UNITED STATES


SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

x

þAnnual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended December 26, 2008, or

for the fiscal year ended December 25, 2009, or

o

oTransition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

for the transition period from ___________ to ___________.

.

Commission File No. 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 No.)

Minnesota
(State or other jurisdiction of incorporation or organization)
41-0285640
(I.R.S. Employer Identification No.)
88 –11th—11th Avenue Northeast


Minneapolis, MN 55413


(Address of principal executive offices) (Zip Code)

(612) 623-6000


(Registrant’s telephone number, including area code)

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


Common Stock, par value $1.00 per share


Preferred Share Purchase Rights


Shares registered on the New York Stock Exchange.

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


None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    YesXþ   No

o

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yeso   NoX

þ

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.    YesXþ   No

o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data file required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yeso   Noo
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-Koþ

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” and “accelerated filer” in Rule 12b-2 of the Exchange Act (Check one): Large accelerated filer X    Accelerated filer ___ Non-accelerated filer ___ Smaller reporting company ___

Large accelerated filerþAccelerated fileroNon-accelerated fileroSmaller reporting companyo
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Act).

Yeso Noþ

Yes   

No X 

The aggregate market value of approximately 60,000,000 shares of common stock held by non-affiliates of the registrant was approximately $2.3$1.3 billion as of June 27, 2008.

As of February 9, 2009, 59,545,50026, 2009.

60,080,211 shares of common stock were outstanding.

outstanding as of February 8, 2010.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Company’s definitive Proxy Statement for its Annual Meeting of Shareholders to be held on April 24, 2009,23, 2010, are incorporated by reference into Part III, as specifically set forth in said Part III.

 


INDEX TO ANNUAL REPORT


ON FORM 10-K

Page

Page
Part I

Item 2

Properties

9

Properties
10

Part II

Purchases of Equity Securities

12

on Accounting and Financial Disclosure

48

49

Part III

Stockholder Matters

49

50

Part IV

Index to Exhibits

53

ACCESS TO REPORTS

Investors may obtain access free of charge to the Graco Inc. annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, other reports and amendments to those reports by visiting the Graco website at www.graco.com. These reports will be available as soon as reasonably practicable following electronic filing with, or furnishing to, the Securities and Exchange Commission.

2


PART I

ITEM 1 BUSINESS

Our Company began business as a Minneapolis, Minnesota-based manufacturer of grease guns and lubricating pumps primarily for servicing vehicles. It was originally incorporated in the state of South Dakota in 1926 as Gray Company, Inc. and reincorporated in the state of Minnesota in 1947. It began business as a Minneapolis, Minnesota-based manufacturer of grease guns and lubricating pumps primarily for servicing vehicles. Our Company changed its name to Graco Inc. and first offered its common stock to the public in 1969. Today we provide fluid handling solutions to organizations involvedcustomers in the manufacturing, processing, construction and maintenance industries throughout the world.

Graco Inc. and its subsidiaries (which we refer to in this Form 10-K as us, we, our Company“us,” “we,” “our Company” or the Company)“Company”) sell a full line of products in each of the following geographic markets: the Americas (North and South America), Europe (including the Middle East and Africa), and Asia Pacific. Sales in the Americas represent approximately 5557 percent of our Company’s total sales; sales in Europe approximately 2925 percent; and sales in Asia Pacific approximately 1618 percent. Part II, Item 7,Results of Operationsand Note B to the Consolidated Financial Statements of this Form 10-K contain financial information about these geographic areas. Our Company provides marketing, product design and application assistance to, and employs sales personnel in, each of these geographic markets. Subsidiaries located in Belgium, the People’s Republic of China (“P.R.C.”), Australia, Japan, and Korea distribute our Company’s products in their local geographies. The majority of our manufacturing occurs in the United States, but limited lines of products are assembled in the P.R.C., the United Kingdom (“U.K.”) and Belgium.

For more information about our Company ourand its products, services and solutions, visit our website at www.graco.com. The information on the website is not part of this report nor any other report filed or furnished to the Securities and Exchange Commission (SEC)(“SEC”).

Business Segments

Our Company classifies its business into three reportable segments, each with a world-wide focus: Industrial, Contractor and Lubrication. Financial information concerning these segments is set forth in Part II, Item 7,Results of Operationsand Note B to the Consolidated Financial Statements of this Form 10-K.

The equipment developed, manufactured and distributed by our Company’s segments is broadly described as fluid handling equipment. It is used to pump, meter, mix, dispense, and spray a wide variety of fluids and semi-solids in a wide variety of applications in the manufacturing, processing, construction and maintenance industries. Our Company’s products enable customers to reduce their use of labor, material and energy, improve quality and achieve environmental compliance.

Our equipment is sold primarily through third-party distributors with approximately 30,000 outlets worldwide.

The development of technologically superior, multiple-featured, reliablemulti-featured, high-quality products is a key strategy of our Company. All segments have been charged with expanding our product offerings through organic growth and targeted acquisitions. We are continually on the lookout for new applications of our core technologies in adjacent markets. Our Company strives to generate 30 percent of its annual sales from products introduced in the prior three years. In 2008,2009, we generated 26 percent of our sales from new products. In both 2007 and 2006,2008, the percentage of sales represented by new products was 26 percent and in 2007 it was 21 percent. Major product development efforts are carried out in facilities located in Minneapolis, Anoka and Rogers, Minnesota, and North Canton, OhioOhio. Design and on Lubricationdevelopment of several limited lines of equipment occur in Suzhou, P.R.C. The product development and engineering group in each segment focuses on new product design, product improvements, new applications for existing products, and strategic technologies for its specific customer base. Total product development expenditures for all segments were $38 million in 2009, $37 million in 2008 and $30 million in both 2007 and 2006.

2007.

Manufacturing is a key competency of Graco. Our Company invests significant resources in maximizing the quality, responsiveness and cost-effectiveness of our production operations by purchasing state-of-the-art equipment and doing most machining, assembly and testing in-house. Principal products are manufactured in vertically integrated focused factories and product cells. Raw materials and purchased components are sourced from suppliers around the world. The segments manage certain operations devoted to the manufacture of their product lines. Oversight and strategic direction of our manufacturing strategy isresources are provided by our Vice President of Manufacturing, Information Systems and Distribution Operations. He also manages those factories not fully aligned with a single segment theas well as our warehouses, customer service, and other shared corporate manufacturing functions.

Other

Our other primary objectives of our Company include the expansion of distribution outlets, the penetration of developing markets and the successful completion of strategic acquisitions. These subjects are discussed below in the context of each segment’s business operations.

3


Our Company’s headquarters are located in a 142,000 sq. ft. facility in Minneapolis, Minnesota. The facility is also occupied by the management, marketing and product development personnel for the Industrial segment. Information systems, accounting services and purchasing for our Company are housed in a 42,000 sq. ft. office building nearby.

A large percentage of our Company’s facilities are devoted to the manufacturing and distribution of the various products offered for sale by the business segments.

Products marketed by the Industrial segment are manufactured in owned facilities in Minneapolis, Minnesota (405,000 sq. ft. manufacturing/warehouse/office), Sioux Falls, South Dakota (149,000 sq. ft. manufacturing/office), and North Canton, Ohio (132,000 sq. ft. manufacturing/office). GlasCraft® products were manufactured in a leased building (50,000 sq. ft. manufacturing/warehouse/office) in Indianapolis, Indiana until December 2008. The lease will expire at the end of January 2009. Limited lines of products are assembled in owned facilities in Suzhou, P.R.C. (79,000 sq. ft. assembly/warehouse/office), and Maasmechelen, Belgium (175,000 sq. ft. assembly/warehouse/office). The Maasmechelen facility also functions as the site of our European headquarters. During 2009 a new European Training, Testing and Education Center (8,600 sq. ft.) was constructed in the Maasmechelen facility. The Center, which opened in April, includes a classroom, hands-on training area, demonstration spray booth, and lab space for future product testing and development. Liquid Control Ltd. and its Wellingborough U.K.facility (12,500 sq. ft. manufacturing/office) and Maasmechelen, Belgium (125,000 sq. ft. assembly/warehouse/office). During 2008, our Company announced that it would close its facility in Vilanova, Spain (7,280 sq. ft. warehouse/office)were sold to a Graco distributor in February 2009. Products formerly distributed from this facility will be distributed from our warehouse in Maasmechelen, Belgium in the future. The assembly of mobile spray rig manufacturing and customer service functions were moved from Mississauga, Ontario to North Canton, Ohio in early 2008. The lease forrigs was discontinued during the Mississauga facility expired at the endthird quarter of June 2008. Some Industrial segment products are assembled for the European market in an owned facility located in Maasmechelen, Belgium, the site of our Company’s European headquarters. A 50,000 sq. ft. warehouse addition to the Maasmechelen facility was completed in July 2008 and a training center is currently being constructed within the warehouse.

2009.

Products marketed by the Contractor segment are manufactured primarily in owned facilities in Rogers, Minnesota (333,000 sq. ft. manufacturing/warehouse/office). Segment management, marketing, engineering, customer service, warehouse, shipping, sales and training are also located at the Rogers facility. The Company has leased space in Rogers, Minnesota to store inventory and assemble a limited line of small electric sprayers (33,000 sq. ft. warehouse/assembly). Our Sioux Falls, South Dakota plant manufactures spray guns and accessories for the Contractor segment. Airlessco®The Company has announced that it will cease the manufacture and warehousing of Airlessco®-branded products are manufacturedsprayers and spray guns at its leased facility in a leased building (10,500Moorpark, California (32,778 sq. ft. manufacturing/warehouse/office) and vacate the building by the end of first quarter 2010. In the future, Airlessco products will be manufactured in Moorpark, California. The lease term extends to December 31, 2010.

existing facilities in Sioux Falls, South Dakota, Rogers, Minnesota and Suzhou, P.R.C. and warehoused in and distributed from Sioux Falls, South Dakota and Maasmechelen, Belgium.

The Lubrication segment conducts its manufacturing operations in an owned facility located in Anoka, Minnesota (207,000 sq. ft. manufacturing/office). Management, marketing, engineering, customer service, warehouse, shipping, sales and training functions for the segment are also housed in this building. The lease for the facility in Madison, Wisconsin terminated at the end of January 2008 and the owned facility in Cleveland, Ohio (88,000 sq. ft. manufacturing/warehouse/office) was sold in May 2008. A limited line of Lubrication products is being assembled in our owned facility in Suzhou, P.R.C. The output ofIn October 2009, the Suzhou plant is shippedbegan distributing a hose reel designed and assembled at the facility directly to Minneapolis, Minnesota, for subsequent worldwide distribution. The plantGraco subsidiaries in Asia and in Maasmechelen, Belgium.
Some Industrial and Contractor products are distributed to the P.R.C. market out of a warehouse located in the Waigaoqiao section of Shanghai, P.R.C. (13,730 sq. ft. warehouse). This facility will be closed during 2010 and distribution to markets in the P.R.C. is expected to produce products designed specifically for the Asia Pacific market sometimebe moved to a foreign-invested commercial enterprise located in the future. Suzhou, P.R.C.
Our Company did not acquire any real estate when it purchased the assets of Lubrication Scientific, Inc. in 2008.

During 2008, our Australian subsidiary entered intohas a third-party logistics arrangement with a global supplier to inventory, pick, packhandle storage and deliverorder fulfillment for Graco products sold to Australian and New Zealand distributors. Product shipments began in October. Operations,The operations, accounting, customer service and administrative staff of the subsidiary are housed in a leased office space (1462 sq. ft. office) in Melbourne, Australia.

Industrial Segment

The Industrial segment is the largest of our Company’s businesses and represents approximately 5754 percent of our total sales. This segment includes the Industrial Products and the Applied Fluid Technologies divisions. While both divisions marketEnd users of our industrial equipment require solutions to their manufacturing and maintenance challenges and are driven by the return on investment that our products provide. The Industrial Products division markets its equipment and services to customers who manufacture, assemble, maintain, repair and refinish products such as appliances, vehicles, airplanes, electronics, cabinets and furniture, and other articles,articles. In addition to marketing its equipment to customers in similar industries, the divisions focus on different fluidsApplied Fluid Technology division also sells to contractors who use its plural component systems to apply foam insulation and application methods in these industries.

protective coatings to buildings and other structures such as ships and bridges.

Most Industrial segment equipment is sold worldwide through general and specialized third-party distributors, integrators, design centers and original equipment manufacturers. We also work with material suppliers to develop or adapt our equipment for use with specialized and hard-to-handle materials. Distributors promote and sell the equipment, hold inventory, provide product application expertise and offer on-site service, technical support and integration capabilities. Integrators implement large individual installations in manufacturing plants where products and services from a number of different vendors are aggregated into a single system. Design centers engineer systems for their customers using our products. Original equipment manufacturers incorporate our Company’s Industrial segment products into the systems and assemblies that they then supply to their customers. In-plant polyurethane and Liquid Control™ equipment is sold through distribution and directly to manufacturers.

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Industrial Products

The Industrial Products division focuses its product development and sales efforts on threetwo main product families:applications: equipment to apply paint and other coatings to products such as motor vehicles, appliances, furniture and other industrial and consumer products (“Liquid Finishing”); and equipment to move and dispense chemicals and liquid and semi-solid foods (“Process Pumps”); and.
Liquid finishing equipment to refinish and repair automobiles (“Sharpe by Graco”).

Finishing equipment for applying paints, varnishes and other coatings includes paint circulating and paint supply pumps, plural component coating proportioners, various accessories to filter, transport, agitate and regulate the fluid, spare parts such as spray tips, seals and filter screens, andscreens. We also offer a variety of applicators that use different methods of atomizing and spraying the paint or other coating depending on the viscosity of the fluid, the type of finish desired, and the need to maximize transfer efficiency, minimize overspray and prevent the release of volatile organic compounds (VOCs) into the air. Liquid finishing equipment is used in the automotive, automotive feeder, truck/bus/RV,recreational vehicle, military and utility vehicle, aerospace, farm and construction, wood and general metals industries.

Graco introduced a new family of electronic proportioners in 2009 with modular components that can be configured in many different ways. ProMix®2KS offers precise and reliable electronic proportioning for a broad range of solventborne and waterborne epoxies, polyurethanes and acid catalyzed materials. These versatile machines are available in manual and automatic configurations and provide the highest degree of ratio assurance, multiple sequential dose sizes, process feedback and material tracking and reporting capabilities.

Our process pumps are used in food and beverage, dairy, pharmaceutical, cosmetic, oil and gas, electronics, waste water, mining and ceramics applications. We offer double diaphragm and piston transfer pumps to the chemical, petroleum, general manufacturing and food processing industries, pumps for sanitary applications including FDA-compliant 3-A sanitary pumps for use in dairies, diaphragm pumps, transfer pumps and drum and bin unloaders. Our process equipmentThe first in a new series of air-operated double diaphragm pumps, the Husky™ 1050 one-inch pump, is significantly more efficient than competitive product, has diaphragms that last significantly longer and is capable of delivering higher fluid flow. The Husky 1050 is currently available in aluminum, polypropylene and stainless steel and will be available in PVDF, conductive polypropylene and hastelloy shortly, allowing the pump to be used in foodwith a wide variety of different fluids and beverage, dairy, pharmaceutical, cosmetic, oilchemicals. The pump has a one-piece ungasketed center section for easier repair and gas, electronics, waste water, miningmaintenance and ceramics applications.

a modular air valve for smooth changeover.

Applied Fluid Technologies

The Applied Fluid Technologies division directs its engineering, sales and marketing efforts toward threetwo broad product families:applications: equipment to apply high performance protective coatings and foam (“Protective Coatings and Foam”); and equipment to apply sealants and adhesives (“Sealants and Adhesives”); and equipment to create reaction injection molded polyurethane parts (“In-Plant Polyurethane”Advanced Fluid Dispense”).

Our Company offers a full line of air-operated airless sprayers and plural component proportioning equipment to apply foam and protective coatings to a wide variety of surfaces. The Xtreme® air-operated airless sprayers apply tough protective coatings for use in harsh environmental conditions. These sprayers offer a de-icing feature, reduced noise and easy access to the integrated air controls. A DataTrak™ control that provides material usage information, system diagnostics and runaway control is available as an option. The XtremeMix™ plural component sprayers provide on-demand mixing, ratio assurance and job site portability to spray high solid epoxies, urethanes and protective coatings with a short pot life. These pumps are incorporated into systems with our Company’s heated hose, supply pumps and applicators with accurate mix capability. The Reactor®Reactor® line of plural componentcomponents pumps is used to apply foam to insulate walls, water heaters, refrigeration, and hot tubs, create commercial roofing membranes and for packaging, architectural design and cavity filling as well as tofilling. Reactors also apply polyurea to cover tanks, pipes, roofs, truck beds and foundations with protective coatings and linings where accurate temperatures and pressures are required to achieve optimal results. The Reactor systems are also available installedKey distributors install Reactors in mobile spray rigs thatto provide portability and accessibility to remote job sites. Spray foam is used in insulating buildings. In 2008June 2009 the Company introducedreleased the Fusion® CSXM Series high-solids plural-component sprayers for corrosion-control applications such as tank and pipeline coatings, shipbuilding, marine and railcar maintenance, wind tower coating, bridge and infrastructure projects and coating structural steel. The XM sprayers provide precise ratio control in a highly configurable system. User controls provide a real-time display of ratio and a USB port for downloading data on spray gun for use inpressures, temperatures, actual ratio and total flow output. To the base unit, customers can add accessories, including material hoppers, hopper heaters, transfer pumps, agitators, hose rack kits and casters, depending on the material used and the application of foam and polyurea insulation. Every time an operator pulls the trigger of this gun a “clear shot” of a non-reactive liquid dissolves foam build-up in the mix chamber. The Fusion CS is the first foam gun with a spray pattern that can be adjusted – from a narrow pattern to touch-up a small area to a wide pattern for a large swath of wall.

method.

Our Company offers a complete line of pumps, meters, applicators and accessories, to supply and precisely dispense sealants and adhesives in automotive assembly, furniture assembly, insulated glass and window manufacturing, bookbinding, wind turbine and solar panel manufacturing and other industrial assembly operations. We work closely with major material manufacturers to identify and configure Graco equipment suitablevalves for the handlingmetering, mixing and dispensing of their materials.

