalents and restricted cash	$ 180,883		$ 118,601

See notes to consolidated financial statements.

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GRACO INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(Unaudited) (In thousands)

	Common Stock	Additional Paid-In Capital	Retained Earnings		Accumulated Other Comprehensive Income (Loss)		Total
Three Months Ended June 28, 2019
Balance, March 29, 2019	$ 166,364	$ 539,067	$ 281,038		$ ( 142,031	)	$ 844,438
Shares issued	428	8,678	—		—		9,106
Stock compensation cost	—	8,425	—		—		8,425
Net earnings	—	—	88,137		—		88,137
Dividends declared ($0.1600 per share)	—	—	( 26,867	)	—		( 26,867	)
Other comprehensive income (loss)	—	—	—		2,719		2,719
Balance, June 28, 2019	$ 166,792	$ 556,170	$ 342,308		$ ( 139,312	)	$ 925,958

Six Months Ended June 28, 2019 — Balance, December 28, 2018	$ 165,171	$ 510,825	$ 220,734		$ ( 144,857	)	$ 751,873
Shares issued	1,621	31,064	—		—		32,685
Stock compensation cost	—	14,281	—		—		14,281
Net earnings	—	—	174,886		—		174,886
Dividends declared ($0.3200 per share)	—	—	( 53,312	)	—		( 53,312	)
Other comprehensive income (loss)	—	—	—		5,545		5,545
Balance, June 28, 2019	$ 166,792	$ 556,170	$ 342,308		$ ( 139,312	)	$ 925,958

Three Months Ended June 29, 2018 — Balance, March 30, 2018	$ 168,033		515,693		176,524		$ ( 133,071	)	$ 727,179
Shares issued	548		( 13,963	)	—		—		( 13,415	)
Shares repurchased	( 1,451	)	( 4,285	)	( 58,352	)	—		( 64,088	)
Stock compensation cost	—		7,897		—		—		7,897
Restricted stock canceled (issued)	—		—		—		—		—
Net earnings	—		—		89,140		—		89,140
Dividends declared ($0.1325 per share)	—		—		( 21,905	)	—		( 21,905	)
Other comprehensive income (loss)	—		—		—		( 13,003	)	( 13,003	)
Balance, June 29, 2018	$ 167,130		505,342		185,407		$ ( 146,074	)	$ 711,805

Six Months Ended June 29, 2018 — Balance, December 29, 2017	$ 169,319		$ 499,934		$ 181,599		$ ( 127,789	)	$ 723,063
Shares issued	1,313		3,360		—		—		4,673
Shares repurchased	( 3,502	)	( 10,340	)	( 141,759	)	—		( 155,601	)
Stock compensation cost	—		13,160		—		—		13,160
Restricted stock canceled (issued)	—		( 772	)	—		—		( 772	)
Net earnings	—		—		174,650		—		174,650
Dividends declared ($0.2650 per share)	—		—		( 44,536	)	—		( 44,536	)
Reclassified to retained earnings from AOCI	—		—		15,453		( 15,453	)	—
Other comprehensive income (loss)	—		—		—		( 2,832	)	( 2,832	)
Balance, June 29, 2018	$ 167,130		$ 505,342		$ 185,407		$ ( 146,074	)	$ 711,805

See notes to consolidated financial statements.

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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 June 28, 2019 and the related statements of earnings, comprehensive income and shareholders' equity for the three and six months ended June 28, 2019 and June 29, 2018 , and cash flows for the six months ended June 28, 2019 and June 29, 2018 have been prepared by the Company and have not been audited.

In the opinion of management, these consolidated financial statements reflect all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the financial position of the Company as of June 28, 2019 , 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 2018 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.