The Liquid Control line of equipment meters, mixes and dispenses precision beads of sealantssealant and adhesivesadhesive to bond, mold, seal, vacuum encapsulate, pot, laminate and is customized for usegasket parts and devices in a wide variety of industrial applications, including the electronics and automotive industriesindustries. The PR70 and in bonding, molding, sealing, potting, doming and gasketing other products. In July 2008, we introduced the Liquid Control PR70v, a variable ratio version of the PR70, are the first meter, mix and dispense plural component systemsystems having Graco Control Architecture™ with built-in diagnostics. The PR70v hasdiagnostics and multiple levels of user interface for providing more data to the end-user. The PR70 is used in potting, sealing, bonding, gasketing and syringe filling applications.

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In-plant polyurethane processing equipment and systems are used to reduce road noise and vibration in motor vehicles and to produce a wide variety of injection molded parts for automobiles, trucks, consumer products and general industrial use. Material suppliers and end-user customers play a significant role in the configuration of in-plant polyurethane systems for specific applications.

The Company has established an Application Development Laboratoryapplication development laboratory in our North Canton, Ohio facility where we work with distributors, materials suppliers and end users to test new materials and reconfigure existing equipment for use in new applications.

Our Company acquired GlasCraft Inc., a subsidiary of Cohesant Technologies Inc., The lab has data collection and reporting capabilities and can heat, remove air from resins through vacuum degassing, agitate and bulk transfer materials in late February 2008. GlasCraft developedpreparation for testing.

In October 2009, the firstPCF metering and dispense system for the manufacturesealants and adhesives was released. The PCF dispenses a precise, continuous flow of composites over 40 years ago and is recognized worldwide as a leader in the composites market today. Fiberglass composites represent a new market for Graco. GlasCraft equipment meters, mixes and dispenses fiberglass materials into open and closed molds. This process is used to manufacture small and medium sized pleasure boats and watercraft, pools and spas, bathware, automotive and aircraft components and to prevent corrosion. This acquisition also enables Graco to broaden its offering of high-performance systems for the dispensing of polyurethane foam and polyurea coatings.

Our Company offers a wide variety of productssingle-component sealants and adhesives in automotive and industrial applications. The beads, dots and spray pattern dispensed by this system are smooth and consistent because of a closed-loop technology that allows changes in material temperatures, viscosities, dispense rates or robot speeds to feed back to the control, resulting in decreased material usage and rework.

Graco entered the composites market with the acquisition of GlasCraft Inc. in 2008. In 2009, Graco focused design and marketing effort on the growing demand for usehigh-performance composites which are used in the manufacture of vehicles and aircraft, wind turbines and bridge materials. High-performance composites are light-weight, corrosion-resistant, strong, structurally simple and have an extended life. Graco equipment moves, dispenses, and applies fluids in all phases of composites manufacturing from precision flow control and resin pumping for blending to continuous meter-mix supply, from molding processes and tooling fabrication to assembly processes and manufacturing products with carbon fiber impregnated fabric.
There are a variety of applications for Graco equipment throughout the alternative energy market. Frommarkets. Graco’s sealant and adhesive application equipment is widely used by manufacturers and material suppliers serving the solar energy market, through the application of primary and secondary seals to solar panels, potting or encapsulating junction boxes, inverters and charge controllers, gasketing or sealing junction box lids, solar module frames, battery cell plates and battery lids, thermal management of solar cells, inverters and charge controllers and the bonding of solar cells and solar mirrors. In addition, we offer durable reliable fluid-handling systems for the manufacture and maintenance of wind power components from spraying protective foam and other coatings on wind turbine towers to the manufacture of rotor blades, from the automatic lubrication of bearings, gears, and generators to the evacuation and dispensing of oil, grease, anti-freeze and hydraulic fluids, we offer durable, reliable versatile fluid-handling systems for the manufacture and maintenance of wind power components.fluids. Our equipment is used worldwide by wind turbine manufacturers to supply a catalyzed plastic resin for the formation of the blades used on turbines and to apply an adhesive for cementing parts of the blades together. In 2008 our Application Development Lab developed the DC12, an application system for dispensing large volumes of high-viscosity adhesive for wind turbine blade, platform and root bonding applications. Two systems offered by recently acquired GlasCraft are used in the manufacture and repair of rotor blades. The GlasCraft Gelcoat System sprays polyester and vinyl ester-based coatings in production and repair operations and the GlasCraft Resin Transfer Molding (“RTM”) System injects polyester and vinyl-ester resin into blade molds. Our Automatic Lubrication Systems dispense precise amounts of lubricant at specific intervals to critical bearings points in the wind turbine towers.

Contractor Segment

The Contractor segment generated approximately 3236 percent of our Company’s 20082009 total sales. The Contractor segment directs its product development, sales and marketing efforts toward three broad applications: paint, texture, and pavement marking. This segment markets a complete line of airless paint and texture sprayers (air, gas, hydraulically- and electrically-powered), accessories such as spray guns, hoses and filters and spare parts such as tips and seals, to professional and semi-professional painters in the construction and maintenance industries. The products are distributed primarily through stores whose main products are paint and other coatings. Contractor products are also sold through general equipment distributors. Airlessco® and ASM® products are sold by Graco employees and independent sales representatives to a distribution network that includes paint stores, wholesalers and rental yards. A limited line of sprayers and accessories are distributed globally through the home center channel.

Contractor equipment encompasses a wide variety of sprayers, including sprayers that apply markings on roads, parking lots, fields and floors; texture to walls and ceilings; highly viscous coatings to roofs; and paint to walls and structures. Many of these sprayers and their accessories contain one or more advanced technological features such as micro-processor basedmicro-processor-based controls for consistent spray and protective shut-down, a pump that may be removed and re-installed without tools, an easy clean feature, gas/electric convertibility, and an extremelya durable pump finish. Continual technological innovation and broad product families with multiple offerings are characteristic of our Company’s Contractor equipment business.segment. Painters are encouraged to upgrade their equipment regularly to take advantage of the new and/or more advanced features.

During 2008, there2009, the Tradeworks™ line of small electric sprayers for do-it-yourself home owners, handymen, remodelers and rental property owners was extended with the addition of several new sprayers. The Tradeworks sprayers, spray guns and accessories are offered exclusively through a great deal of activityworld leader in the home center channel world-wide, including the introductionmanufacture and sale of a new line of upgraded entry-level sprayers, a private-label arrangement with a major equipment supplier in Europe,coatings and related products to professional, commercial and retail customers. After a successful test program within 2008, we extended our placement of a line of electric paint sprayers in a large number of the stores of a major home center chain in the United States. Our Airlessco line of spray equipment is used by a major home center chain as its primary tool rental offering.
In August 2009, we introduced the ThermoLazer™ an innovative striper that applies thermoplastic lines to pavement. The ThermoLazer can be connected to a Graco LineDriver™ for ride-on comfort, ease of handling, improved quality and increased

6


productivity. The unit, an advancement over thermoplastic stripers currently on the market, offers precise material flow control with the pull of a lever, a more efficient method of mixing the material, an electronic ignition system, a quick system for line width changes and a system for protecting the springs.
A new lineportable sprayer for the application of sprayers for stripinga wide range of texture materials in addition to paint — from thick concrete-based filler to finish coat — was introduced in 2008.during 2009. The LineDriver™ and the LineDriver HD Ride-On Systems enableTexSpray™ HXT™ 2030 features an interchangeable displacement pump system that allows users to double their production by providingalternate between a motorized riding module to attach to their LineLazers. This system has an advanced vibration reduction system, a dual foot pedalhigh-output piston pump for forward and reverse motion, a parking brakethe heavy aggregate and a FlexBeam Break-A-Way Light to permit striping in low light conditions.

Also introduced in 2008 wassmaller pump for the Nova™390 ProStep™, a rugged yet lightweight sprayer with an innovative snap on-snap off ProStep that provides the user with an extended reach. The Sherwin-Williams Company, with an extensive nation-wide network offiner materials, paint stores, selected Graco as its exclusive supplier of entry-level paint sprayers in the fall of 2008. These sprayers, the Tradeworks™ series, offer a range of performance capabilities to support a variety of materials and frequency of use.

primer.

A large percentage of our Contractor sales come from the North American market, although Contractor products are marketed and sold in all major geographic areas. In recent years, the segment has increased its effort to appeal to customers outside of North America by developing products specifically for these markets, like the Mark X™TexSpray HXT 2030 texture sprayer designed for applications in countries where the use of concrete in residential construction is more prevalent. Another product with a 240 volt, 2.4 gallons per minute electricmarketing focus outside of the United States is the Ultra® Max II Platinum sprayer used to fill in rough areas on plaster and concrete walls and designed to be soldintroduced in Europe during 2009. The Platinum has an integrated hose reel, a wireless pressure remote control (E-Control™) to adjust pressure at any time without having to approach the unit, and Asia Pacific where less drywall is used.

the E-Lock™ mechanism to deter theft by electronically locking the sprayer.

In Europe and Asia Pacific, we are pursuing a broad strategy of converting contractors accustomed to the manual application of paint and other coatings by brush and roller to spray technology. This requires extensive in-person demonstration of the productivity advantages, cost savings and finish quality of our spray equipment. This also requires the conversion of local paint distributors who may have a different method of selling their product. For example, in the P.R.C. some paint companies include spray application in the price they charge for their paint. During 2008 sales teams were created in Europe and Asia Pacific focused exclusively on the development and servicing of distribution and application of contractor equipment in their geographies.

The Contractor segment made two asset acquisitions during 2008: the assets of the Hero-branded airless paint sprayer business from ICTC Holdings Corporation and the Airlessco spray painting assets of Durotech Co. The Company intends to convert Hero™ customers in the rental and paint sprayer business to Graco products. The Airlessco line of paint sprayers which the Company continues to manufacture in California, complement our sprayer and accessory offerings and give the Company entry into additional channels of distribution.

Lubrication Segment

The Lubrication segment represented approximately 1110 percent of our Company’s sales during 2008. Traditionally, the2009. The Lubrication segment has focusedfocuses its engineering, marketing and sales efforts on two main lubrication markets: vehicle services and industrial. We supply pumps, applicators and accessories, such as meters and hose reels, forto the motor vehicle lubrication market. In this market where our Company’s customers include fast oil change facilities, service garages, fleet service centers, automobile dealerships, and auto parts stores. Recent acquisitions have expandedIn the segment’s product offering, providing access to new markets. Systems for the centralized and automaticindustrial lubrication of bearings, gears and transmissions are an example. In August 2008, the Company acquired the assets of Lubrication Scientifics, Inc. (“LubeSci™”), based in southern California. LubeSci manufactured and sold automated lubrication systems and components for use in a wide variety of industrial applications and offered an extended line of injectors and metering systems. The Company is integrating LubeSci’s products and customers into its Industrial Lubrication equipment business, a process it expects to be completed by the end of the first quarter of 2009.

The Lubriquip® product line, acquired in 2006, consists ofmarket, we offer systems for the automatic lubrication of factory machine tools, compressors and pumps used in petrochemical and gas transmissions plants; bearings and gears on equipment in metal, pulp and paper mills; conveyors and material handling equipment; and off-road and over-the-road trucks. The Lubrication segment isWe are also developing products for the wind power market, offering automatic lubrication systems for the lubrication of turbines on site and factory-based lubrication dispense equipment to transfer, unload and evacuate bulk oil and grease and meter and dispense various lubricants.

In 2007, Our lubrication products are sold through independent third party distributors, oil jobbers and directly to original equipment manufacturers.

The Company expects that LubeSci™ automated lubrication systems and components, injectors and metering systems will be fully integrated into our industrial lubrication equipment business by the end of the first half of 2010.
Our Company introduced a new line of hose reels in 2009, ranging from entry-level for standard duty applications to high performance for heavy-duty jobs. These reels can handle a wide variety of fluids including air, water, anti-freeze, windshield washer fluid, petroleum- and synthetic-based oils and grease. The LD Series Enclosed reel was designed by engineers in our Asia Pacific group for light-duty applications and is being manufactured in our factory in Suzhou, P.R.C. The spring tension on this reel is easy to adjust and the Dyna-Star 10:1,reel is compact, lightweight, easy to install and enclosed in a high-ratio hydraulically-powered lubrication pumppolypropylene enclosure for operator safety and protection from dirty environments. The SD Series Composite reel, which can tolerate moderate indoor and outdoor use, features a composite spool and is designed to fit in small indoor spaces in tire/muffler shops, small fast lubes and maintenance shops.
The GLC 4400, a multi-purpose controller for the pumps used in automatic lubrication systems, installed on heavy-duty construction and mining equipment, including front-end loaders, mining trucks, shovel fronts, bucket wheel extractors, crushers, ship loaders and sludge pumps. A new line of dispense meters was released for sale in 2008.June 2009. The LDGLC 4400 is versatile and works with all major automatic metering systems: single line resistive, single line parallel, series is designed for lighter duty lower-volume applications, the HD series for standardprogressive and heavier duty higher-volume applications. The Matrix® 3.0 Fluid Management System introduced in late 2008 uses wireless technology to dispense and monitor bulk tank supply of lubricating oils and anti-freeze at auto dealerships, fleet maintenance facilities, off-road maintenance shops and with industrial in-plant lubricationdual line systems. The controls allow the operator to track the use oflubrication time, pressure, cycle and control the amount of oil and anti-freeze being dispensed. The new Matrix has three platforms of operating software offering the full range of fluid management solutions to any size shop.

Although the bulkmachine counts of the Lubrication segment’s sales come from North America, thelubrication cycle can be easily customized.

The segment is responsible for world-wide marketing and sales of our lubrication equipment.equipment, although the bulk of its sales come from North America. Products are distributed in each of our Company’s major geographic markets, primarily through independent distributors serviced by independent sales representatives, a dedicated sales force in the automatic lubrication systems market and direct sales generalists in foreign markets. Some automatic lubrication systems are marketed to original equipment manufacturers (OEMs)(“OEM“s). Fuel and oil transfer pumps are marketed through OEMs, select home centers, auto parts stores and our traditional distribution channel. During 2008Beginning in 2009, a market development specialist was added to the lubrication sales teams were createdteam in Europe to locate new customers and Asia Pacific focused exclusively on thehelp establish product development and servicing ofmarketing plans for the Company’s lubrication distribution and applicationsequipment in their geographies.this geography.

7


Raw Materials

The primary materials and components used in the manufacturing process are steel of various alloys, sizes and hardness; specialty stainless steel and aluminum bar stock, tubing and castings; tungsten carbide; electric motors; injection molded plastics; sheet metal; forgings; powdered metal; hoses; and electronic components. In general, the raw materials and components used are adequately available through multiple sources of supply. In order to manage cost, our Company continues to increase its global sourcing of materials and components, primarily in the Asia Pacific region.

During 2008,2009, our Company experienced significant volatilitywas able to take advantage of a downturn in the price of some commodities, like aluminum, stainlessnickel, copper, steel and natural gas, that occurred at the end of 2008. Nickel, copper and aluminum experienced significant price increases over the commodities that contained these materials, from sizablecourse of 2009. The price spikes atof oil is expected to continue putting pressure on the beginningcost of the year to falling prices for some at the end. In addition,transportation and the price of oil inall commodities was trending upward at the end of the year. In the tough economic conditions existing during much of 2009, a small number of our first six months sparked a large increase in the cost of transportation. The price of steel remains high.and second tier suppliers entered bankruptcy or closed facilities. Our Company endeavors to address fluctuations in the price and availability of various materials and components through adjustable surcharges and credits, close management of current suppliers, agreements and an intensive search for new suppliers.

We have performed risk assessments of our key suppliers and are factoring the risks identified into our commodity plans.

Intellectual Property

We own a number of patents and have patent applications pending both in the United States and in other countries, license our patents to others, and are a licensee of patents owned by others. In our opinion, our business is not materially dependent upon any one or more of these patents or licenses. Our Company also owns a number of trademarks in the United States and foreign countries, including registered trademarks for “GRACO,” several forms of a capital “G,” “Decker,“Airlessco,“Gusmer,” “Lubriquip,“ASM,” and various product trademarks which are material to our business, inasmuch as they identify Graco and our products to our customers.

Competition

We face substantial competition in all of our markets. The nature and extent of this competition varies in different markets due to the depth and breadth of our Company’s product lines. Product quality, reliability, design, customer support and service, personal relationships, specialized engineering and pricing are the major competitive factors in our markets. Although no competitor duplicates all of our products, some competitors are larger than our Company, both in terms of sales of directly competing products and in terms of total sales and financial resources. We also face competitors with different cost structures and expectations of profitability and these companies offer competitive products at lower prices. We believe we are one of the world’s leading producers of high-quality specialized fluid handling equipment in the markets we serve.

Environmental Protection

Our compliance with federal, state and local environmental laws and regulations did not have a material effect upon our capital expenditures, earnings or competitive position during the fiscal year ended December 26, 2008.

25, 2009.

Employees

As of December 26, 2008,25, 2009, we employed approximately 2,400 persons on a full-time basis.2050 persons. Of this total, approximately 460420 were employees based outside the United States, and 900730 were hourly factory workers in the United States. None of our Company’s U.S. employees are covered by a collective bargaining agreement. Various national industry-wide labor agreements apply to certain employees in Europe.various countries outside the United States. Compliance with such agreements has no material effect on our Company or its operations. In an effort to adapt to the difficult economic environment during the first half of 2009, we implemented several reductions in force in our US businesses. Many of our factory and warehouse employees affected by these reductions had returned to work by year end.

8


Item 1A. Risk Factors

Economic Environment Demand for our products depends on the level of commercial and industrial activity worldwide.

The current economic downturn and financial market turmoil has depressed demand for our equipment in all major geographies and in all major markets. If our distributors and OEMs remain unable to purchase our products because of unavailable credit or unfavorable credit terms or are simply unwilling to purchase our products, our net sales and earnings will be adversely affected.

Major Customers — Our Contractor segment depends on a few large customers for a significant portion of its sales. Significant declines in the level of purchases by these customers could reduce our sales.

Our Contractor segment derives a significant amount of revenue from a few large customers. Substantial decreases in purchases by these customers, difficulty in collecting amounts due or the loss of their business would adversely affect the profitability of this segment. The business of these customers is dependent upon the economic vitality of the construction and home maintenance markets. If these markets decline, the business of our customers could be adversely affected and their purchases of our equipment could decrease.

Acquisitions — Our growth strategy includes acquisitions. Suitable acquisitions must be located, completed and effectively integrated into our existing businesses in order for this strategy to be successful.

We have identified acquisitions as one of the strategies by which we intend to grow our business. If we are unable to obtain financing at a reasonable cost, are unsuccessful in acquiring and integrating businesses into our current business model, or do not realize projected efficiencies and cost-savings from the businesses we acquire, we may be unable to meet our growth or profit objectives.

Foreign Operations — Conditions in foreign countries and changes in foreign exchange rates may impact our sales volume, rate of growth or profitability.

In 2008,2009, approximately 5352 percent of our sales was generated by customers located outside the United States. Sales to customers located outside the United States expose us to special risks, including the risk of terrorist activities, civil disturbances, environmental catastrophes, supply chain disruptions, and special taxes, regulations and restrictions. We are increasing our presence in the Asia Pacific, region, South America, Eastern Europe and the Middle East.East and our revenues and net income may be adversely affected by the more volatile economic and political conditions prevalent in these regions. We assemble limited lines of products at our factory in Suzhou, P.R.C. and source an increasing number of the components and materials used in the assembly process from the local market. Sales in Eastern Europe, Russia and the former socialist republics are increasing at a faster rate than in Western Europe. Our revenues and net income may be adversely affected by more volatile economic and political conditions in Asia, South America, Eastern Europe and the Middle East. Changes in exchange rates between the U.S. dollar and other currencies will impact our reported sales and earnings.

earnings and may make it difficult for some of our distributors to purchase products.

Foreign Suppliers Our Company has increased its sourcing of raw materials and components from vendors located outside the United States. Interruption or delays in delivery may adversely affect our profitability.

We are sourcing an increasing percentage of our materials and components from suppliers outside the United States. Long lead times may reduce our flexibility and make it more difficult to respond promptly to fluctuations in demand.demand or respond quickly to product quality problems. Changes in exchange rates between the U.S. dollar and other currencies and fluctuations in the price of oil may impact the manufacturing costs of our products and affect our profitability.

Protective tariffs may make certain foreign-sourced parts no longer competitively priced. Long supply chains may be disrupted by environmental events.

Natural Disasters — Our operations are at risk of damage or destruction by natural disasters, such as earthquakes, tornadoes or unusually heavy precipitation.

The loss of, or substantial damage to, one of our facilities could make it difficult to supply our customers with product and provide our employees with work. Our manufacturing and distribution facility in Minneapolis is on the banks of the Mississippi River where it is exposed to flooding. Flooding could also damage our European headquarters and warehouse in Maasmechelen, Belgium or our factory in Suzhou, P.R.C. Tornadoes could damage or destroy our facilities in Sioux Falls, Rogers, Minneapolis or Anoka and a typhoon could do the same to our facility in Suzhou. An earthquake may adversely impact our operations in Suzhou.

9


Competition — Demand for our products may be affected by new entrants who copy our products and infringe on our intellectual property
From time to time, our Company has been faced with instances where competitors have intentionally infringed our intellectual property and/or taken advantage of our design and development efforts. In some instances, these competitors have launched broad marketing campaigns. The inability of our Company to effectively meet these challenges could adversely affect our revenues and profits and hamper our ability to grow.

Item 1B. Unresolved Staff Comments

None.

Item 2. Properties

The information concerning the location and general character of the physical properties of our Company contained under the heading “Business-Business“BUSINESS-Business Segments” in Part I of this 20082009 Annual Report on Form 10-K is incorporated herein by reference.

Sales activities in the countriescountry of Japan Korea, and the P.R.C. are conducted out of a leased facilities –facility in Yokohama, Japan (18,500 gross sq. ft. office) and warehousing is provided by a third-party logistics supplier. Sales and distribution activities in Korea are provided out of leased facilities in Gwangju-Gun, Korea (15,750 sq. ft. total for two separate facilities-warehouse and office). Our Company also leases space for liaison offices in the P.R.C., Vietnam and India.

Our Company’s facilities are in satisfactory condition, suitable for their respective uses and are generally adequate to meet current needs. During 2008,2009, manufacturing capacity met and in the latter part of the year exceeded business demand. Production requirements in the immediate future are expected to be met through existing facilities, the installation of new automatic and semi-automatic machine tools, efficiency and productivity improvements, and the use of leased space and available subcontract services.

Item 3. Legal Proceedings

Our Company is engaged in routine litigation incident to our business, which management believes will not have a material adverse effect upon our operations or consolidated financial position.

Item 4. Submission of Matters to a Vote of Security Holders

No issues were submitted to a vote of security holders during the fourth quarter of 2008.

2009.

Executive Officers of Our Company

The following are all the executive officers of Graco Inc. as of February 16, 2008:

15, 2009:

Patrick J. McHale, 47,48,is President and Chief Executive Officer, a position he has held since June 2007. He served as Vice President and General Manager, Lubrication Equipment Division from June 2003 to June 2007. He was Vice President of Manufacturing and Distribution Operations from April 2001 to June 2003. He served as Vice President, Contractor Equipment Division from February 2000 to March 2001. Prior to becoming Vice President, Lubrication Equipment Division in September 1999, he held various manufacturing management positions in Minneapolis, Minnesota; Plymouth, Michigan; and Sioux Falls, South Dakota. Mr. McHale joined the Company in December 1989.

David M. Ahlers, 5051, became Vice President, Human Resources in September 2008. Prior to joining Graco, Mr. Ahlers held various human resources positions, including, most recently, Chief Human Resources Officer and Senior Managing Director of GMAC Residential Capital, from August 2003 to August 2008. He joined the Company in September 2008.

Caroline M. Chambers, 44,45,became Vice President and Controller in December 2006 and has served as the Company’s principal accounting officer since September 2007. She was Corporate Controller from October 2005 to December 2006 and Director of Information Systems from July 2003 through September 2005. Prior to becoming Director of Information Systems, she held various management positions in the internal audit and accounting departments. Prior to joining Graco, Ms. Chambers was an auditor with Deloitte & Touche in Minneapolis, Minnesota and Paris, France. Ms. Chambers joined the Company in 1992.

10


Karen Park Gallivan, 5253, became Vice President, General Counsel and Secretary in September 2005. She was Vice President, Human Resources from January 2003 to September 2005. Prior to joining Graco, she was Vice President of Human Resources and Communications at Syngenta Seeds, Inc., from January 1999 to January 2003. From 1988 through January 1999, she was the general counsel of Novartis Nutrition Corporation. Prior to joining Novartis, Ms. Gallivan was an attorney with the law firm of Rider, Bennett, Egan and Arundel. She joined the Company in January 2003.

James A. Graner, 64,65,became Chief Financial Officer and Treasurer in September 2005. He was Vice President and Controller from March 1994 to September 2005. He was Treasurer from May 1993 through February 1994. Prior to becoming Treasurer, he held various managerial positions in the treasury, accounting and information systems departments. He joined the Company in 1974.

Dale D. Johnson, 54,55,became Vice President and General Manager, Contractor Equipment Division in April 2001. From January 2000, through March 2001, he served as President and Chief Operating Officer. From December 1996 to January 2000, he was Vice President, Contractor Equipment Division. Prior to becoming the Director of Marketing, Contractor Equipment Division, in June 1996, he held various marketing and sales positions in the Contractor Equipment Division and the Industrial Equipment Division. He joined the Company in 1976.

Jeffrey P. Johnson,4950, is Vice President and General Manager, Asia Pacific, a position he has held since February 2008. He served as Director of Sales and Marketing, Applied Fluid Technologies Division, from June 2006 until February 2008. Prior to joining Graco, he held various sales and marketing positions, including, most recently, President of Johnson Krumwiede Roads, a full-service advertising agency, and European sales manager at General Motors Corp. He joined the Company in 2006.

David M. Lowe, 53,54,became Vice President and General Manager, Industrial Products Division in February 2005. He was Vice President and General Manager, European Operations from September 1999 to February 2005. Prior to becoming Vice President, Lubrication Equipment Division in December 1996, he was Treasurer. Mr. Lowe joined the Company in February 1995.

Simon J. W. Paulis, 61,62,became Vice President and General Manager, Europe in September 2005. From February 2005 to September 2005, he served as Director and General Manager, Europe. He served as Sales and Marketing Director, Contractor Equipment Europe from January 1999 to September 2005. Prior to joining Graco, he served as business unit manager for Black & Decker N.V., general sales manager for Alberto Culver, and marketing manager for Ralston Purina/Quaker Oats. Mr. Paulis joined the Company in January 1999.

Charles L. Rescorla, 57,58,became Vice President of Manufacturing, Information Systems and Distribution Operations in September 2005.April 2009. He served as Vice President, Manufacturing and Distribution Operations from September 2005 to April 2009. From June 2003 to until September 2005, he was Vice President, Manufacturing/Distribution Operations and Information Systems from June 2003 to September 2005.Systems. From April 2001 until June 2003, he was Vice President of the Industrial/Automotive Equipment Division. Prior to June 2003, he held various positions in manufacturing and engineering management. Mr. Rescorla joined the Company in June 1988.

Mark W. Sheahan,4445, became Vice President and General Manager, Applied Fluid Technologies Division in February 2008. He served as Chief Administrative Officer from September 2005 until February 2008, and was Vice President and Treasurer from December 1998 to September 2005. Prior to becoming Treasurer in December 1996, he was Manager, Treasury Services, where he was responsible for strategic and financial activities. He joined the Company in September 1995.

Brian J. Zumbolo, 39,40,became Vice President and General Manager, Lubrication Equipment Division in August 2007. He was Director of Sales and Marketing, Lubrication Equipment and Applied Fluid Technologies, Asia Pacific, from November 2006 through July 2007. From February 2005 to November 2006, he was the Director of Sales and Marketing, High Performance Coatings & Foam, Applied Fluid Technologies Division. Mr. Zumbolo was the Director of Sales and Marketing, Finishing Equipment from May 2004 to February 2005. Prior to May 2004, he held various marketing positions in the Industrial Equipment Division. Mr. Zumbolo joined the Company in 1999.

With the exception of Patrick J. McHale, Brian J. Zumbolo, Caroline M. Chambers, Jeffrey P. Johnson, Mark W. Sheahan and David M. Ahlers, the

The Board of Directors electedre-elected each of the above executive officers to their current position on April 21, 2006. Mr. McHale was elected President and Chief Executive Officer effective June 24, 2009.

11 2007; Mr. Zumbolo was elected Vice President and General Manager, Lubrication Equipment Division, effective August 1, 2007; Ms. Chambers was elected Vice President and Controller, effective December 8, 2006; Jeffrey P. Johnson was elected Vice President and General Manager, Asia Pacific, effective February 15, 2008; Mark W. Sheahan was elected Vice President and General Manager, Applied Fluid Technologies Division, effective February 15, 2008; and David M. Ahlers was appointed Vice President, Human Resources, effective September 22, 2008.


PART II

Item 5. Market for the Company’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities

Graco Common Stock

Graco common stock is traded on the New York Stock Exchange under the ticker symbol “GGG.” As of February 9, 2009,8, 2010, the share price was $22.26$26.38 and there were 59,545,50060,080,211 shares outstanding and 2,8742,845 common shareholders of record, which includes nominees or broker dealers holding stock on behalf of an estimated 31,50043,000 beneficial owners.

The graph below compares the cumulative total shareholder return on the common stock of the Company for the last five fiscal years with the cumulative total return of the S&P 500 Index and the Dow Jones Industrial Machinery Index over the same period (assuming the value of the investment in Graco common stock and each index was $100 on December 31, 2003, and all dividends were reinvested).

12

Five Year* Cumulative Total Shareholder Return


*Fiscal Year Ended Last Friday in December


Quarterly Financial Information (Unaudited)


(In thousands, except per share amounts)

                 
  First Second Third Fourth
  Quarter Quarter Quarter Quarter
2009
                
Net sales $137,880  $147,712  $147,308  $146,312 
Gross profit  64,328   73,008   78,141   77,339 
Net earnings  2,768   11,634   17,336   17,229 
                 
Per common share                
Basic net earnings $0.05  $0.19  $0.29  $0.29 
Diluted net earnings  0.05   0.19   0.29   0.28 
Dividends declared  0.19   0.19   0.19   0.20 
                 
Stock price (per share)                
High $25.98  $24.82  $30.66  $30.70 
Low  14.48   17.34   20.91   26.41 
Close1
  17.07   22.02   27.87   28.57 
                 
Volume (# of shares)  44,750   44,217   29,086   22,551 
                 
  First Second Third Fourth
  Quarter Quarter Quarter Quarter
2008
                
Net sales $204,120  $239,230  $207,231  $166,689 
Gross profit  111,853   128,763   110,160   81,401 
Net earnings  35,566   42,459   32,772   10,082 
                 
Per common share                
Basic net earnings $0.58  $0.70  $0.55  $0.17 
Diluted net earnings  0.57   0.69   0.54   0.17 
Dividends declared  0.19   0.19   0.19   0.19 
                 
Stock price (per share)                
High $36.98  $41.84  $40.45  $35.03 
Low  32.37   36.88   34.48   17.67 
Close1
  36.26   38.07   35.61   23.73 
            ��    
Volume (# of shares)  33,416   30,260   39,776   52,431 
1As of the last trading day of the calendar quarter.

13

 

2008

First

Quarter

Second

Quarter

Third

Quarter

Fourth

Quarter

 

Net sales

$204,120

$239,230

$207,231

$166,689

 

Gross profit

111,853

128,763

110,160

81,401

 

Net earnings

35,566

42,459

32,772

10,082

 

Per common share

 

 

 

 

 

Basic net earnings

.58

.70

.55

.17

 

Diluted net earnings

.57

.69

.54

.17

 

Dividends declared

.19

.19

.19

.19

 

Stock price (per share)

 

 

 

 

 

High

$36.98

$41.84

$40.45

$35.03

 

Low

32.37

36.88

34.48

17.67

 

Close1

36.26

38.07

35.61

23.73

 

Volume (# of shares)

33,416

30,260

39,776

52,431

 

 

 

 

 

 

 

 

2007

First

Quarter

Second

Quarter

Third

Quarter

Fourth

Quarter

 

Net sales

$197,495

$231,384

$207,270

$205,190

 

Gross profit

104,862

122,232

110,646

109,686

 

Net earnings

33,735

44,180

39,263

35,658

 

Per common share

 

 

 

 

 

Basic net earnings

.51

.67

.61

.57

 

Diluted net earnings

.50

.66

.60

.56

 

Dividends declared

.17

.17

.17

.19

 

Stock price (per share)

 

 

 

 

 

High

$42.27

$42.07

$46.07

$40.50

 

Low

38.44

38.27

37.84

36.25

 

Close1

39.16

40.28

39.11

37.26

 

Volume (# of shares)

22,604

40,254

46,605

28,941

 

1 As of the last trading day of the calendar quarter.


Issuer Purchases of Equity Securities

On September 28, 2007, the Board of Directors authorized the Company to purchase up to 7,000,000 shares of its outstanding common stock.stock, primarily through open-market transactions. This authorization expired on September 30, 2009.
On September 18, 2009, the Board of Directors authorized the Company to purchase up to an additional 6,000,000 shares. The new authorization expires on September 30, 2009.

2012.

In addition to shares purchased under the Board authorization, 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 stock option exercises.

Information on issuer purchases of equity securities follows:

Period

(a)

Total Number of Shares Purchased

(b)

Average Price Paid per Share

(c)

Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs

(d)

Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs (at end of period)

 

 

 

 

 

Sep 27, 2008 – Oct 24, 2008

15,000

$33.02

      15,000     

3,068,234

 

 

 

 

 

Oct 25, 2008 – Nov 21, 2008

—  

3,068,234

 

 

 

 

 

Nov 22, 2008 – Dec 26, 2008

—  

3,068,234

 

 

 

 

 

                 
              Maximum Number
          Total Number of of Shares that May
  Total Average Shares Purchased Yet Be Purchased
  Number Price as Part of Publicly Under the Plans
  of Shares Paid per Announced Plans or Programs
Period Purchased Share or Programs (at end of period)
Sep 26, 2009 - Oct 23, 2009    $      6,000,000 
Oct 24, 2009 - Nov 20, 2009    $      6,000,000 
Nov 21, 2009 - Dec 25, 2009  1,121  $28.17      6,000,000 

Item 6. Selected Financial Data

Graco Inc. and Subsidiaries (in thousands, except per share amounts)
                     
  2009 2008 2007 2006 2005
Net sales $579,212  $817,270  $841,339  $816,468  $731,702 
Net earnings  48,967   120,879   152,836   149,766   125,854 
Per common share                    
Basic net earnings $0.82  $2.01  $2.35  $2.21  $1.83 
Diluted net earnings  0.81   1.99   2.32   2.17   1.80 
Cash dividends declared  0.77   0.75   0.68   0.60   0.54 
                     
Total assets $476,434  $579,850  $536,724  $511,603  $445,630 
Long-term debt (including current portion)  86,260   180,000   107,060       

14


(In thousands, except per share amounts)

2008

2007

2006

2005

2004

Net sales

$817,270

$841,339

$816,468

$731,702

$605,032

Net earnings

120,879

152,836

149,766

125,854

108,681

Per common share

 

 

 

 

 

Basic net earnings

$      2.01

$      2.35

$      2.21

$      1.83

$      1.57

Diluted net earnings

1.99

2.32

2.17

1.80

1.55

Total assets

$579,850

$536,724

$511,603

$445,630

$371,714

Long-term debt (including current portion)

180,000

107,060

— 

— 

— 

Cash dividends declared

 

 

 

 

 

per common share

.75

        .68

         .60

        .54

        .41

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following Management’s Discussion and Analysis (MD&A) reviews significant factors affecting the Company’s consolidated results of operations, financial condition and liquidity. This discussion should be read in conjunction with our financial statements and the accompanying notes to the financial statements (“Notes”).statements. The discussion is organized in the following sections:

§

Overview

Results of Operations
Segment Results
Financial Condition
Critical Accounting Estimates
Outlook

§

Results of Operations

Overview

§

Segment Results

§

Financial Condition

§

Significant Accounting PoliciesGraco designs, manufactures and Estimates

§

Outlook

Overview

Our Company’s key strategies include offering new products, expanding distribution, opening new markets systems and completing strategic acquisitions. Long-term financial growth targets accompany these strategies, including 10 percent revenue growthequipment to move, measure, control, dispense and 12 percent net earnings growth.

spray fluid materials used in many different applications. Graco’s business is classified by management into three reportable segments, each responsible for product development, manufacturing, marketing and sales of their products. The segments are headquartered in North America. They have responsibility for sales and marketing in the Americas and joint responsibility with Europe and Asia Pacific regional management for sales and marketing in those geographic areas.