1. Segment Information

The Company has three reportable segments: Industrial, Process and Contractor. Sales and operating earnings by segment were as follows (in thousands):

	Three Months Ended — June 28, 2019		June 29, 2018		Six Months Ended — June 28, 2019		June 29, 2018
Net Sales
Industrial	$ 188,507		$ 190,459		$ 377,607		$ 385,655
Process	85,064		85,059		171,958		165,094
Contractor	154,757		149,052		283,633		280,169
Total	$ 428,328		$ 424,570		$ 833,198		$ 830,918
Operating Earnings
Industrial	$ 64,428		$ 67,030		$ 129,631		$ 136,155
Process	18,378		17,065		38,392		34,767
Contractor	40,054		38,382		66,593		69,793
Unallocated corporate (expense)	( 10,499	)	( 9,099	)	( 17,728	)	( 15,641	)
Total	$ 112,361		$ 113,378		$ 216,888		$ 225,074

Assets by segment were as follows (in thousands):

	June 28, 2019	December 28, 2018
Industrial	$ 633,813	$ 640,683
Process	364,496	350,306
Contractor	361,832	283,727
Unallocated corporate	280,406	198,025
Total	$ 1,640,547	$ 1,472,741

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Geographic information follows (in thousands):

	Three Months Ended — June 28, 2019	June 29, 2018	Six Months Ended — June 28, 2019	June 29, 2018
Net Sales (based on customer location)
United States	$ 221,565	$ 212,541	$ 424,450	$ 406,323
Other countries	206,763	212,029	408,748	424,595
Total	$ 428,328	$ 424,570	$ 833,198	$ 830,918

	June 28, 2019	December 28, 2018
Long-lived Assets
United States	$ 229,398	$ 178,331
Other countries	57,123	50,964
Total	$ 286,521	$ 229,295

1. Earnings per Share

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

	Three Months Ended — June 28, 2019	June 29, 2018	Six Months Ended — June 28, 2019	June 29, 2018
Net earnings available to common shareholders	$ 88,137	$ 89,140	$ 174,886	$ 174,650
Weighted average shares outstanding for basic earnings per share	166,684	167,260	166,150	168,166
Dilutive effect of stock options computed using the treasury stock method and the average market price	5,363	6,005	5,303	6,291
Weighted average shares outstanding for diluted earnings per share	172,047	173,265	171,453	174,457
Basic earnings per share	$ 0.53	$ 0.53	$ 1.05	$ 1.04
Diluted earnings per share	$ 0.51	$ 0.51	$ 1.02	$ 1.00

Stock options to purchase 1,532,000 and 1,099,000 shares were not included in the June 28, 2019 and June 29, 2018 computations of diluted earnings per share, respectively, because they would have been anti-dilutive.

1. 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 28, 2018	12,270		$ 24.67	7,312	$ 20.17
Granted	1,285		45.91
Exercised	( 1,241	)	15.59
Canceled	( 22	)	32.72
Outstanding, June 28, 2019	12,292		$ 27.79	7,731	$ 22.98

The Company recognized year-to-date share-based compensation of $ 17.5 million in 2019 and $ 15.8 million in 2018 . As of June 28, 2019 , there was $ 12.4 million of unrecognized compensation cost related to unvested options, expected to be recognized over a weighted average period of 2.0 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:

	Six Months Ended — June 28, 2019	June 29, 2018
Expected life in years	7.5	7.5
Interest rate	2.6 %	2.8 %
Volatility	24.6 %	25.5 %
Dividend yield	1.4 %	1.2 %
Weighted average fair value per share	$ 12.26	$ 12.84

Under the Company’s Employee Stock Purchase Plan, the Company issued 398,000 shares in 2019 and 480,000 shares in 2018 . 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:

	Six Months Ended — June 28, 2019	June 29, 2018
Expected life in years	1.0	1.0
Interest rate	2.6 %	2.1 %
Volatility	22.7 %	21.3 %
Dividend yield	1.4 %	1.2 %
Weighted average fair value per share	$ 11.36	$ 10.28

1. Retirement Benefits

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

	Three Months Ended — June 28, 2019		June 29, 2018		Six Months Ended — June 28, 2019		June 29, 2018
Pension Benefits
Service cost	$ 1,635		$ 1,998		$ 3,644		$ 4,211
Interest cost	3,572		3,411		7,310		6,845
Expected return on assets	( 4,216	)	( 4,632	)	( 8,575	)	( 8,718	)
Amortization and other	1,838		2,080		3,817		4,175
Net periodic benefit cost	$ 2,829		$ 2,857		$ 6,196		$ 6,513
Postretirement Medical
Service cost	$ 123		$ 175		$ 273		$ 350
Interest cost	264		265		581		529
Amortization	29		136		137		272
Net periodic benefit cost	$ 416		$ 576		$ 991		$ 1,151