Graco’s key strategies include development and marketing new products, expanding distribution globally, opening new markets with technology and channel expansion and completing strategic acquisitions. Long-term financial growth targets accompany these strategies, including 10 percent revenue growth and 12 percent net earnings growth.
Manufacturing is a key competency of the Company. Strategic manufacturing expertise is provided by ourOur management team in Minneapolis whichprovides strategic manufacturing expertise, and is also responsible for factories not fully aligned with a single division. Our primary manufacturing facilities are in the United States and distribution facilities are located in the United States, Belgium, Japan, Korea, China and Australia. In 2007, Lubrication division manufacturing activities were consolidated in Anoka, Minnesota and in 2006, an assembly operation in Suzhou, China began production.

Results of Operations

(In millions, except per share amounts) 

2008

2007

2006

Net Sales

$817.3

$841.3

$816.5

Operating Earnings

187.4

232.5

226.0

Net Earnings

120.9

152.8

149.8

Diluted Net Earnings per Common Share

$  1.99

$  2.32

$  2.17

Net sales, net earnings and earnings per share were as follows (in millions except per share amounts):

2008

             
  2009 2008 2007
Net Sales $579  $817  $841 
Operating Earnings  74   187   232 
Net Earnings  49   121   153 
Diluted Net Earnings per Common Share $0.81  $1.99  $2.32 
2009 Summary:

§

Weak economic conditions worldwide affected the Company’s operating results. Although sales strengthened in the second half as compared to the first half of 2009, sales decreased in all segments and regions as compared to last year. By region, the sales decline was 28 percent in the Americas, 39 percent in Europe and 17 percent in Asia Pacific. Sales declinein the Industrial segment declined by 32 percent; sales in the Contractor segment declined by 22 percent and sales in the Lubrication segment declined by 34 percent.
Unfavorable currency translation decreased net sales by approximately $10 million and decreased net earnings by approximately $4 million in 2009.
The Company incurred $5 million of cost related to workforce reductions, mostly in the first quarter. The decrease in cost structure resulting from cost reduction actions contributed to improvements in net earnings in the last three quarters of the year.
Gross profit margin as a percentage of sales decreased by 2 percentage points from 2008. The favorable effects of pricing, product mix, lower material costs and other cost reduction activities partially offset the effects of low production volumes and increased pension costs.
Investment in new product development was $38 million or 61/2 percent of sales in 2009.
Overall, total operating expenses were 11 percent lower than the prior year, due to lower workforce reduction costs and lower volume-related expenses. Expense reductions were partially offset by higher pension costs.

15


The effective tax rate was 29 percent as compared to 32 percent in 2008. The effect of federal business credits and the domestic production deduction was greater in 2009 as a percentage of pre-tax earnings as compared to the prior year.
Cash flows from operations remained strong at $147 million.
2008 Summary:
Incoming order rates declined substantially in the fourth quarter of 2008, affecting all segments and regions.
Sales declined by 3 percent as compared to the prior year as growth in Europe and Asia Pacific of 8 percent and 3 percent, respectively, did not offset declines in the Americas. Sales in the Industrial segment grew 4 percent worldwide, while sales in the ContactorContractor and Lubrication segments declined by 13 percent and 3 percent, respectively, from the prior year.

§

Net

Three businesses were acquired in 2008 (Glascraft, Airlessco and LubeSci), increasing net sales by $13 million or 2 percent.
Favorable currency translation increased net sales by approximately $12 million from favorable currency translation. Net earnings declined by 21 percent from the prior year. Currency translationand increased net earnings by approximately $4 million in 2008.

§

Incoming order rates declined substantially

Investment in new product development grew to 41/2 percent of sales in 2008 from 31/2 percent of sales in 2007.
Incremental costs associated with the programs to introduce new entry-level sprayers in the fourth quarter, affecting all segmentsContractor segment to additional paint and regions.

home center outlets were approximately $12 million.

§

A workforce reduction affecting approximately 150 people or 6 percent of the global employee base was communicated in December 2008. Early retirement and severance costs were approximately $5 million. The number of temporary and contract workers was reduced in earlier months.

§

Impairment charges of approximately $4 million were recorded, primarily due to reduced expectations with respect to future sales of certain branded products within the Industrial segment.

§

Incremental costs associated with the programs to introduce a new entry-level sprayer in the Contractor segment to additional paint and home center outlets were approximately $12 million. The programs are expected to provide future returns in the form of market share growth.

§

Three businesses were acquired in 2008: GlasCraft, Airlessco and LubeSci, increasing net sales by $13 million or 2 percent.

§

Investment in product development grew to 4.5 percent of sales in 2008 from 3.6 percent of sales in 2007.

§

Positive cash flows from operations were $162 million, down 8 percent as compared to the prior year.

2007 Summary:

§

Sales growth of 3 percent in 2007, with strong growth in Europe and Asia Pacific of 23 percent and 18 percent, respectively. Sales in the Americas decreased by 6 percent, primarily due to the weak housing and construction industries.

§

Sales were higher in the Industrial and Lubrication segments, with growth of 7 percent and 13 percent respectively, offset by a 4 percent decline in Contractor.

§

Net sales increased by approximately $17 million from favorable currency translation.

§

Net earnings grew 2 percent. Currency translation increased net earnings by approximately $7 million.

§

Investment in new products was 3.6 percent of sales in 2007 and 3.7 percent of sales in 2006.

§

The full year impact of the Lubriquip acquisition increased net sales by $11 million or 1 percent in 2007.

§

Increased cash flows from operations.

The following table presents net sales by geographic region.

region (in millions).

(In millions)

2008

2007

2006

 

Geographic Sales

 

 

            
 2009 2008 2007 

Americas1

$455.5

$500.4

$534.9

 

 $329 $455 $500 

Europe2

232.3

215.5

175.7

 

 143 232 216 

Asia Pacific

129.5

125.4

105.9

 

 107 130 125 
       

Total

$817.3

$841.3

$816.5

 

 $579 $817 $841 

1North and South America, including the United States. Sales in the United States were $384 million in 2008, $434 million in 2007 and $474 million in 2006.

2Europe, Africa and Middle East

       

1North and South America, including the United States. Sales in the United States were $280 million in 2009, $384 million in 2008 and $434 million in 2007.
2Europe, Africa and Middle East
In 2009, sales in the Americas declined by 28 percent overall, with declines of 32 percent in the Industrial segment, 19 percent in the Contractor segment and 34 percent in the Lubrication segment as compared to the prior year. Despite the severity of the global recession, commercial resources were maintained and new distribution outlets were opened in all regions and segments.
In 2008, sales in the Americas declined by 9 percent overall and by 22 percent and 7 percent in the Contractor and Lubrication segments, respectively, in 2008 as compared to the prior year. Industrial sales increased by 3 percent in the Americas, primarily due to the Glascraft acquisition. Sales grew in Europe and Asia Pacific in all three segments as a result of continued emphasis on expanding sales and marketing resources and focus on new distribution and acquisitions.

16


The following table presents components of net sales change:

2008

 

Industrial

 

Contractor

 

Lubrication

 

Consolidated

 

 

 

Americas

 

Europe

Asia Pacific

 

Consolidated

Volume & price

0%

(15%)

(4%)

(6%)

 

(11%)

2%

1%

(6%)

Acquisitions

2%

1%

1%

2%

 

2%

1%

2%

2%

Currency

2%

1%

0%

1%

 

0%

5%

0%

1%

Total

4%

(13%)

(3%)

(3%)

 

(9%)

8%

3%

(3%)

 

 

 

 

 

 

 

 

 

 

                            

2007

 2009 

 

Industrial

 

Contractor

 

Lubrication

 

Consolidated

 

 

 

Americas

 

Europe

Asia Pacific

 

Consolidated

 Segment Region   

Volume & price

4%

(6%)

(2%)

0%

 

(8%)

13%

16%

0%

 Industrial Contractor Lubrication Americas Europe Asia Pacific Consolidated 
Volume and Price  (31)%  (23)%  (33)%  (28)%  (36)%  (17)%  (29)%

Acquisitions

0%

0%

14%

1%

 

2%

1%

1%

1%

  %  3%  %  1%  1%  %  1%

Currency

3%

2%

1%

2%

 

0%

9%

1%

2%

  (1)%  (2)%  (1)%  (1)%  (4)%  %  (1)%
               

Total

7%

(4%)

13%

3%

 

(6%)

23%

18%

3%

  (32)%  (22)%  (34)%  (28)%  (39)%  (17)%  (29)%
               

                             
  2008 
  Segment  Region    
  Industrial  Contractor  Lubrication  Americas  Europe  Asia Pacific  Consolidated 
Volume and Price  %  (15)%  (4)%  (11)%  2%  1%  (6)%
Acquisitions  2%  1%  1%  2%  1%  2%  2%
Currency  2%  1%  %  %  5%  %  1%
                      
Total  4%  (13)%  (3)%  (9)%  8%  3%  (3)%
                      
The following table presents an overview of components of operating earnings as a percentage of net sales:
             
  2009  2008  2007 
Net Sales  100.0%  100.0%  100.0%
Cost of products sold  49.4   47.1   46.8 
          
Gross profit  50.6   52.9   53.2 
Product development  6.5   4.5   3.6 
Selling, marketing and distribution  19.9   17.0   14.8 
General and administrative  11.3   8.5   7.2 
          
Operating earnings  12.9   22.9   27.6 
Interest expense  0.8   0.9   0.4 
Other expense, net  0.2   0.1    
          
Earnings before income taxes  11.9   21.9   27.2 
Income taxes  3.4   7.1   9.0 
          
Net Earnings  8.5%  14.8%  18.2%
          
2009 Compared to 2008
Gross profit margin as a percentage of sales was 51 percent in 2009 as compared to 53 percent in 2008. Lower production volumes accounted for approximately 4 percentage points of the reduction and increased pension costs accounted for an additional 1 percentage point of the reduction. Favorable effects of pricing, product mix, lower material costs and other cost reduction activities partially offset the effects of low production volumes and increased pension costs.
Although operating expenses in 2009 declined to $218 million compared to $245 million in the prior year, the reduction in expense as a percentage of net sales was not as great as the change in sales volume. Product development spending was $38 million as compared to $37 million in the prior year, reflecting the Company’s strategic decision to continue investing in new product development. Selling, marketing and distribution costs were $116 million in 2009 as compared to $139 million in 2008. General and administrative costs were $65 million in 2009 as compared to $70 million in the prior year. Included in operating expenses was an increase in pension cost of $11 million as compared to 2008.
Consolidated operating earnings decreased 60 percent to $74 million, or 13 percent of sales in 2009, reflecting the effects of lower sales volumes, unfavorable currency translation and increased pension costs, partially offset by spending reductions and lower volume-related expenses.
Interest expense was $5 million in 2009 as compared to $8 million in 2008. Debt was reduced by $100 million in 2009 from the prior year.

17


 

2008

2007

2006

Net Sales

100.0

100.0

100.0

Cost of products sold

47.1

46.8

46.8

Gross profit

52.9

53.2

53.2

Product development

4.5

3.6

3.7

Selling, marketing and distribution

17.0

14.8

14.6

General and administrative

8.5

7.2

7.2

Operating earnings

22.9

27.6

27.7

The Company’s effective tax rate was 29 percent in 2009, lower than the effective tax rate of 32 percent in 2008. The rate is lower than the U.S. federal statutory rate of 35 percent due primarily to U.S. business credits and the Domestic Production Deduction (DPD). The effect of the business credits and the DPD was greater in 2009 as a percentage of pre-tax earnings as compared to the prior year.

Interest expense

0.9

0.4

0.1

Other expense, net

0.1

0.0

0.1

Earnings before income taxes

21.9

27.2

27.5

Income taxes

7.1

9.0

9.2

Net Earnings

14.8

18.2

18.3

2008 Compared to 2007

Gross profit margin as a percentage of sales was 53 percent in 2008 and 2007. The gross profit margin in 2008 was affected by lower volume and cost reduction actions taken in the fourth quarter of 2008.
Operating expenses in 2008 were $245 million compared to $215 million in the prior year. The increase includes $8 million related to the rollout of entry-level paint sprayers to additional paint and home center stores, $7 million from acquired operations, $4 million of impairment charges and $3 million related to workforce reductions. During 2008, investment in new product development increased by $6 million as compared to the prior year, to 4.541/2 percent of sales. Total operating expenses as a percentage of sales was 30 percent as compared to 26 percent in the prior year.

Operating expenses in 2007 were $215 million versus $208 million in 2006. Although spending increased for selling, marketing and distribution (increase of $5 million) and general and administrative (increase of $1 million), total operating expenses as a percentage of sales was consistent with the prior year at 26 percent. Included in cost of goods sold and operating expenses were costs and expenses totaling $2.3 million in 2007 related to the closure and move of the Lubriquip operations in Cleveland, Ohio and Madison, Wisconsin to the Anoka, Minnesota factory.

Consolidated operating earnings decreased 19 percent to $187 million, or 23 percent of sales in fiscal 2008, with a decrease in sales of 3 percent as compared to the prior year and increased expenses. Gross profit margin as a percentage of sales was slightly down from the prior year, as the unfavorable impact of material costs and volume were greater than the impact of favorable currency translation rates and manufacturing productivity improvements.

Consolidated operating earnings increased 3 percent to $232 million, or 28 percent of sales in fiscal 2007, compared to $226 million, or 28 percent of sales in fiscal 2006, reflecting growth in sales of 3 percent as compared to the prior year and consistent gross profit margins and expenses. Gross profit margin as a percentage was consistent with the prior year, as the favorable impact of pricing and foreign currency translation offset higher spending and material costs.

Interest expense increased byin 2008 was $4 million in 2008 and $2.5 millionhigher than in 2007 as the Company increased its utilization of credit lines for acquisitions and to purchasepurchases of Company stock.

The Company’s effective tax rate was 32 percent in 2008, lower than the effective tax rate of 33 percent in both 2007 and 2006.2007. The rate is lower than the U.S.U. S. federal statutory rate of 35 percent due primarily to U.S. business credits and the Domestic Production Deduction (DPD).

DPD.

Segment Results

The following table presents net sales and operating earnings by business segment:

segment (in millions):

(In millions)

2008 

2007 

2006 

Segment Sales

 

            
 2009 2008 2007 
Sales 

Industrial

$462.9 

$444.7 

$416.5 

 $313 $463 $445 

Contractor

266.8 

306.7 

320.5 

 208 267 306 

Lubrication

87.6 

89.9 

 79.5 

 58 87 90 

Consolidated

$817.3 

$841.3 

$816.5 

 

       

Segment Operating Earnings

 

Total $579 $817 $841 
       
 
Operating Earnings 

Industrial

$138.2 

$152.3 

$128.5 

 $68 $138 $152 

Contractor

47.2 

81.5 

89.1 

 29 47 82 

Lubrication

12.5 

9.3 

18.7 

  (3) 13 9 

Unallocated corporate

(10.5)

(10.6)

(10.3)

  (20)  (11)  (11)

Consolidated

$187.4 

$232.5 

$226.0 

       
Total $74 $187 $232 
       

Management looks at economic and financial indicators relevant to each segment and geography to gauge the business environment, as noted in the discussion below for each segment.

18


Industrial

Industrial
The following table presents net sales, components of net sales change and operating earnings for the Industrial segment.

segment (dollars in millions).

(In millions)

2008 

2007 

2006 

            
 2009 2008 2007 

Sales

 

 

Americas

$219.6 

$213.1 

$221.4 

 $149 $220 $213 

Europe

148.1 

138.0 

115.9 

 89 148 138 

Asia Pacific

95.2 

93.6 

79.2 

 75 95 94 
       

Total

$462.9 

$444.7 

$416.5 

 $313 $463 $445 

 

       
 

Components of Net Sales Change

 

 

Volume & Price

0%

4%

12%

Volume and Price  (31)%  %  4%

Acquisitions

2%

0%

1%

  %  2%  %

Currency

2%

3%

1%

  (1)%  2%  3%
       

Total

4%

7%

14%

  (32)%  4%  7%

 

       
 

Operating Earnings as a Percentage of Sales

30%

34%

31%

  22%  30%  34%
       

In 2009, sales in the Industrial segment decreased by 32 percent, with declines in all regions. Sales declined by 32 percent in the Americas, 40 percent in Europe (36 percent at consistent exchange rates) and 21 percent in Asia Pacific. Although still below the prior year, sales improved in the fourth quarter of 2009 as compared to earlier quarters.
In 2009, operating earnings in the Industrial segment were $68 million, or 22 percent of sales in 2009 as compared to $138 million, or 30 percent the prior year. One percentage point of the change in operating earnings is attributable to unfavorable currency translation and 4 percentage points of the change in operating earnings is attributable to greater unabsorbed manufacturing costs. The favorable effects of reductions in product cost, mix and price partially offset the effects of volume on operating earnings.
In 2008, sales in the Industrial segment increased by 4 percent, with sales growth in all regions. Sales in the Americas increased 3 percent. Sales in Europe grew by 7 percent, including 5 percentage points related to favorable currency translation rates. The sales growth in Asia Pacific was 2 percent and the effect of currency translation rates was not significant.

In 2008, operating earnings in the Industrial segment declined 9 percent and were affected by impairment charges of $4 million, selling and product development initiatives, costs and expenses resulting from acquisition and integration related activities, workforce reduction costs and unabsorbed manufacturing costs.

In 2007, sales in the Industrial segment increased by 7 percent, with sales growth in Europe and Asia offsetting sales declines in the Americas. Sales in Europe grew by 19 percent, including 9 percentage points related to favorable currency translation rates. The sales growth in Asia Pacific was 18 percent and the effect of currency translation rates was not significant.

In 2007, operating earnings in the Industrial segment were up 19 percent due to the increase in sales, improvements in gross profit margins and lower spending as percentage of sales. The lower spending is primarily the result of efficiencies obtained following the move of Gusmer operations into the Minneapolis, Sioux Falls and Ohio facilities and closure of the New Jersey facility in 2006.

In this segment, sales in each geographic region are significant and management looks at economic and financial indicators in each region, including gross domestic product, industrial production, capital investment rates, automobile production, building construction and the level of the U.S. dollar versus the euro, the Canadian dollar and various Asian currencies.

19


Contractor

Contractor
The following table presents net sales, components of net sales change and operating earnings for the Contractor segment.

segment (dollars in millions).

(In millions)

2008  

2007  

2006  

            
 2009 2008 2007 

Sales

 

 

Americas

$165.0  

$210.9  

$244.0

 $133 $165 $211 

Europe

76.8  

71.0  

55.3

 50 77 71 

Asia Pacific

25.0  

24.8  

21.2

 25 25 25 
       

Total

$266.8  

$306.7  

$320.5

 $208 $267 $307 

 

       
 

Components of Net Sales Change

 

 

Volume & Price

(15%)

(6%)

4%

Volume and Price  (23)%  (15)%  (6)%

Acquisitions

1% 

0% 

0%

  3%  1%  %

Currency

1% 

2% 

1%

  (2)%  1%  2%
       

Total

(13%)

(4%)

5%

  (22)%  (13)%  (4)%

 

       
 

Operating Earnings as a Percentage of Sales

18% 

27% 

28%

  14%  18%  27%
       

In 2009, sales in the Contractor segment decreased by 22 percent, with declines of 19 percent and 35 percent (31 percent at consistent exchange rates) in the Americas and Europe, respectively. Sales in Asia Pacific were steady compared to last year. In the Americas, sales declined in both the professional paint store and home center channels.
In 2009, operating earnings in the Contractor segment were $29 million or 14 percent of sales in 2009 as compared to $47 million or 18 percent the prior year. One percentage point of the change in operating earnings is attributable to unfavorable currency translation and 2 percentage points of the change is attributable to greater unabsorbed manufacturing costs in 2009. The favorable effects of reductions in product cost, mix and price partially offset the effects of volume on operating earnings.
In 2008, sales in the Contractor segment decreased by 13 percent. While sales in the Americas decreased by 22 percent, sales in Europe and Asia Pacific grew by 8 percent and 1 percent, respectively. Sales in the Americas reflected sales declines in both the home center and professional paint store channels. Sales growth in both Europe and Asia Pacific is attributed to continued focus on converting professional contractors from manual to spray applications and new distribution.

In 2008, operating earnings in the Contractor segment decreaseddeclined by 42 percent. Approximately $12 million of incremental cost and expense relates to the production and launch of new paint sprayer lines into existing and new paint store and home center outlets. Operating earnings were also affected by increased product development spending, costs of the workforce reduction, costs and lower profit levels of the acquired business and unabsorbed manufacturing costs.

In 2007, sales in the Contractor segment decreased by 4%. Although sales in the Americas decreased by 14 percent, sales in Europe and Asia Pacific grew by 28 percent and 17 percent, respectively. Sales in the Americas were lower due to declines in both the home center and professional paint store channels. Sales growth in both Europe and Asia Pacific is attributed to continued focus on converting professional contractors from manual to spray applications and new distribution.

In 2007, operating earnings in the Contractor segment decreased by 9 percent. Operating earnings include approximately $1 million of incremental expense related to the launch and production of a new paint sprayer line for the home center channel. Gross profit margins and spending levels were otherwise consistent with the prior year.

In this segment, sales in the Americas and Europe are significant and management reviews economic and financial indicators in each region, including levels of residential, commercial and institutional building,construction, remodeling rates and interest rates. Management also reviews gross domestic product for the regions and the level of the U.S. dollar versus the euro.

20


Lubrication

Lubrication
The following table presents net sales, components of net sales change and operating earnings for the Lubrication segment.

segment (dollars in millions).

(In millions)

2008 

2007 

2006 

         
 2009 2008 2007 

Sales

 

 

Americas

$70.8  

$76.4  

$69.5

 $47 $71 $76 

Europe

7.5  

6.6  

4.5

 4 8 7 

Asia Pacific

9.3  

6.9  

5.5

 7 9 7 
       

Total

$87.6  

$89.9  

$79.5

 $58 $88 $90 

 

       
 

Components of Net Sales Change

 

 

Volume & Price

(4%)

(2%)

8%

Volume and Price  (33)%  (4)%  (2)%

Acquisitions

1% 

14%  

25%

  %  1%  14%

Currency

0% 

1%  

1%

  (1)%  %  1%
       

Total

(3%)

13%  

34%

  (34)%  (3)%  13%

 

       
 

Operating Earnings as a Percentage of Sales

14% 

10%  

24%

  (5)%  14%  10%
       

In 2009, sales in the Lubrication segment decreased by 34 percent, with declines of 34 percent in the Americas, 45 percent (44 percent at consistent exchange rates) in Europe and 26 percent (27 percent at consistent exchange rates) in Asia Pacific, with declines in both the petroleum management and industrial lubrication channels.
In 2009, the operating loss in the Lubrication segment was $3 million or 5 percent of sales in 2009 as compared to operating earnings of $12 million or 14 percent of sales the prior year. The segment continued to invest in new product development and growth in international commercial capabilities, but was severely affected by low volumes and unabsorbed manufacturing costs.
In 2008, sales in the Lubrication segment decreased by 3 percent. Although sales in the Americas decreased by 7 percent, sales in Europe and Asia Pacific grew by 13 percent and 34 percent, respectively. Sales in the Americas reflected sales declines in the vehicle servicespetroleum management product line. Sales growth in both Europe and Asia Pacific is attributed to additional sales and marketing resources, new distribution and growth in industrial lubrication products in Asia Pacific.

In 2008, operating earnings in the Lubrication segment increased by 35 percent. Improvement in operating profitability is related to the integration and consolidation of Lubrication operationsactivities in Anoka, Minnesota in 2007. The Lubrication segment incurred costs in 2008 related to the workforce reduction, unabsorbed manufacturing costs and higher investment in new product development.

In 2007, sales in the Lubrication segment increased by 13 percent. Sales in the Americas increased by $7 million, with full year effect of the Lubriquip acquisition of $9 million for the region. Sales in Europe increased by 46 percent, including 7 percentage points related to favorable currency translation rates. Sales in Asia Pacific increased by 26 percent; the effect of currency translation was not significant.

In 2007, operating earnings decreased by $9 million, including $2.3 million of expenses related to the integration of the Lubriquip manufacturing operations, closure of the Lubriquip facilities in Madison, Wisconsin and Cleveland, Ohio and the transfer of Lubrication manufacturing from the facility in Minneapolis to the new facility in Anoka, Minnesota. The segment also had higher spending in 2007 than the prior year in new product development, marketing and warranty expense, partially due to the full year impact of the Lubriquip acquisition.

The Americas represent the vastsubstantial majority of sales for the Lubrication Equipment segment and indicators in that region are the most important. The indicators used by management include levels of capital investment, industrial production and gross domestic product.

Unallocated corporate

(In millions)

2008 

2007 

2006 

Unallocated corporate (expenses)

$(10.5)

$(10.6)

$(10.3)

(in millions)

             
  2009 2008 2007
Unallocated corporate (expense) $(20) $(11) $(11)
Unallocated corporate includes items such as stock compensation, bad debt expense, contributions to the Company’s charitable foundation and certain other charges or credits driven by corporate decisions. In 2009, unallocated corporate included $9 million related to the non-service cost portion of pension expense and $9 million of stock compensation.
In 2008, unallocated corporate included $9 million of stock compensation and $2 million of contributions to the Company’s charitable foundation.

21


In 2007, unallocated corporate included $9 million of stock compensation and $1 million of contributions to the Company’s charitable foundation.

Financial Condition

Working Capital.The following table highlights several key measures of asset performance.

performance (dollars in millions).

(Dollars in millions)

2008

2007

        
 2009 2008 

Working capital

$139.4

$123.0

 $85 $139 

Current ratio

2.2

2.0

 1.8 2.2 

Days of sales in receivables outstanding

57

61

 63 57 

Inventory turnover (LIFO)

4.4

5.0

 3.9 4.4 

The Company’s financial condition and cash flows from operations remain strong. Cash flows from operations totaled $162$147 million in 2008.2009. The primary uses of cash included repayment of debt of $100 million, dividends of $45 million, capital expenditures of $11 million and a contribution of $15 million into the funded pension plan. Accounts receivable decreased by $27 million due mostly to lower sales during the year as compared to the prior year. Inventories decreased by $33 million.
In 2008, the Company used cash for capital expenditures of $29 million, acquisitions of $55 million, dividends of $45 million and share repurchases of $115 million. Accounts receivable decreased by $13 million (9 percent) due mostly to lower sales in the fourth quarter of 2008 compared to the same period in the prior year. Inventories increased $17 million, including $8 million from acquired operations and increases to support new distribution initiatives internationally.

In 2007, the Company used cash and long-term borrowings for share repurchases of $230 million and dividend payments of $43 million. Accounts receivable increased by $6 million to $140 million. The 5 percent increase was primarily due to higher sales (increase of 3 percent) compared to the prior year. Inventories decreased $2 million in 2007 to $75 million.

Capital Structure.At December 26, 2008,25, 2009, the Company’s capital structure included current debt of $18$12 million, long-term debt of $180$86 million and shareholders’ equity of $168$210 million.

Shareholders’ equity decreasedincreased by $77$42 million in 2008.2009. The key components of changes in shareholders’ equity include current year earnings of $121$49 million and common stock issued of $14 million, reduced by $45 million of dividends declared, $112 million of shares repurchased and $68 million of other comprehensive lossincome of $23 million (mostly from changesdue to improvements in the funded status of pension obligations).

; reduced by $46 million of dividends declared.

Liquidity and Capital Resources.Resources. At December 26, 2008,25, 2009, the Company had various lines of credit totaling $283$272 million, including a $250 million, 5five year credit facility entered into in 2007.2007 and $22 million with foreign banks. At year-end, long-term debt outstanding under this facility was $180$86 million. The unused portion of committed credit lines was $87$175 million at year-end. In addition, the Company has an unused, uncommitted linelines of credit for $20totaling $12 million. Internally generated funds and unused financing sources are expected to provide the Company with the flexibility to meet its liquidity needs in 2009,2010, including its capital expenditure plan of approximately $20$15 million, planned dividends (estimated at $45$48 million) and acquisitions.

In December 2008,2009, the Company’s Board of Directors increased the Company’s regular common dividend from an annual rate of $0.74$0.76 to $0.76$0.80 per share, a 35 percent increase.

Cash Flow

A summary of cash flow follows:

follows (in millions):

(In millions)

2008 

2007 

2006 

            
 2009 2008 2007 

Operating Activities

$162 

$177 

$156 

 $147 $162 $177 

Investing Activities

(85)

(38)

(65)

  (13)  (85)  (38)

Financing Activities

(71)

(138)

(103)

  (139)  (71)  (138)

Effect of exchange rates on cash

(2)

(1)

  (2) 1  (2)
       

Net cash provided (used)

$    7 

$  (1)

$ (13)

  (7) 7  (1)
       

Cash and cash equivalents at year-end

$  12 

$   5 

$    6 

 $5 $12 $5 
       

Cash Flows Provided by Operating Activities. During 2009, $147 million was generated from operating cash flows, compared to $162 million in 2008. The effect of lower net earnings on cash flow was partially offset by cash provided by decreases in accounts receivable and inventory of $28 million and $33 million, respectively.
During 2008, $162 million was generated from operating cash flows, compared to $177 million in 2007. Although net earnings decreased by $32 million in 2008 as compared to the prior year, non-cash items such as depreciation and amortization, deferred income taxes and share-based compensation totaled $42 million, an increase of $10 million as compared to the prior year.

22


During 2007, $177 million was generated from operating cash flows, compared to $156 million in 2006. The higher cash flows from operating activities in 2007 were primarily due to changes in inventories (decreased $2 million in 2007 and increased $16 million in 2006) and the $3 million increase in net earnings.

Cash Flows Used in Investing ActivitiesActivities..During 2009, cash was used to fund $11 million of additions to property, plant and equipment. During 2008, cash was used to fund $55 million for business acquisitions and $29 million of additions to property, plant and equipment. During 2007, cash was used to fund $37 million of additions to property, plant and equipment including expansion of manufacturing facilities in North Canton, Ohio and Sioux Falls, South Dakota.

Cash Flows Used in Financing Activities..During 2008, $712009, $139 million was used in financing activities as compared to $138$71 million in 2007.2008. Net payments on borrowings on the long-term line of credit totaled $73$100 million. Cash dividends paid totaled $45 million, consistent with the prior year. During 2008, net borrowings totaled $72 million and cash was used for share repurchases totaling $115 million, a decrease of $116 million from the prior year. Cash dividends paid totaled $45 million, an increase of $2 million from the prior year.

million.

In September 2007,2009, the Board of Directors authorized the Company to purchase up to 76 million shares of its outstanding stock, primarily through open-market transactions. This authorization will expire on September 30, 2012 and the entire 6 million shares remain available under this authorization as of December 25, 2009. Although the Company decided to suspend share repurchases early in the fourth quarter of 2008, 3 million shares remain available under the current board authorization and the Company may decide to resumemake opportunistic share repurchases in the future.

Off-Balance Sheet Arrangements and Contractual Obligations.As of December 26, 2008,25, 2009, the Company is obligated to make cash payments in connection with its long-term debt, capital leases, operating leases and purchase obligations in the amounts listed below. The Company has no significant off-balance sheet debt or other unrecorded obligations other than the items noted in the following table. In addition to the commitments noted in the following table, the Company could be obligated to perform under standby letters of credit totaling $2 million at December 26, 2008.25, 2009. The Company has also guaranteed the debt of its subsidiaries for up to $7$30 million. All debt of subsidiaries is reflected in the consolidated balance sheets.

The total liability for uncertain tax positions under FIN 48 at December 26, 200825, 2009 was approximately $2$3 million. The Company is not able to reasonably estimate the timing of future payments relating to non-current unrecognized tax benefits.

(In millions)

Payments due by period

Total

Less than

1 year  

1-3 

years

3-5 

years

More than

5 years  

                    
 Payments due by period (in millions) 
 Less than 1-3 3-5 More than 
 Total 1 year years years 5 years 

Long-term debt

$ 180

$ —

$ —

$ 180

$ —

 $86 $ $86 $ $ 

Capital lease obligations

Operating leases

7

3

2

1

1

 4 2 1  1 

Purchase obligations1

35

35

 35 35    

Interest on long-term debt

14

4

8

2

 2 1 1   

Fixed rate payments on interest swap

8

4

4

Fixed rate payments on interest swaps 4 4    

Unfunded pension and postretirement medical benefits2

29

3

6

5

15

 28 3 5 5 15 
           

Total

$ 273

$ 49

$ 20

$ 188

$ 16

 $159 $45 $93 $5 $16 
           

1 The Company is committed to pay suppliers under the terms of open purchase orders issued in the normal course of business. The Company also has commitments with certain suppliers to purchase minimum quantities, and under the terms of certain agreements, the Company is committed for certain portions of the supplier’s inventory. The Company does not purchase, or commit to purchase, quantities in excess of normal usage or amounts that cannot be used within one year.

2 The amounts and timing of future Company contributions to the funded qualified defined benefit pension plan are unknown because they are dependent on pension fund asset performance. The Company expects that no contribution to the funded pension plan will be required in 2009.

1The Company is committed to pay suppliers under the terms of open purchase orders issued in the normal course of business. The Company also has commitments with certain suppliers to purchase minimum quantities, and under the terms of certain agreements, the Company is committed for certain portions of the supplier’s inventory. The Company does not purchase, or commit to purchase, quantities in excess of normal usage or amounts that cannot be used within one year.
2The amounts and timing of future Company contributions to the funded qualified defined benefit pension plan are unknown because they are dependent on pension fund asset performance. The Company expects that no contribution to the funded pension plan will be required in 2010.
Critical Accounting Estimates

The Company prepares its consolidated financial statements in conformity with generally accepted accounting principles in the United States of America (“U.S. GAAP”). The Company’s most significant accounting policies are disclosed in Note A to the consolidated financial statements. The preparation of the consolidated financial statements, in conformity with U.S. GAAP, requires management to make estimates and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual amounts will differ from those estimates. The Company considers the following policies to involve the most judgment in the preparation of the Company’s consolidated financial statements.

Sales Returns.An allowance is established for possible returnreturns of products from distributors. The written agreements with distributors typically limit the amount that may be returned. In its arrangements with certain home center customers, the Company may agree to accept returns from the retailer’s end-user customers. The amount of the allowance for sales returns is an estimate, which is based on the historical ratios of returns to sales, the historical average length of time between the sale and the return and other factors.

23


From time to time, the Company may choose to terminate a distributor relationship and may take back inventory or may promote the sale of new products by agreeing to accept returns of superseded products. These are considered period events and are not included in the allowance for returns. Although management considers these balances adequate, changes in customers’ behavior versus historical experience or changes in the Company’s return policies are among the factors that would result in materially different amounts for this item.

Excess and Discontinued Inventory.Inventory. The Company’s inventories are valued at the lower of cost or market. Reserves for excess and discontinued products are estimated. The amount of the reserve is determined based on projected sales information, plans for discontinued products and other factors. Though management considers these balances adequate, changes in sales volumes due to unanticipated economic or competitive conditions are among the factors that would result in materially different amounts for this item.

Product Warranty. A liability is established for estimated warranty claims to be paid in the future that relate to current and prior period sales. The Company estimates these costs based on historical claim experience, changes in warranty programs and other factors, including evaluating specific product warranty issues. The establishment of reserves requires the use of judgment and assumptions regarding the potential for losses relating to warranty issues. Though management considers these balances adequate, changes in the Company’s warranty policy or a significant change in product defects versus historical averages are among the factors that would result in materially different amounts for this item.