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1. Shareholders’ Equity

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

	Pension and Postretirement Medical		Cumulative Translation Adjustment		Total
Three Months Ended June 28, 2019
Balance, March 29, 2019	$ ( 85,232	)	$ ( 56,799	)	$ ( 142,031	)
Other comprehensive income (loss) before reclassifications	—		1,232		1,232
Reclassified to pension cost and deferred tax	1,487		—		1,487
Balance, June 28, 2019	$ ( 83,745	)	$ ( 55,567	)	$ ( 139,312	)

Six Months Ended June 28, 2019 — Balance, December 28, 2018	$ ( 86,889	)	$ ( 57,968	)	$ ( 144,857	)
Other comprehensive income (loss) before reclassifications	—		2,401		2,401
Reclassified to pension cost and deferred tax	3,144		—		3,144
Balance, June 28, 2019	$ ( 83,745	)	$ ( 55,567	)	$ ( 139,312	)

Three Months Ended June 29, 2018 — Balance, March 30, 2018	$ ( 92,458	)	$ ( 40,613	)	$ ( 133,071	)
Other comprehensive income (loss) before reclassifications	—		( 15,112	)	( 15,112	)
Reclassified to pension cost and deferred tax	2,109		—		2,109
Balance, June 29, 2018	$ ( 90,349	)	$ ( 55,725	)	$ ( 146,074	)

Six Months Ended June 29, 2018 — Balance, December 29, 2017	$ ( 78,430	)	$ ( 49,359	)	$ ( 127,789	)
Other comprehensive income (loss) before reclassifications	—		( 6,366	)	( 6,366	)
Reclassified to pension cost and deferred tax	3,534		—		3,534
Reclassified to retained earnings	( 15,453	)	—		( 15,453	)
Balance, June 29, 2018	$ ( 90,349	)	$ ( 55,725	)	$ ( 146,074	)

Amounts related to pension and postretirement medical adjustments are reclassified to non-service components of pension cost that are included within other non-operating expenses.

In February 2018, the Financial Accounting Standards Board ("FASB") issued a new standard related to reclassification of certain tax effects from accumulated other comprehensive income (AOCI). We adopted the new standard in the first quarter of 2018. We elected to reclassify $ 15.5 million from accumulated other comprehensive income to retained earnings, representing the amount of "stranded" tax effects resulting from the change in the U.S. federal tax rate and the consequent revaluation of deferred tax assets related to pension and postretirement medical expense.

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1. Inventories

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

Finished products and components	June 28, 2019 — $ 147,159		December 28, 2018 — $ 142,535
Products and components in various stages of completion	87,670		83,768
Raw materials and purchased components	122,318		115,705
Subtotal	357,147		342,008
Reduction to LIFO cost	( 59,602	)	( 58,026	)
Total	$ 297,545		$ 283,982

1. Intangible Assets

Components of other intangible assets were (dollars in thousands):

	Finite Life — Customer Relationships		Patents and Proprietary Technology		Trademarks, Trade Names and Other		Indefinite Life — Trade Names		Total
As of June 28, 2019
Cost	$ 182,410		$ 18,913		$ 1,020		$ 60,220		$ 262,563
Accumulated amortization	( 73,974	)	( 9,557	)	( 545	)	—		( 84,076	)
Foreign currency translation	( 10,352	)	( 861	)	( 72	)	( 3,638	)	( 14,923	)
Book value	$ 98,084		$ 8,495		$ 403		$ 56,582		$ 163,564
Weighted average life in years	13		10		4		N/A

As of December 28, 2018 — Cost	$ 179,449		$ 18,571		$ 1,020		$ 59,537		$ 258,577
Accumulated amortization	( 67,322	)	( 8,647	)	( 439	)	—		( 76,408	)
Foreign currency translation	( 10,817	)	( 895	)	( 73	)	( 4,074	)	( 15,859	)
Book value	$ 101,310		$ 9,029		$ 508		$ 55,463		$ 166,310
Weighted average life in years	13		10		4		N/A