Goodwill and Other Intangible AssetsAssets..The Companycompany performs impairment testing for goodwill and other intangible assets annually, or more frequently if events or changes in circumstances indicate that the asset might be impaired. For goodwill, the Company performs impairment reviews for the Company’s reporting units, which have been determined to be the Company’s divisions using a fair-value method based on management’s judgments and assumptions. The Company estimates the fair value of the reporting units by an allocation of market capitalization value, cross-checked by a present value of future cash flows calculation. The estimated fair value is then compared with the carrying amount of the reporting unit, including recorded goodwill. The Company also performs a separate impairment test for each other intangible asset with indefinite life, based on estimated future use and discounting estimated future cash flows. A considerable amount of management judgment and assumptions are required in performing the impairment tests. Though management considers its judgments and assumptions to be reasonable, changes in product offerings or marketing strategies could change the estimated fair values and result in impairment charges.

Product Warranty.A liability is established for estimated warranty claims to be paid in the future that relate to current and prior period sales. The Company estimates these costs based on historical claim experience, changes in warranty programs and other factors, including evaluating specific product warranty issues. The establishment of reserves requires the use of judgment and assumptions regarding the potential for losses relating to warranty issues. Though management considers these balances adequate, changes in the Company’s warranty policy or a significant change in product defects versus historical averages are among the factors that would result in materially different amounts for this item.
Self-Insured Retentions.Retentions. The Company purchases insurance for products liability, workers compensation and employee medical benefits with high deductibles. Third party insurance is carried for what is believed to be the major portion of potential exposures that would exceed the Company’s self-insured retentions. The Company has established liabilities for potential uninsured claims, including estimated costs and legal fees. The Company employs actuaries to assist in evaluating its potential ultimate exposure for uninsured claims and then considers factors such as known outstanding claims, historical experience, sales trends and other relevant factors in setting the liabilities. Though management considers these balances adequate, a substantial change in the number and/or severity of claims would result in materially different amounts for this item.

Income TaxesTaxes..In the preparation of the Company’s consolidated financial statements, management calculates income taxes. This includes estimating current tax liability as well as assessing temporary differences resulting from different treatment of items for tax and financial statement purposes. These differences result in deferred tax assets and liabilities, which are recorded on the balance sheet using statutory rates in effect for the year in which the differences are expected to reverse. These assets and liabilities are analyzed regularly and management assesses the likelihood that deferred tax assets will be recoverable from future taxable income. A valuation allowance is established to the extent that management believes that recovery is not likely. Liabilities for uncertain tax positions are also established for potential and ongoing audits of federal, state and international issues. The Company routinely monitors the potential impact of such situations and believes that liabilities are properly stated. Valuations related to amounts owed and tax rates could be impacted by changes to tax codes, changes in statutory tax rates, the Company’s future taxable income levels and the results of tax audits.

Retirement ObligationsObligations..The measurements of the Company’s pension and postretirement medical obligations are dependent on a number of assumptions including estimates of the present value of projected future payments, taking into consideration future events such as salary increasesincrease and demographic experience. These assumptions may have an impact on the expense and timing of future contributions.

The assumptions used in developing the required estimates for pension obligations include discount rates,rate, inflation, salary increases, retirement rates, expected return on plan assets and mortality rates. The assumptions used in developing the required estimates for postretirement medical obligations include discount rates, rate of future increase in medical costs and participation rates.

24


For U.S. plans, the Company establishes its discount rate assumption by reference to the “Citigroup Pension Liability Index,”Index”, a published index commonly used as a benchmark. For plans outside of the U.S., the Company establishes a rate by country by reference to highly rated corporate bonds. These reference points have been determined to adequately match expected plan cash flows. The Company bases its inflation assumption on an evaluation of external market indicators. The salary assumptions are based on actual historical experience, the near-term outlook and assumed inflation. Retirement rates are based on experience. The investment return assumption is based on the expected long-term performance of plan assets. In setting this number, the Company considers the input of actuaries and investment advisors, its long-term historical returns, the allocation of plan assets and projected returns on plan assets. The Company reducedmaintained its investment return assumption by one-half percentage point, toat 8.5 percent for 2009.2010. Mortality rates are based on a common group mortality table for males and females.

Net pension creditcost in 20082009 was $0.7$15 million and was allocated to cost of products sold and operating expenses based on salaries and wages. At December 26, 2008,25, 2009, a one-half percentage point decrease in the indicated assumptions would have the following effects (in millions):

        

Assumption

Funded Status

 

Expense

 Funded Status Expense 

Discount rate

$ (14.9)

 

$ 0.5

 $(15) $2 

Expected return on assets

$     —

 

$ 1.1

  1 

Recent Accounting Pronouncements

In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 157, “Fair Value Measurements.” This statement establishesa new accounting standard that established a consistent framework for measuring fair value and expandsexpanded disclosures on fair market value measurements. SFAS No. 157It was effective for the Company starting in fiscal 2008 for financial assets and liabilities. The impact of the initial adoption of SFAS No. 157 in 2008 had no impact on the consolidated financial statements. With respect to non-financial assets and liabilities, the statement isit was effective for the Company starting in fiscal 2009. The Company expects the adoption of this statementstandard as it pertains to non-financial assets and liabilities will not have ahad no significant impact on itsthe consolidated financial statements.

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities.” This statement expands disclosures but does not change accounting for derivative instruments and hedging activities. The statement is effective for the Company starting in fiscal 2009.

SFAS No. 141 (revised 2007), “Business Combinations,” is effective for acquisitions completed by the Company after fiscal 2008, and had no impact on the 2008 consolidated financial statements. This statement retains the fundamental requirements in SFAS No. 141 that the acquisition method (purchase method) of accounting be used for all business combinations. It provides new guidance for valuation of acquisitions and accounting for such items as transaction costs, contingent consideration, contingent liabilities and in-process R&D.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

The Company sells and purchases products and services in currencies other than the U.S. dollar and pays variable interest rates on borrowings under its primary credit facility. Consequently, the Company is subject to profitability risk arising from exchange and interest rate movements. The Company may use a variety of financial and derivative instruments to manage foreign currency and interest rate risks. The Company does not enter into any of these instruments for trading purposes to generate revenue. Rather, the Company’s objective in managing these risks is to reduce fluctuations in earnings and cash flows associated with changes in foreign currency exchange and interest rates.

The Company may use forward exchange contracts, options and other hedging activities to hedge the U.S. dollar value resulting from anticipated currency transactions and net monetary asset and liability positions. At December 26, 2008,25, 2009, the currencies to which the Company had the most significant balance sheet exchange rate exposure were the euro, Canadian dollar, British pound and various Asian currencies. It is not possible to determine the true impact of currency rate changes; however, the direct translation effect on net sales and net earnings can be estimated. When compared to 20072008 results, the weakerstronger U.S. dollar versus other currencies helped to increasedecreased sales and net earnings. For the year ended December 26, 2008,25, 2009, the impact of currency translation resulted in a calculated increasedecrease in net sales and net earnings of approximately $12$10 million and $4 million, respectively. For the year ended December 28, 2007,26, 2008, the calculated impact of currency translation resulted in an increase in net sales and net earnings of approximately $17$12 million and $7$4 million, respectively.

In 2007 the Company entered into interest rate swap contracts that effectively fix the rates paid on a total of $80 million of variable rate borrowings under the Company’s primary credit facility. The contracts fix the rates at approximately 4.7 percent through 2010.

2009

2010 Outlook

Management believes that economic conditions will continue to present a challenging operating environment in the coming year. WeThe Company will continue to closely manage working capital, expenditures, headcount, discretionary spending and discretionary expenses closely. As a result of increased investmentcapital expenditures.

25


The Company has continued to invest in new product engineering and in development significantof global commercial capabilities, and expects to see growth through the launch of new products/platforms are expected to be launched in 2009. Salesproducts and marketing resources in Europe and Asia Pacific increased in 2008.  We will continue to expandexpanded distribution coverage around the world in the coming year. The Company expects those investments will continueallow the Company to look for opportunitiesgrow with the recovery and to acquire businesses where there is adeliver strong incremental operating margins. The Company will pursue strategic acquisitions to expand product or customer fit.  An $18 million increaseofferings and to leverage current technologies in pension costnew markets and less favorable currency translation are expected in 2009. channels.
The Company’s backlog is typically small compared to annual sales and is not a good indicator of future business levels. Although the strength of the recovery is uncertain and may be uneven, the Company believes that many key end markets will gradually improve throughout 2010. In addition to economic growth, the sales outlook is dependent uponon many factors, including the successful launch of new products, expanding distribution coverage, realization of price increases and stable foreign currency exchange rates.

Forward-Looking Statements

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 Annual 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. Please refer to Item 1A of, and Exhibit 99 to, this Annual Report on Form 10-K for fiscal year 20082009 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.

Item 8. Financial Statements and Supplementary Data

Page

Selected Quarterly Financial Data (See Part II, Item 5, Market for the                              

Company's Common Equity, Related Shareholder Matters and Issuer

Purchases of Equity Securities)                                                                                           12

Page
     Selected Quarterly Financial Data (See Part II, Item 5, Market for the Company’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities)
12
Management’s Report on Internal Control Over Financial Reporting

26

27

Reports of Independent Registered Public Accounting Firm

27

28

Consolidated Statements of Earnings for fiscal years 2009, 2008 2007 and 2006

2007

29

30

Consolidated Statements of Comprehensive Income for fiscal years 2009, 2008 2007 and 2006

2007

29

30

Consolidated Balance Sheets for fiscal years 20082009 and 2007

2008

30

31

Consolidated Statements of Cash Flows for fiscal years 2009, 2008 2007 and 2006

2007

31

32

Consolidated Statements of Shareholders’ Equity for fiscal years 2009, 2008 2007 and 2006

2007

32

33

Notes to Consolidated Financial Statements

33

34

26


Management’s Report on Internal Control Over Financial Reporting

Management is responsible for establishing and maintaining adequate internal control over financial reporting. The internal control system was designed to provide reasonable assurance to management and the board of directors regarding the reliability of financial reporting and preparation of financial statements in accordance with generally accepted accounting principles.

Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 26, 2008.25, 2009. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) inInternal Control-Integrated Framework.

Based on our assessment and those criteria, management believes the Company’s internal control over financial reporting is effective as of December 26, 2008.

25, 2009.

The Company’s independent auditors have issued an attestation report on the Company’s internal control over financial reporting. That report appears in this Form 10-K.

27


REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Internal Control Over Financial Reporting

To the Shareholders and Board of Directors of


Graco Inc.


Minneapolis, Minnesota

We have audited the internal control over financial reporting of Graco Inc. and Subsidiaries (the “Company”) as of December 26, 2008,25, 2009, based on criteria established inInternal Control — Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 26, 2008,25, 2009, based on the criteria established inInternal Control — Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement scheduleasschedule as of and for the year ended December 26, 2008,25, 2009, of the Company and our report dated February 16, 200915, 2010 expressed an unqualified opinion on those financial statements and financial statement schedule.

DELOITTE & TOUCHE LLP

Minneapolis, Minnesota
February 15, 2010

28

February 16, 2009


Consolidated Financial Statements

To the Shareholders and Board of Directors of


Graco Inc.


Minneapolis, Minnesota

We have audited the accompanying consolidated balance sheets of Graco Inc. and Subsidiaries (the “Company”) as of December 26, 200825, 2009 and December 28, 2007,26, 2008, and the related consolidated statements of earnings, comprehensive income, shareholders’ equity, and cash flows for each of the three years in the period ended December 26, 2008.25, 2009. Our audits also included the financial statement schedule listed in the Index at Item 15. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Graco Inc. and Subsidiaries as of December 26, 200825, 2009 and December 28, 2007,26, 2008, and the results of their operations and their cash flows for each of the three years in the period ended December 26, 2008,25, 2009, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 26, 2008,25, 2009, based on the criteria established inInternal Control—Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 16, 200915, 2010 expressed an unqualified opinion on the Company’s internal control over financial reporting.

DELOITTE & TOUCHE LLP

Minneapolis, Minnesota
February 15, 2010

29

February 16, 2009


GRACO INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF EARNINGS                                Graco Inc. and Subsidiaries
(In thousands except per share amounts)
             
  Years Ended 
  December 25,  December 26,  December 28, 
  2009  2008  2007 
Net Sales $579,212  $817,270  $841,339 
Cost of products sold  286,396   385,093   393,913 
          
Gross Profit  292,816   432,177   447,426 
Product development  37,538   36,558   30,277 
Selling, marketing and distribution  115,550   138,665   124,508 
General and administrative  65,261   69,589   60,161 
          
Operating Earnings  74,467   187,365   232,480 
Interest expense  4,854   7,633   3,433 
Other expense, net  946   1,153   211 
          
Earnings Before Income Taxes  68,667   178,579   228,836 
Income taxes  19,700   57,700   76,000 
          
Net Earnings $48,967  $120,879  $152,836 
          
             
Basic Net Earnings per Common Share $0.82  $2.01  $2.35 
             
Diluted Net Earnings per Common Share $0.81  $1.99  $2.32 
             
Cash Dividends Declared per Common Share $0.77  $0.75  $0.68 
See notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
             
  Years Ended 
  December 25,  December 26,  December 28, 
  2009  2008  2007 
Net Earnings $48,967  $120,879  $152,836 
Other comprehensive income (loss)            
Cumulative translation adjustment  234   (1,105)  108 
Pension and postretirement medical liability adjustment  34,576   (102,741)  (875)
Gain (loss) on interest rate hedge contracts  1,214   (3,236)  (1,700)
Income taxes  (13,263)  39,290   895 
          
Other comprehensive income (loss)  22,761   (67,792)  (1,572)
          
Comprehensive Income $71,728  $53,087  $151,264 
          
See notes to consolidated financial statements.

30

 

Years Ended

 

(In thousands, except per share amounts)

 

December 26, 2008

 

December 28, 2007

 

December 29, 2006

Net Sales

$817,270

$841,339

$816,468

Cost of products sold

385,093

393,913

382,511

Gross Profit

432,177

447,426

433,957

Product development

36,558

30,277

29,970

Selling, marketing and distribution

138,665

124,508

119,122

General and administrative

69,589

60,161

58,866

Operating Earnings

187,365

232,480

225,999

Interest expense

7,633

3,433

946

Other expense, net

1,153

211

687

Earnings before Income Taxes

178,579

228,836

224,366

Income taxes

57,700

76,000

74,600

Net Earnings

$120,879

$152,836

$149,766

Basic Net Earnings per Common Share

$      2.01

$      2.35

$      2.21

Diluted Net Earnings per Common Share

$      1.99

$      2.32

$      2.17

Dividends Declared per Common Share

$        .75

$        .68

$        .60


See Notes to Consolidated Financial Statements.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

Graco Inc. and Subsidiaries

GRACO INC. AND SUBSIDIARIES

Years Ended

(In thousands)

December 26, 2008

December 28, 2007

December 29, 2006

Net Earnings

$120,879 

$152,836 

$149,766 

  Other comprehensive income (loss)

     Cumulative translation adjustment

(1,105)

108 

2,693 

     Pension and postretirement medical liability adjustment

(102,741)

(875)

115 

     Gain (loss) on interest rate hedge contracts

(3,236)

(1,700)

—  

     Income taxes

39,290 

895 

(3)

     Other comprehensive income (loss)

(67,792)

(1,572)

2,805 

Comprehensive Income

$ 53,087 

$151,264 

$152,571 

See Notes to Consolidated Financial Statements.

CONSOLIDATED BALANCE SHEETSGraco Inc.
(In thousands, except share and Subsidiariesper share amounts)
         
  December 25,  December 26, 
  2009  2008 
ASSETS
        
Current Assets        
Cash and cash equivalents $5,412  $12,119 
Accounts receivable, less allowances of $6,500 and $6,600  100,824   127,505 
Inventories  58,658   91,604 
Deferred income taxes  20,380   23,007 
Other current assets  3,719   6,360 
       
Total current assets  188,993   260,595 
         
Property, Plant and Equipment, net  139,053   149,754 
Goodwill  91,740   91,740 
Other Intangible Assets, net  40,170   52,231 
Deferred Income Taxes  8,372   18,919 
Other Assets  8,106   6,611 
       
Total Assets $476,434  $579,850 
       
LIABILITIES AND SHAREHOLDERS’ EQUITY
        
Current Liabilities        
Notes payable to banks $12,028  $18,311 
Trade accounts payable  17,983   18,834 
Salaries and incentives  14,428   17,179 
Dividends payable  12,003   11,312 
Other current liabilities  47,373   55,524 
       
Total current liabilities  103,815   121,160 
         
Long-term Debt  86,260   180,000 
Retirement Benefits and Deferred Compensation  73,705   108,656 
Uncertain Tax Positions  3,000   2,400 
Commitments and Contingencies (Note K)        
         
Shareholders’ Equity        
Common stock, $1 par value; 97,000,000 shares authorized; 59,999,158 and 59,516,201 shares outstanding in 2009 and 2008  59,999   59,516 
Additional paid-in-capital  190,261   174,161 
Retained earnings  11,121   8,445 
Accumulated other comprehensive income (loss)  (51,727)  (74,488)
       
Total shareholders’ equity  209,654   167,634 
       
Total Liabilities and Shareholders’ Equity $476,434  $579,850 
       
See notes to consolidated financial statements.

31

 

(In thousands, except share and per share amounts)

December 26, 2008

December 28, 2007

ASSETS

 

 

Current Assets

 

 

Cash and cash equivalents

 $ 12,119 

   $ 4,922 

Accounts receivable, less allowances of $6,600 and $6,500

127,505 

140,489 

Inventories

91,604 

74,737 

Deferred income taxes

23,007 

21,650 

Other current assets

6,360 

7,034 

Total current assets

260,595 

248,832 

Property, Plant and Equipment, net

149,754 

140,594 

Prepaid Pension

— 

31,823 

Goodwill

91,740 

67,204 

Other Intangible Assets, net

52,231 

41,889 

Deferred Income Taxes

18,919 

— 

Other Assets

6,611 

6,382 

Total Assets

$579,850 

$536,724 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

Current Liabilities

 

 

Notes payable to banks

$ 18,311 

$ 18,991 

Trade accounts payable

18,834 

27,379 

Salaries, wages and commissions

17,179 

20,470 

Dividends payable

11,312 

11,476 

Other current liabilities

55,524 

47,561 

Total current liabilities

121,160 

125,877 

Long-Term Debt

180,000 

107,060 

Retirement Benefits and Deferred Compensation

108,656 

40,639 

Uncertain Tax Positions

2,400 

5,400 

Deferred Income Taxes

— 

13,074 

Commitments and Contingencies (Note K)

 

 

Shareholders’ Equity

 

 

Common stock, $1 par value; 97,000,000 shares authorized;
59,516,201 and 61,963,962 shares outstanding in 2008 and 2007

59,516 

61,964 

Additional paid-in capital

174,161 

156,420 

Retained earnings

8,445 

32,986 

Accumulated other comprehensive income (loss)

(74,488)

(6,696)

Total shareholders’ equity

167,634 

244,674 

Total Liabilities and Shareholders’ Equity

$579,850 

$536,724 

 


See Notes to Consolidated Financial Statements.

GRACO INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWSGraco Inc. and Subsidiaries
(In thousands)
             
  Years Ended 
  December 25,  December 26,  December 28, 
  2009  2008  2007 
Cash Flows From Operating Activities
            
Net earnings $48,967  $120,879  $152,836 
Adjustments to reconcile net earnings to net cash provided by operating activities            
Depreciation, amortization and impairment  35,140   35,495   28,665 
Deferred income taxes  (69)  (160)  (1,590)
Share-based compensation  9,369   9,051   8,583 
Excess tax benefit related to share-based payment arrangements  (375)  (2,873)  (4,508)
Change in            
Accounts receivable  28,420   14,965   (1,844)
Inventories  32,663   (9,937)  2,045 
Trade accounts payable  (701)  (6,806)  (2,314)
Salaries and incentives  (2,893)  (3,169)  (6,527)
Retirement benefits and deferred compensation  (848)  (2,672)  (2,290)
Other accrued liabilities  (2,838)  5,658   4,666 
Other  (303)  2,047   (625)
          
Net cash provided by operating activities  146,532   162,478   177,097 
          
Cash Flows From Investing Activities
            
Property, plant and equipment additions  (11,463)  (29,102)  (36,869)
Proceeds from sale of property, plant and equipment  770   1,768   296 
Investment in life insurance  (1,499)  (1,499)  (1,499)
Capitalized software and other intangible asset additions  (602)  (1,327)  (85)
Acquisition of businesses, net of cash acquired     (55,186)   
          
Net cash used in investing activities  (12,794)  (85,346)  (38,157)
          
Cash Flows From Financing Activities
            
Net borrowings (payments) on short-term lines of credit  (6,385)  (1,329)  (312)
Borrowings on long-term line of credit  77,996   242,849   158,351 
Payments on long-term line of credit  (171,736)  (169,909)  (51,295)
Excess tax benefit related to share-based payment arrangements  375   2,873   4,508 
Common stock issued  6,571   13,701   24,055 
Common stock retired  (187)  (114,836)  (230,412)
Cash dividends paid  (45,444)  (44,702)  (43,188)
          
Net cash used in financing activities  (138,810)  (71,353)  (138,293)
          
Effect of exchange rate changes on cash  (1,635)  1,418   (1,596)
          
Net increase (decrease) in cash and cash equivalents  (6,707)  7,197   (949)
Cash and Cash Equivalents
            
Beginning of year  12,119   4,922   5,871 
          
End of year $5,412  $12,119  $4,922 
          
See notes to consolidated financial statements.

32

 

Years Ended

(In thousands)

December 26, 2008 

December 28, 2007 

December 29, 2006 

Cash Flows from Operating Activities

 

 

 

Net earnings

$120,879 

$152,836 

$149,766 

   Adjustments to reconcile net earnings to
      net cash provided by operating activities

 

 

 

Depreciation, amortization and impairment

35,495 

28,665 

26,046 

Deferred income taxes

(160)

(1,590)

(6,597)

Share-based compensation

9,051 

8,583 

8,392 

            Excess tax benefit related to share-based
               payment arrangements

(2,873)

(4,508)

(2,857)

Change in

 

 

 

               Accounts receivable

14,965 

(1,844)

(3,584)

Inventories

(9,937)

2,045 

(15,587)

              Trade accounts payable

(6,806)

(2,314)

(74)

Salaries, wages and commissions

(3,169)

(6,527)

1,917 

Retirement benefits and deferred  compensation

(2,672)

(2,290)

(12)

Other accrued liabilities

5,658 

4,666 

(2,302)

Other

2,047 

(625)

521 

Net cash provided by operating activities

162,478 

177,097 

155,629 

Cash Flows from Investing Activities

 

 

 

Property, plant and equipment additions

(29,102)

(36,869)

(33,652)

Proceeds from sale of property, plant and equipment

1,768 

296 

128 

Investment in life insurance

(1,499)

(1,499)

—  

Capitalized software and other intangible asset additions

(1,327)

(85)

(202)

Acquisitions of businesses, net of cash acquired

(55,186)

—  

(30,676)

Net cash used in investing activities

(85,346)

(38,157)

(64,402)

Cash Flows from Financing Activities

 

 

 

Net borrowings (payments) on short-term lines of credit

(1,329)

(312)

9,593 

Borrowings on long-term line of credit

242,849 

158,351 

—  

Payments on long-term line of credit

(169,909)

(51,295)

—  

Excess tax benefit related to share-based
payment arrangements

2,873 

4,508 

2,857 

Common stock issued

13,701 

24,055 

12,008 

Common stock retired

(114,836)

(230,412)

(87,570)

Cash dividends paid

(44,702)

(43,188)

(39,429)

Net cash used in financing activities

(71,353)

(138,293)

(102,541)

Effect of exchange rate changes on cash

1,418 

(1,596)

(1,479)

Net increase (decrease) in cash and cash equivalents

7,197 

(949)

(12,793)

Cash and cash equivalents

 

 

 

Beginning of year

4,922 

5,871 

18,664 

End of year

$    12,119 

$    4,922 

$    5,871 


See Notes to Consolidated Financial Statements.

GRACO INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS'SHAREHOLDERS’ EQUITYGraco Inc. and Subsidiaries
(In thousands)
             
  Years Ended 
  December 25,  December 26,  December 28, 
  2009  2008  2007 
Common Stock
            
Balance, beginning of year $59,516  $61,964  $66,805 
Shares issued  491   645   1,077 
Shares retired  (8)  (3,093)  (5,918)
          
Balance, end of year  59,999   59,516   61,964 
          
Additional Paid-In Capital
            
Balance, beginning of year  174,161   156,420   130,621 
Shares issued  6,080   13,056   24,093 
Stock compensation cost  9,369   9,051   8,583 
Tax benefit related to stock options exercised  674   3,473   5,808 
Restricted stock cancelled (issued)     254   (1,115)
Shares retired  (23)  (8,093)  (11,570)
          
Balance, end of year  190,261   174,161   156,420 
          
Retained Earnings
            
Balance, beginning of year  8,445   32,986   138,702 
Net earnings  48,967   120,879   152,836 
Dividends declared  (46,135)  (44,539)  (43,609)
Shares retired  (156)  (100,881)  (214,943)
          
Balance, end of year  11,121   8,445   32,986 
          
Accumulated Other Comprehensive Income (Loss)
            
Balance, beginning of year  (74,488)  (6,696)  (5,124)
Other comprehensive income (loss)  22,761   (67,792)  (1,572)
          
Balance, end of year  (51,727)  (74,488)  (6,696)
          
Total Shareholders’ Equity
 $209,654  $167,634  $244,674 
          
See notes to consolidated financial statements.

33

 

Years Ended

 

(In thousands)

 

December 26, 2008 

 

December 28, 2007 

 

December 29, 2006 

Common Stock

 

 

 

Balance, beginning of year

$  61,964 

$  66,805 

$  68,387 

Shares issued

645 

1,077 

539 

Shares repurchased

(3,093)

(5,918)

(2,121)

Balance, end of year

59,516 

61,964 

66,805 

Additional Paid-In Capital

 

 

 

Balance, beginning of year

156,420 

130,621 

110,842 

Shares issued

13,056 

24,093 

11,469 

Stock compensation cost

9,051 

8,583 

8,392 

      Tax benefit related to stock options exercised

3,473 

5,808 

3,357 

Restricted stock cancelled (issued)

254 

(1,115)

— 

Shares repurchased

(8,093)

(11,570)

(3,439)

Balance, end of year

174,161 

156,420 

130,621 

Retained Earnings

 

 

 

Balance, beginning of year

32,986 

138,702 

112,506 

Net income

120,879 

152,836 

149,766 

Dividends declared

(44,539)

(43,609)

(40,554)

Shares repurchased

(100,881)

(214,943)

(83,016)

Balance, end of year

8,445 

32,986 

138,702 

Accumulated Other Comprehensive Income (Loss)

 

 

Balance, beginning of year

(6,696)

(5,124)

(4,051)

Other comprehensive income (loss)

(67,792)

(1,572)

2,805 

Adjustments to initially apply new accounting standard, net of tax

— 

(3,878)

Balance, end of year

(74,488)

(6,696)

(5,124)

Total Shareholders’ Equity

$167,634 

$244,674 

$331,004 


See Notes to Consolidated Financial Statements.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


Graco Inc. and Subsidiaries


Years Ended December 25, 2009, December 26, 2008 and December 28, 2007 and December 29, 2006

A. Summary of Significant Accounting Policies

Fiscal Year.The fiscal year of Graco Inc. and Subsidiaries (the Company) is 52 or 53 weeks, ending on the last Friday in December. The years ended December 25, 2009, December 26, 2008 and December 28, 2007, and December 29, 2006, were 52-week years.

Basis of Statement Presentation.The consolidated financial statements include the accounts of the parent company and its subsidiaries after elimination of all significant intercompany balances and transactions. As of December 26, 2008,25, 2009, all subsidiaries are 100 percent owned.

Foreign Currency Translation. The functional currency of one subsidiary in Great Britain is local currency. Accordingly, adjustments resulting from the translation of that subsidiary’s financial statements into U.S. dollars are charged or credited to accumulated other comprehensive income. The U.S. dollar is the functional currency for all other foreign subsidiaries, including one subsidiary in Spain whose functional currency changed to the U.S. dollar from the euro effective at the beginning of 2007.subsidiaries. Accordingly, gains and losses from the translation of foreign currency balances and transactions of those subsidiaries are included in other expense, net.

Accounting Estimates.The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. Such estimates and assumptions also affect the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.


Cash Equivalents.All highly liquid investments with a maturity of three months or less at the date of purchase are considered to be cash equivalents.

Inventory Valuation.Inventories are stated at the lower of cost or market. The last-in, first-out (LIFO) cost method is used for valuing most U.S. inventories. Inventories of foreign subsidiaries are valued using the first-in, first-out (FIFO) cost method.

Other Current Assets.Amounts included in other current assets were:

were (in thousands):

(In thousands)

2008

2007

        
 2009 2008 

Prepaid income taxes

$4,534

$4,936

 $1,928 $4,534 

Prepaid expenses and other

1,826

2,098

 1,791 1,826 
     

Total

$6,360

$7,034

 $3,719 $6,360 
     

Property, Plant and Equipment.For financial reporting purposes, plant and equipment are depreciated over their estimated useful lives, primarily by using the straight-line method as follows:

Buildings and improvements

10 to 30 years

Leasehold improvements

lesser of 5 to 10 years or life of lease

Manufacturing equipment

lesser of 5 to 10 years or life of equipment

Office, warehouse and automotive equipment

3 to 10 years

Intangible Assets.Goodwill has been assigned to reporting units, which are the Company’s divisions. The amounts of goodwill for each reportable segment were:were (in thousands):
         
  2009  2008 
Industrial $59,511  $59,511 
Contractor  12,732   12,732 
Lubrication  19,497   19,497 
       
Total $91,740  $91,740 
       

34

(In thousands)

2008

2007

Industrial

$59,511

$42,221

Contractor

12,732

7,939

Lubrication

19,497

17,044

Total

$91,740

$67,204


Components of other intangible assets were:

were (dollars in thousands):

(Dollars in thousands)

Estimated Life (Years)

      Cost

Accumulated Amortization

Foreign Currency Translation

Book Value

December 26, 2008

 

 

 

 

 

Customer relationships

3 – 8 

$41,075

$(12,470)

$(181)    

$28,424

Patents, proprietary technology and product documentation

3 – 15

23,780

(11,290)

(87)    

12,403

Trademarks, trade names and other

3 – 10

5,514

(3,908)

(12)    

1,594

 

 

70,369

(27,668)

(280)    

42,421

Not Subject to Amortization

 

 

 

 

 

Brand names

 

9,810

—   

—      

9,810

Total

 

$80,179

$(27,668)

$(280)    

$52,231

 

 

 

 

 

 

December 28, 2007

 

 

 

 

 

Customer relationships and distribution

  network

 

4 – 8 

 

$26,102

 

$(11,092)

 

$   29     

 

$15,039

Patents, proprietary technology and  product documentation

5 – 15

22,243

(7,720)

16     

14,539

Trademarks, trade names and other

3 – 10

4,684

(2,555)

22     

2,151

 

 

53,029

(21,367)

67     

31,729

Not Subject to Amortization

 

 

 

 

 

Brand names

 

10,160

— 

—     

10,160

Total

 

$63,189

$(21,367)

$   67     

$41,889

                     
  Estimated          Foreign    
  Life      Accumulated  Currency  Book 
  (years)  Cost  Amortization  Translation  Value 
December 25, 2009                    
Customer relationships  3-8  $41,075  $(18,655) $(181) $22,239 
Patents, proprietary technology and product documentation  3-10   22,862   (13,708)  (87)  9,067 
Trademarks, trade names and other  3-10   8,154   (2,470)     5,684 
                 
       72,091   (34,833)  (268)  36,990 
Not Subject to Amortization Brand names      3,180         3,180 
                 
Total     $75,271  $(34,833) $(268) $40,170 
                 
                     
December 26, 2008                    
Customer relationships  3-8  $41,075  $(12,470) $(181) $28,424 
Patents, proprietary technology and product documentation  3-15   23,780   (11,290)  (87)  12,403 
Trademarks, trade names and other  3-10   5,514   (3,908)  (12)  1,594 
                 
       70,369   (27,668)  (280)  42,421 
Not Subject to Amortization Brand names      9,810         9,810 
                 
Total     $80,179  $(27,668) $(280) $52,231 
                 

Amortization of intangibles was $12.3 million in 2009 and $10.5 million in 2008 and $8.5 million in 2007.2008. Estimated future annual amortization is as follows: $11.8 million in 2010, $10.7 million in 2009, $9.7 million in 2010, $8.6 million in 2011, $7.7$8.8 million in 2012, $4.1 million in 2013 and $5.7$1.6 million thereafter.

The

In 2009, the useful life of certain brand names was determined to be no longer indefinite. After impairment charges totaling $0.5 million, reflected above as a reduction of cost, the remaining cost of such brand names, totaling $6.1 million, is being amortized over a three-year period. In 2008, the Company recorded impairment charges totaling $3.6 million, in the fourth quarter of 2008, primarily due to reduced expectations with respect to future sales of certain branded products within the industrial segment. The impairmentImpairment charges arein 2008 were reflected above as reductions of cost, reducing brand names by $3.1 million, customer relationships by $0.3 million and proprietary technology by $0.2 million.

Other Assets.Components of other assets were:

were (in thousands):

(In thousands)

2008

2007

        
 2009 2008 

Cash surrender value of life insurance

$2,678

$1,450

 $4,409 $2,678 

Assets held for sale

1,138

Capitalized software

1,436

1,019

 945 1,436 

Deposits and other

2,497

2,775

 2,752 2,497 
     

Total

$6,611

$6,382

 $8,106 $6,611 
     

The Company paid $1.5 million in 2008 and $1.5 million in 20072009 for contracts insuring the lives of certain employees who are eligible to participate in certain non-qualified pension and deferred compensation plans. These insurance contracts will be used to fund the non-qualified pension and deferred compensation arrangements. The insurance contracts are held in a trust and are available to general creditors in the event of the Company’s insolvency. Changes in cash surrender value are recorded in operating expense and were not significant in 2009, 2008 and 2007.

Operations in Cleveland, Ohio were moved to new facilities in Anoka, Minnesota in 2007. The property that formerly housed those operations was classified in other assets at estimated market value in 2007 and was sold in 2008.

Capitalized software is amortized over its estimated useful life (generally 2 to 5 years) beginning at date of implementation.

Impairment of Long-Lived Assets.The Company evaluates long-lived assets (including property and equipment, goodwill and other intangible assets) for impairment whenever events or changes in business circumstances indicate the carrying value of the assets may not be recoverable. Goodwill and other intangible assets not subject to amortization are also reviewed for

35


impairment annually in the fourth quarter. Except for the impairment of certain intangibles noted above, there have been no significant write-downs of any long-lived assets in the periods presented.

Other Current Liabilities.Components of other current liabilities were:

were (in thousands):

(In thousands)

2008

2007

Accrued self-insured retentions

 $7,896

 $7,842

        
 2009 2008 
Accrued self-insurance retentions $7,785 $7,896 

Accrued warranty and service liabilities

8,033

7,084

 7,437 8,033 

Accrued trade promotions

9,001

6,480

 2,953 9,001 

Payable for employee stock purchases

5,473

5,829

 5,115 5,473 

Income taxes payable

904

678

 1,550 904 

Other

24,217

19,648

 22,533 24,217 
     

Total

$55,524

$47,561

 $47,373 $55,524 
     

Self-Insurance.The Company is self-insured for certain losses and costs relating to product liability, workers’ compensation and employee medical benefits claims. The Company has purchased stop-loss coverage in order to limit its exposure to significant claims. Accrued self-insured retentions are based on claims filed and estimates of claims incurred but not reported.

Product Warranties.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:

liabilities (in thousands):

(In thousands)

2008 

2007 

        
 2009 2008 

Balance, beginning of year

$ 7,084 

$ 6,675 

 $8,033 $7,084 

Charged to expense

6,793 

6,053 

 4,548 6,793 

Margin on parts sales reversed

3,698 

3,186 

 2,876 3,698 

Reductions for claims settled

(9,542)

(8,830)

  (8,020)  (9,542)
     

Balance, end of year

$ 8,033 

$ 7,084 

 $7,437 $8,033 
     

Revenue Recognition.Sales are recognized when revenue is realized or realizable and has been earned. The Company’s policy is to recognize revenue when risk and title passes to the customer. This is generally on the date of shipment, however certain sales are shipped with terms requiring recognition when received by the customer. In cases where there are specific customer acceptance provisions, revenue is recognized at the later of customer acceptance or shipment (subject to shipping terms). Payment terms are established based on the type of product, distributor capabilities and competitive market conditions. Rights of return are typically contractually limited, amounts are estimable, and the Company records provisions for anticipated returns and warranty claims at the time revenue is recognized. Historically, sales returns have been approximately 2 percent of sales. Provisions for sales returns are recorded as a reduction of net sales, and provisions for warranty claims are recorded in selling, marketing and distribution expenses. From time to time, the Company may promote the sale of new products by agreeing to accept returns of superseded products. In such cases, provisions for estimated returns are recorded as a reduction of net sales.