Amortization of intangibles for the quarter was $ 3.8 million in 2019 and $ 4.0 million in 2018 and for the year to date was $ 7.7 million in 2019 and $ 8.0 million in 2018 . Estimated annual amortization expense based on the current carrying amount of other intangible assets is as follows (in thousands):

	2019	2020	2021	2022	2023	Thereafter
Estimated Amortization Expense	$ 15,503	$ 15,289	$ 15,089	$ 15,001	$ 14,088	$ 39,686

Changes in the carrying amount of goodwill for each reportable segment were (in thousands):

	Industrial	Process	Contractor	Total
Balance, December 28, 2018	$ 177,124	$ 97,168	$ 19,554	$ 293,846
Additions, adjustments from business acquisitions	—	1,575	—	1,575
Foreign currency translation	803	49	—	852
Balance, June 28, 2019	$ 177,927	$ 98,792	$ 19,554	$ 296,273

The Company completed business acquisitions in 2019 that were not material to the consolidated financial statements.

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1. Other Current Liabilities

Components of other current liabilities were (in thousands):

	June 28, 2019	December 28, 2018
Accrued self-insurance retentions	$ 7,920	$ 7,870
Accrued warranty and service liabilities	11,797	11,056
Accrued trade promotions	7,229	11,449
Payable for employee stock purchases	6,437	11,916
Customer advances and deferred revenue	41,509	39,995
Income taxes payable	9,727	8,515
Right of return refund liability	12,996	12,705
Operating lease liability, current	8,416	—
Other	35,504	39,535
Total	$ 141,535	$ 143,041

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 28, 2018	$
Charged to expense	5,001
Margin on parts sales reversed	1,537
Reductions for claims settled	( 5,797	)
Balance, June 28, 2019	$ 11,797

Deferred Revenues

For certain products or services and customer types, we require payment before delivery to the customer . We defer revenue when cash payments are received or due in advance of our performance, including amounts which are refundable. This is also the case for services associated with certain product sales. The balance in the deferred revenue and customer advances was $ 41.5 million as of June 28, 2019 and $ 40.0 million as of December 28, 2018 . Net sales for the year to date included $ 29.9 million in 2019 and $ 20.0 million in 2018 that related to deferred revenue as of the beginning of each period.

1. 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 28, 2019	December 28, 2018
Assets
Cash surrender value of life insurance	2	$ 16,572	$ 14,320
Forward exchange contracts	2	78	82
Total assets at fair value		$ 16,650	$ 14,402
Liabilities
Contingent consideration	3	$ 4,700	$ 7,200
Deferred compensation	2	4,373	4,203
Total liabilities at fair value		$ 9,073	$ 11,403

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

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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 $ 225 million , including $ 75 million classified as current, and an estimated fair value of $ 240 million as of June 28, 2019 and $ 235 million as of December 28, 2018 . 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.

1. Recent Accounting Pronouncements

Leases

Adoption of New Accounting Standard

The Company adopted ASU No. 2016-02— Leases (Topic 842) as of December 29, 2018, the beginning of our fiscal year 2019. Using the modified retrospective approach with transition relief, we recorded operating lease assets and liabilities of approximately $ 35 million as of December 29, 2018, and made no adjustments to retained earnings. Adoption of the new standard did not materially impact our consolidated net earnings and cash flows.

Practical Expedients and Exemptions

Electing the package of practical expedients permitted under transition guidance, we did not reassess previous conclusions about whether existing contracts contained a lease, historical lease classification, or initial direct costs. Electing the hindsight practical expedient to determine the lease term for existing leases did not result in any changes to existing lease terms. We elected not to apply recognition requirements to short term leases with terms of twelve months or less across all asset classes. We elected to analyze vehicle assets using the portfolio approach. Lastly, we elected as an accounting policy not to separate the lease and non-lease components in the lease payments across all asset classes.

Accounting Policy

The Company owns most of the assets used in its operations, but leases certain buildings and land, vehicles, office equipment and other rental assets. The Company determines if an arrangement is a lease at inception. All of the Company's current lease arrangements are classified as operating leases. The Company historically has not entered into financing leases. Operating lease assets and obligations are recognized at the lease commencement date based on the present value of lease payments over the lease term. Lease expense is recognized by amortizing the amount recorded as an asset on a straight-line basis over the lease term.

In determining lease asset value, the Company considers fixed or variable payment terms, prepayments, incentives, and options to extend, terminate or purchase. Renewal, termination or purchase options affect the lease term used for determining lease asset value only if the option is reasonably certain to be exercised. The Company generally uses its incremental borrowing rate based on information available at the lease commencement date in determining the present value of lease payments.

As of June 28, 2019 , the weighted average remaining lease term was 6.0 years and the weighted average discount rate used to determine the operating lease liability was 4.1 % . For the six months ended June 28, 2019 , expense related to operating leases was $ 5.8 million , operating lease payments included in operating cash flows totaled $ 5.7 million and non-cash additions to operating lease assets totaled $ 2.0 million .

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As of June 28, 2019 , future maturities of operating lease liabilities were as follows (in thousands):

2019	Operating Leases — $ 4,755
2020	8,581
2021	6,473
2022	5,320
2023	3,947
2024	1,825
Thereafter	7,507
Total lease payments	$ 38,408
Present value adjustment	( 4,258	)
Operating lease liabilities	$ 34,150

Aggregate annual rental commitments under operating leases with noncancelable terms of more than one year at December 28, 2018 were reported under previous lease accounting standards as follows (in thousands):

	Total
2019	$ 11,613
2020	8,759
2021	6,745
2022	5,102
2023	3,721
Thereafter	2,340
Total	$ 38,280

Credit Losses

In June 2016, the FASB issued a final standard on accounting for credit losses. The new standard is effective for the Company in fiscal 2020 and requires a change in credit loss calculations using the expected loss method. The Company expects no significant impact on earnings or financial condition from the adoption of the new standard. The Company is continuing to evaluate the effects of the new standard on related disclosures and accounting systems.

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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 supplies technology and expertise for the management of fluids and coatings in both industrial and commercial applications. It 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

A summary of financial results follows (in millions except per share amounts):

	Three Months Ended — June 28, 2019	June 29, 2018	% Change		Six Months Ended — June 28, 2019	June 29, 2018	% Change
Net Sales	$ 428.3	$ 424.6	1	%	$ 833.2	$ 830.9	0	%
Operating Earnings	112.4	113.4	(1	)%	216.9	225.1	(4	)%
Net Earnings	88.1	89.1	(1	)%	174.9	174.7	0	%
Net Earnings, adjusted (1)	85.9	82.7	4	%	166.0	166.8	0	%
Diluted Net Earnings per Common Share	$ 0.51	$ 0.51	0	%	$ 1.02	$ 1.00	2	%
Diluted Net Earnings per Common Share, adjusted (1)	$ 0.50	$ 0.48	4	%	$ 0.97	$ 0.96	1	%

(1) See below for a reconciliation of adjusted non-GAAP financial measures to GAAP.

Sales increases in the Americas and EMEA were offset by decreases in Asia Pacific. Changes in currency translation rates decreased worldwide sales by approximately $9 million (2 percentage points) for the quarter and $20 million for the year to date (3 percentage points). Gross margin rates decreased from the comparable periods last year, and operating expenses decreased both in dollars and as a percentage of sales.

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Excluding the impact of tax benefits related to stock option exercises and the effects of certain tax provision adjustments presents a more consistent basis for comparison of financial results. A calculation of the non-GAAP measurements of adjusted income taxes, effective income tax rates, net earnings and diluted earnings per share follows (in millions except per share amounts):

	Three Months Ended — June 28, 2019		June 29, 2018		Six Months Ended — June 28, 2019		June 29, 2018
Earnings before income taxes	$ 107.8		$ 105.2		$ 208.5		$ 212.7
Income taxes, as reported	$ 19.7		$ 16.1		$ 33.6		$ 38.0
Excess tax benefit from option exercises	2.2		6.4		7.4		7.9
Other non-recurring tax benefit	—		—		1.5		—
Income taxes, adjusted	$ 21.9		$ 22.5		$ 42.5		$ 45.9
Effective income tax rate
As reported	18.2	%	15.3	%	16.1	%	17.9	%
Adjusted	20.3	%	21.4	%	20.4	%	21.6	%
Net Earnings, as reported	$ 88.1		$ 89.1		$ 174.9		$ 174.7
Excess tax benefit from option exercises	(2.2	)	(6.4	)	(7.4	)	(7.9	)
Other non-recurring tax benefit	—		—		(1.5	)	—
Net Earnings, adjusted	$ 85.9		$ 82.7		$ 166.0		$ 166.8
Weighted Average Diluted Shares	172.0		173.3		171.5		174.5
Diluted Earnings per Share
As reported	$ 0.51		$ 0.51		$ 1.02		$ 1.00
Adjusted	$ 0.50		$ 0.48		$ 0.97		$ 0.96

The following table presents an overview of components of net earnings as a percentage of net sales:

	Three Months Ended — June 28, 2019	June 29, 2018	Six Months Ended — June 28, 2019	June 29, 2018
Net Sales	100.0 %	100.0 %	100.0 %	100.0 %
Cost of products sold	47.0	45.9	46.8	45.6
Gross Profit	53.0	54.1	53.2	54.4
Product development	4.1	3.8	4.1	3.8
Selling, marketing and distribution	14.1	14.8	14.6	15.1
General and administrative	8.6	8.8	8.5	8.4
Operating Earnings	26.2	26.7	26.0	27.1
Interest expense	0.8	0.9	0.8	0.9
Other expense, net	0.2	1.0	0.2	0.6
Earnings Before Income Taxes	25.2	24.8	25.0	25.6
Income taxes	4.6	3.8	4.0	4.6
Net Earnings	20.6 %	21.0 %	21.0 %	21.0 %

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Net Sales

The following table presents net sales by geographic region (in millions):

	Three Months Ended — June 28, 2019	June 29, 2018	Six Months Ended — June 28, 2019	June 29, 2018
Americas (1)	$ 253.7	$ 245.7	$ 485.7	$ 467.1
EMEA (2)	101.1	96.8	200.6	198.2
Asia Pacific	73.5	82.1	146.9	165.6
Consolidated	$ 428.3	$ 424.6	$ 833.2	$ 830.9

(1) North, South and Central America, including the United States

(2) Europe, Middle East and Africa

The following table presents the components of net sales change by geographic region:

	Three Months — Volume and Price	Acquisitions	Currency	Total	Six Months — Volume and Price	Acquisitions	Currency	Total
Americas	4%	0%	(1)%	3%	4%	0%	0%	4%
EMEA	10%	0%	(6)%	4%	7%	0%	(6)%	1%
Asia Pacific	(6)%	0%	(4)%	(10)%	(7)%	0%	(4)%	(11)%
Consolidated	3%	0%	(2)%	1%	3%	0%	(3)%	0%

Gross Profit

Gross profit margin rates for the quarter and year to date decreased by 1 percentage point from the comparable periods last year. Changes in currency translation rates accounted for approximately half of the decrease. Price changes implemented in the first quarter had a stronger impact on second quarter gross margin rate, largely offsetting the adverse impacts of higher material costs, lower factory volume and product and channel mix.

Operating Expenses

Total operating expenses for the quarter and year to date decreased $2 million (2 percent) and $1 million (1 percent), respectively, compared to last year. Reductions in volume and earnings-based expenses more than offset increases in product development expenses, which increased 8 percent for both the quarter and the year to date.

Income Taxes

The effective income tax rate for the quarter was 18 percent, up 3 percentage points from the comparable period last year. The increase was primarily due to a $4 million decrease in excess tax benefits related to stock option exercises. The effective income tax rate for the year to date was 16 percent, down 2 percentage points from the comparable period last year. The decrease was due to additional net benefits from U.S. tax reform provisions and non-recurring benefits from other tax planning activities.

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Segment Results

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

Industrial Segment

The following table presents net sales and operating earnings as a percentage of sales for the Industrial segment

(dollars in millions):

	Three Months Ended — June 28, 2019	June 29, 2018	Six Months Ended — June 28, 2019	June 29, 2018
Net Sales
Americas	$ 80.7	$ 79.3	$ 161.6	$ 153.5
EMEA	59.1	56.5	117.2	116.7
Asia Pacific	48.7	54.7	98.8	115.5
Total	$ 188.5	$ 190.5	$ 377.6	$ 385.7
Operating earnings as a percentage of net sales	34 %	35 %	34 %	35 %

The following table presents the components of net sales change by geographic region for the Industrial segment:

	Three Months — Volume and Price	Acquisitions	Currency	Total	Six Months — Volume and Price	Acquisitions	Currency	Total
Americas	2%	0%	0%	2%	6%	0%	(1)%	5%
EMEA	10%	0%	(5)%	5%	7%	0%	(7)%	0%
Asia Pacific	(6)%	0%	(5)%	(11)%	(10)%	0%	(4)%	(14)%
Segment Total	2%	0%	(3)%	(1)%	1%	0%	(3)%	(2)%

For both the quarter and the year to date, Industrial segment sales growth in the Americas and EMEA was more than offset by decreases in Asia Pacific, where end markets softened. Operating earnings as a percentage of sales decreased as the favorable effects of pricing and expense leverage were more than offset by the adverse impacts of currency translation, higher material costs, lower factory volume and product and channel mix.

Process Segment

The following table presents net sales and operating earnings as a percentage of sales for the Process segment

(dollars in millions):

	Three Months Ended — June 28, 2019	June 29, 2018	Six Months Ended — June 28, 2019	June 29, 2018
Net Sales
Americas	$ 55.1	$ 54.8	$ 112.2	$ 106.1
EMEA	14.3	14.4	30.1	29.4
Asia Pacific	15.7	15.9	29.7	29.6
Total	$ 85.1	$ 85.1	$ 172.0	$ 165.1
Operating earnings as a percentage of net sales	22 %	20 %	22 %	21 %

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The following table presents the components of net sales change by geographic region for the Process segment:

	Three Months — Volume and Price	Acquisitions	Currency	Total	Six Months — Volume and Price	Acquisitions	Currency	Total
Americas	1%	0%	0%	1%	6%	0%	0%	6%
EMEA	2%	1%	(4)%	(1)%	6%	0%	(4)%	2%
Asia Pacific	3%	0%	(4)%	(1)%	4%	0%	(4)%	0%
Segment Total	1%	0%	(1)%	0%	6%	0%	(2)%	4%

Process segment sales for the year to date increased in all product applications, although the rate of growth slowed in the second quarter. Gross margin rates were consistent with the comparable periods last year at constant currency translation rates. Operating margin rate for the quarter for this segment improved by 2 percentage points, driven by lower volume and earnings-based costs. For the year to date, higher sales volume and expense leverage led to a 1 percentage point increase in operating margin rate.

Contractor Segment

The following table presents net sales and operating earnings as a percentage of sales for the Contractor segment

(dollars in millions):

	Three Months Ended — June 28, 2019	June 29, 2018	Six Months Ended — June 28, 2019	June 29, 2018
Net Sales
Americas	$ 118.0	$ 111.6	$ 211.9	$ 207.5
EMEA	27.7	26.0	53.3	52.2
Asia Pacific	9.1	11.5	18.4	20.5
Total	$ 154.8	$ 149.1	$ 283.6	$ 280.2
Operating earnings as a percentage of net sales	26 %	26 %	23 %	25 %

The following table presents the components of net sales change by geographic region for the Contractor segment:

	Three Months — Volume and Price	Acquisitions	Currency	Total	Six Months — Volume and Price	Acquisitions	Currency	Total
Americas	6%	0%	0%	6%	2%	0%	0%	2%
EMEA	12%	0%	(5)%	7%	9%	0%	(7)%	2%
Asia Pacific	(17)%	0%	(4)%	(21)%	(5)%	0%	(5)%	(10)%
Segment Total	5%	0%	(1)%	4%	3%	0%	(2)%	1%

Contractor segment sales at consistent currency translation rates increased by 5 percent, driving year-to-date growth to 3 percent. Operating margin rate for the quarter was consistent with the rate for the comparable quarter last year. Reductions in volume and earnings-based costs offset the adverse impacts of currency translation. Operating margin rate for the year to date was 2 percentage points lower than last year due to changes in currency translation rates, higher material costs, lower factory volume and higher factory spending.

Liquidity and Capital Resources

Net cash provided by operating activities totaled $164 million in the first half of 2019 compared to $171 million in the comparable period of 2018. The decrease reflects increased payments related to various accrued liabilities. Increases in accounts receivable and inventories reflect growth in business activity in the six months ended June 28, 2019 . Significant uses of cash in 2019 included dividend payments of $53 million, property, plant and equipment additions of $70 million and net payments on credit lines of $16 million. Proceeds from shares issued in the first half of 2019 totaled $34 million, partially offset by $2 million of payments for shares repurchased in 2018 and settled in 2019. Although the Company did not repurchase any shares in the first half of 2019, it may make additional opportunistic purchases going forward.

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In 2018, significant uses of cash included share repurchases of $156 million, cash dividends of $45 million, and property, plant and equipment additions of $27 million.

At June 28, 2019 , the Company had various lines of credit totaling $594 million, of which $559 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 2019, including its capital expenditure plan (including several building projects to expand production and distribution capacity), planned dividends, share repurchases, and acquisitions. Subsequent to the end of the second quarter of 2019, the Company prepaid $75 million of private placement debt that was due in January, 2020.

Outlook

Given the slow start to the year, we lowered our full-year 2019 worldwide outlook to low single-digit organic sales growth on a constant currency basis. While overall economic conditions are challenging, we continue to pursue our growth strategies and manage the business for the long term.

Cautionary Statement Regarding Forward-Looking Statements

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 2018 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; changes in currency translation rates; economic conditions in the United States and other major world economies; the ability to meet our customers’ needs and changes in product demand; supply interruptions or delays; security breaches; new entrants who copy our products or infringe on our intellectual property; risks incident to conducting business internationally; catastrophic events; changes in laws and regulations; compliance with anti-corruption and trade laws; changes in tax rates or the adoption of new tax legislation; 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; our ability to attract, develop and retain qualified personnel; the possibility of decline in purchases from a few large customers of the Contractor segment; and variations in activity in the construction, automotive, mining and oil and natural gas industries. Please refer to Item 1A of our Annual Report on Form 10-K for fiscal year 2018 for a more comprehensive discussion of these and other risk 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.

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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 2018 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 and the Chief Financial Officer and Treasurer. Based upon that evaluation, the Company's President and Chief Executive Officer and the Chief Financial Officer and Treasurer 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

Item 1A. Risk Factors

There have been no material changes to the Company’s risk factors from those disclosed in the Company’s 2018 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 18,000,000 shares of its outstanding common stock, primarily through open-market transactions. There were approximately 3.3 million shares remaining under the authorization on December 7, 2018, when the board of Directors authorized the purchase of up to an additional 18 million shares. The authorizations are 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.

No shares were purchased in the second quarter of 2019. As of June 28, 2019 , there were 21,002,528 shares that may yet be purchased under the Board authorizations.

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Item 6. Exhibits

3.1	Restated Articles of Incorporation as amended December 8, 2017. ( Incorporated by reference to Exhibit 3.1 to the Company's Report on Form 8-K filed December 8, 2017. )
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	Graco Inc. 2019 Stock Incentive Plan. (Incorporated by reference to Appendix A to the Company’s Definitive Proxy Statement on Schedule 14A filed March 13, 2019.)
10.2	Stock Option Agreement. Form of agreement used for award of non-incentive stock options to nonemployee directors under the Graco Inc. 2019 Stock Incentive Plan in 2019.
10.3	Nonemployee Director Stock and Deferred Stock Program (2019 Restatement).
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 Second Quarter Earnings dated July 24, 2019.
101	Interactive data files pursuant to Rule 405 of Regulation S-T formatted in iXBRL (Inline eXtensible Business Reporting Language).

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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.

GRACO INC.

Date:	July 24, 2019	By:	/s/ Patrick J. McHale
			Patrick J. McHale
			President and Chief Executive Officer
			(Principal Executive Officer)
Date:	July 24, 2019	By:	/s/ Mark W. Sheahan
			Mark W. Sheahan
			Chief Financial Officer and Treasurer
			(Principal Financial Officer)
Date:	July 24, 2019	By:	/s/ Caroline M. Chambers
			Caroline M. Chambers
			Executive Vice President, Corporate Controller and Information Systems
			(Principal Accounting Officer)