Trade promotions are offered to distributors and end users through various programs, generally with terms of one year or less. Such promotions include cooperative advertising arrangements, rebates based on annual purchases, coupons and reimbursement for competitive products. Payment of incentives may take the form of cash, trade credit, promotional merchandise or free product. Under cooperative advertising arrangements, the Company reimburses the distributor for a portion of its advertising costs related to the Company’s products; estimated costs are accrued at the time of sale and classified as selling, marketing and distribution expense. Rebates are accrued based on the program rates and progress toward the estimated annual sales amount, and are recorded as a reduction of sales (cash, trade credit) or cost of products sold (free goods). The estimated costs related to coupon programs are accrued at the time of sale and classified as selling, marketing and distribution expense or cost of products sold, depending on the type of incentive offered.

Share-based Compensation. SFAS No. 123(R), “Share-Based Payment,” became effective for the Company at the beginning of 2006. This standard requires compensation costs related to share-based payment transactions to be recognized in the financial statements. The Company adopted the standard using the modified prospective transition method, whereby compensation cost related to unvested awards as of the effective date are recognized as calculated for pro forma disclosures under SFAS No. 123, and cost related to new awards are recognized in accordance with SFAS No. 123(R). The Company continues to use the Black-Scholes option-pricing model to value option grants.

Earnings Per Common Share.Basic net earnings per share is computed by dividing earnings available to common shareholders by the weighted average number of shares outstanding during the year. Diluted net earnings per share is computed after giving effect to the exercise of all dilutive outstanding option grants.

36


Comprehensive Income.Comprehensive income is a measure of all changes in shareholders’ equity except those resulting from investments by and distributions to owners, and includes such items as net earnings, certain foreign currency translation items, changes in the value of qualifying hedges and pension liability adjustments.

Derivative Instruments and Hedging Activities.The Company accounts for all derivatives, including those embedded in other contracts, as either assets or liabilities and measures those financial instruments at fair value. The accounting for changes in the fair value of derivatives depends on their intended use and designation.

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.

In 2007, the Company entered into interest rate swap contracts that effectively fix the rates paid on a total of $80 million of variable rate borrowings. One contract fixed the rate on $40 million of borrowings at 4.7 percent plus the applicable spread (depending on cash flow leverage ratio) until December 2010. The second contract fixed an additional $40 million of borrowings at 4.6 percent plus the applicable spread until January 2011. Both contracts have been designated as cash flow hedges against interest rate volatility. Consequently, changes in the fair market value are recorded in accumulated other comprehensive income (loss) (AOCI). Amounts included in AOCI will be reclassified to earnings as interest rates increase and as the swap contracts approach their expiration dates. Net paymentsamounts paid or payable under terms of the contracts were charged to interest expense and totaled $3.0 million in 2009 and $0.9 million in 2008.

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, net. There were seven contracts outstanding as of December 25, 2009, with notional amounts totaling $16 million. There were 62 contracts outstanding during all or part of 2009, with net losses of $1.5 million offsetting $0.9 million of exchange gains on net monetary positions, included in other expense, net. 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. The fair market value and balance sheet classification of such instruments follows:

(In thousands)

2008 

2007 

Gain (loss) on interest rate hedge contracts, other current liabilities

$(4,936)

$(1,700)

Gain (loss) on foreign currency forward contracts, accounts receivable

1,198 

(282)

Total

$(3,738)

$(1,982)

follows (in thousands):
           
       
 Balance Sheet Classification2009  2008 
Gain (loss) on interest rate hedge contracts Other current liabilities$(3,722) $(4,936)
       
Gain (loss) on foreign currency forward contracts         
Gains $207  $1,868 
Losses  (249)  (670)
       
Net Accounts receivable    $1,198 
        
  Other current liabilities$(42)    
        

The Company may periodically hedge other anticipated transactions, generally with forward exchange contracts, which are designated as cash flow hedges. Gains and losses representing effective hedges are initially recorded as a component of other comprehensive income and are subsequently reclassified into earnings when the hedged exposure affects earnings. There were no gains or losses on such transactions in 2009, 2008 2007 and 2006,2007, and there were no such transactions outstanding as of December 26, 2008,25, 2009, and December 28, 2007.

26, 2008.

Recent Accounting Pronouncements.In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 157, “Fair Value Measurements.” This statement establishesa new accounting standard that established a consistent framework for measuring fair value and expandsexpanded disclosures on fair market value measurements. SFAS No. 157It was effective for the Company starting in fiscal 2008 with respect tofor financial assets and liabilities. The impact of the initial adoption of SFAS No. 157 in 2008 had no impact on the consolidated financial statements. With respect to non-financial assets and liabilities, the statement isit was effective for the Company starting in fiscal 2009. The Company expects the adoption of this statementstandard as it pertains to non-financial assets and liabilities will not have ahad no significant impact on itsthe consolidated financial statements.

37


In March 2008,

Subsequent Events.The company has evaluated subsequent events through the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities.” This statement expands disclosures but does not change accountingtime the financial statements were approved for derivative instruments and hedging activities. The statement is effective for the Company starting in fiscal 2009.

SFAS No. 141 (revised 2007), “Business Combinations,” is effective for acquisitions completed by the Company after fiscal 2008, and had no impactissuance on the 2008 consolidated financial statements. This statement retains the fundamental requirements in SFAS No. 141 that the acquisition method (purchase method) of accounting be used for all business combinations. It provides new guidance for valuation of acquisitions and accounting for such items as transaction costs, contingent consideration, contingent liabilities and in-process R&D.

February, 15, 2010.

B. Segment Information

The Company has three reportable segments: Industrial, Contractor and Lubrication. The Industrial segment markets equipment and pre-engineered packages for moving and applying paints, coatings, sealants, adhesives and other fluids. Markets served include automotive and truck assembly and components plants, wood products, rail, marine, aerospace, farm, construction, bus, recreational vehicles, and various other industries. The Contractor segment markets sprayers for architectural coatings for painting, roofing, texture, corrosion control and line striping and also high-pressure washers. The Lubrication segment markets products to move and dispense lubricants for fast oil change facilities, service garages, fleet service centers, automobile dealerships, the mining industry and industrial lubrication. All segments market parts and accessories for their products.

The accounting policies of the segments are the same as those described in the summary of significant accounting policies. The cost of manufacturing for each segment is based on product cost, and expenses are based on actual costs incurred along with cost allocations of shared and centralized functions based on activities performed, sales or space utilization. Assets of the Company are not tracked along reportable segment lines. Depreciation expense is charged to the manufacturing or operating cost center that utilizes the asset, and is then allocated to segments on the same basis as other expenses within that cost center.

Reportable segments are defined by product. Segments are responsible for development, manufacturing, marketing and sales of their products. This allows for focused marketing and efficient product development. The segments share common purchasing, certain manufacturing, distribution and administration functions.

(In thousands)

 

Reportable Segments

2008 

2007 

2006 

Net sales

 

 

            
Reportable Segments (in thousands) 2009 2008 2007 
Net Sales 

Industrial

$462,941 

$444,725 

$416,498 

 $312,935 $462,941 $444,725 

Contractor

266,772 

306,703 

320,476 

 208,544 266,772 306,703 

Lubrication

87,557 

89,911 

79,494 

 57,733 87,557 89,911 
       

Total

$817,270 

$841,339 

$816,468 

 $579,212 $817,270 $841,339 

Operating earnings

 

       
Operating Earnings 

Industrial

$138,240 

$152,278 

$128,460 

 $68,310 $138,240 $152,278 

Contractor

47,156 

81,528 

89,064 

 28,952 47,156 81,528 

Lubrication

12,475 

9,252 

18,744 

  (2,907) 12,475 9,252 

Unallocated corporate (expense)

(10,506)

(10,578)

(10,269)

  (19,888)  (10,506)  (10,578)
       

Total

$187,365 

$232,480 

$225,999 

 $74,467 $187,365 $232,480 
       

Unallocated corporate is not included in management’s measurement of segment performance and includes such items as stock compensation, bad debt expense, charitable contributions and certain other charges or credits driven by corporate decisions.

(In thousands)

 

 

 

Geographic Information

2008

2007

2006

Net sales (based on customer location)

 

 

 

United States

$384,221

$434,012

$474,366

Other countries

433,049

407,327

342,102

Total

$817,270

$841,339

$816,468

Long-lived assets

 

 

 

United States

$295,860

$266,722

$240,341

Other countries

23,395

21,170

32,279

Total

$319,255

$287,892

$272,620

In 2009, unallocated corporate also included $9.4 million related to the non-service portion of pension expense.
             
Geographic Information (in thousands) 2009  2008  2007 
Net sales (based on customer location)            
United States $279,814  $384,221  $434,012 
Other countries  299,398   433,049   407,327 
          
Total $579,212  $817,270  $841,339 
          
Long-lived assets            
United States  122,035   132,036     
Other countries  17,018   17,718     
           
Total $139,053  $149,754     
           

Sales to Major Customers

There were no customers that accounted for 10 percent or more of consolidated sales in 2009, 2008 andor 2007. Sales to a paint retailer were 10 percent of consolidated sales in 2006.

38


C. Inventories

Major components of inventories were as follows:

follows (in thousands):

(In thousands)

2008 

2007 

        
 2009 2008 

Finished products and components

$ 50,703 

$ 46,677 

 $36,665 $50,703 

Products and components in various stages of completion

24,938 

24,805 

 22,646 24,938 

Raw materials and purchased components

51,348 

37,311 

 31,826 51,348 

126,989 

108,793 

     
 91,137 126,989 

Reduction to LIFO cost

(35,385)

(34,056)

  (32,479)  (35,385)
     

Total

$ 91,604 

$ 74,737 

 $58,658 $91,604 
     

Inventories valued under the LIFO method were $36.7 million for 2009 and $58.1 million for 2008 and $46.6 million for 2007.2008. All other inventory was valued on the FIFO method.

Certain inventory quantities were reduced in 2007,2009, resulting in liquidation of LIFO inventory quantities carried at lower costs from prior years. The effect on net earnings was not significant.

D. Property, Plant and Equipment

Property, plant and equipment were as follows:

follows (in thousands):

(In thousands)

2008

2007 

        
 2009 2008 

Land and improvements

$ 10,303

$ 10,066 

 $10,303 $10,303 

Buildings and improvements

101,445 

92,145 

 102,222 101,445 

Manufacturing equipment

177,044 

166,869 

 188,225 177,044 

Office, warehouse and automotive equipment

31,619 

30,580 

 31,442 31,619 

Additions in progress

6,318 

6,413 

 2,248 6,318 
     

Total property, plant and equipment

326,729 

306,073 

 334,440 326,729 

Accumulated depreciation

(176,975)

(165,479)

  (195,387)  (176,975)
     

Net property, plant and equipment

$149,754 

$140,594 

 $139,053 $149,754 
     

Depreciation expense was $21.7 million in 2009, $20.9 million in 2008 and $19.5 million in 2007 and $18.2 million in 2006.

2007.

E. Income Taxes

Earnings before income tax expense consist of:of (in thousands):
             
  2009  2008  2007 
Domestic $55,749  $159,972  $203,795 
Foreign  12,918   18,607   25,041 
          
Total $68,667  $178,579  $228,836 
          

39


(In thousands)

2008

2007

2006

Domestic

$159,972

$203,795

$197,410

Foreign

18,607

25,041

26,956

Total

$178,579

$228,836

$224,366

Income tax expense consists of:

of (in thousands):

(In thousands)

2008 

2007 

2006 

            
 2009 2008 2007 

Current

 

 

 

Domestic

 

 

 

Federal

$50,483 

$67,255 

$65,652 

 $17,002 $50,483 $67,255 

State and local

2,300 

4,600 

4,520 

  (133) 2,300 4,600 

Foreign

4,741 

6,023 

7,206 

 2,953 4,741 6,023 

57,524 

77,878 

77,378 

       
 19,822 57,524 77,878 
       
 

Deferred

 

 

Domestic

(436)

(1,874)

(2,611)

  (448)  (436)  (1,874)

Foreign

612 

(4)

(167)

 326 612  (4)

176 

(1,878)

(2,778)

       
  (122) 176  (1,878)
       

Total

$57,700 

$76,000 

$74,600 

 $19,700 $57,700 $76,000 
       

Income taxes paid were $15.3 million, $55.8 million and $74.6 million in 2009, 2008 and $77.6 million in 2008, 2007 and 2006.

2007.

A reconciliation between the U.S. federal statutory tax rate and the effective tax rate follows:

            

2008

2007

2006

 2009 2008 2007 

Statutory tax rate

35%

35% 

  35%  35%  35%

Earnings from non-U.S. sales at lower tax rates

(1)  

(2)   

  (1)  (1)  (1)

State taxes, net of federal effect

1   

2    

2    

  1 2 

U.S. general business tax credits

(1)  

(1)   

(1)   

  (3)  (1)  (1)

Domestic production deduction

(2)  

(2)   

(1)   

  (2)  (2)  (2)
       

Effective tax rate

32%

33% 

  29%  32%  33%
       

Deferred income taxes are provided for temporary differences between the financial reporting and the tax basis of assets and liabilities. The deferred tax assets (liabilities) resulting from these differences are as follows:

follows (in thousands):

(In thousands)

2008 

2007 

        
 2009 2008 

Inventory valuations

$ 8,723 

$ 8,986 

 $7,532 $8,723 

Self-insurance retention accruals

2,356 

2,298 

 2,403 2,356 

Warranty reserves

2,628 

2,331 

 2,370 2,628 

Vacation accruals

2,036 

1,917 

 2,025 2,036 

Bad debt reserves

1,858 

1,888 

 1,730 1,858 

Stock compensation

2,000 

2,000 

 2,000 2,000 

Interest rate swaps

1,827 

— 

 1,397 1,827 

Other

1,579 

2,230 

 923 1,579 

Current

23,007 

21,650 

     
Total Current 20,380 23,007 
     

Unremitted earnings of consolidated foreign subsidiaries

(1,900)

(1,800)

  (1,800)  (1,900)

Excess of tax over book depreciation

(22,307)

(14,483)

  (22,114)  (22,307)

Pension liability (asset)

29,751 

(8,415)

Pension liability 16,951 29,751 

Postretirement medical

7,932 

7,462 

 7,587 7,932 

Stock compensation

3,864 

1,862 

 5,947 3,864 

Deferred compensation

806 

1,965 

 833 806 

Other

773 

335 

 968 773 

Non-current

18,919 

(13,074)

     
Total Non-current 8,372 18,919 
     

Net deferred tax assets

$41,926 

$ 8,576 

 $28,752 $41,926 
     

Total deferred tax assets were $78.6$65.1 million and $36.8$78.6 million, and total deferred tax liabilities were $36.7$36.3 million and $28.2$36.7 million on December 26, 2008,25, 2009, and December 28, 2007.26, 2008.

40


The Company files income tax returns in the U.S. federal jurisdiction, and various states and foreign jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations by tax authorities for years before 2002. The Internal Revenue Service (IRS) completed the examination of the Company’s U.S. income tax returns for 2004 and 2005 in the first quarter of 2008. Resolution of the audit did not result in a material change to the Company’s financial position.

A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:

2003.

(In thousands)

2008 

2007 

Unrecognized tax benefits beginning balance

$4,700 

$4,900 

Gross Increases – current period tax positions

700 

800 

Settlements

(1,100)

— 

Lapse of statute of limitations

(2,300)

(1,000)

Unrecognized tax benefits ending balance

$2,000 

$4,700 

At the end of 2008, the Company’s liability for uncertain tax positions was $2.4 million, including $ 0.4 million of interest and penalties. Unrecognized tax benefits of $2.0 million would affect the Company’s effective tax rate if recognized. The Company records penalties and accrued interest related to uncertain tax positions in income tax expense.

There is a reasonable possibility that unrecognized Total reserves for uncertain tax benefits will decrease by approximately $0.5 to $1 million in the next twelve months pursuant to the following events: expiring statute of limitations and the closure of other tax jurisdiction audits.

positions were not material.

F. Debt

In July 2007, the Company entered into an agreement with a syndicate of lenders providing an unsecured credit facility for 5 years. This credit facility provides $250 million of committed credit, available for general corporate purposes, working capital needs, share repurchases and acquisitions. Borrowings under the facility bear interest at either the bank’s prime rate, the federal funds rate plus 0.5 percent or the London Interbank Offered Rate plus a spread of between 0.23 percent and 0.57 percent, depending on the Company’s cash flow leverage ratio (debt to earnings before interest, taxes, depreciation and amortization). The weighted average interest rate on borrowings against the credit facility was 2.30.6 percent as of December 26, 2008.25, 2009. The Company is also required to pay a facility fee on the full amount of the loan commitment at an annual rate ranging from 0.07 percent to 0.15 percent, depending on the Company’s cash flow leverage ratio. The agreement requires the Company to maintain certain financial ratios as to cash flow leverage and interest coverage.

On December 26, 2008,25, 2009, the Company had $283$272 million in lines of credit, including the $250 million in committed credit facilities described above and $33$22 million with foreign banks. The unused portion of committed credit lines was $87$175 million as of December 26, 2008.25, 2009. In addition, the Company has an unused, uncommitted linelines of credit for $20with foreign banks totaling $12 million. Borrowing rates under these credit lines vary with the prime rate, rates on domestic certificates of deposit and the London Interbank market. The weighted average short-termcost of borrowing rates were(including the effect of interest rate swaps) was 3.3 percent, 3.9 percent 5.3 percent and 5.25.3 percent for the years ended December 25, 2009, December 26, 2008 and December 28, 2007 and December 29, 2006.2007. The Company pays facility fees of up to 0.15 percent per annum on certain of these lines. No compensating balances are required.

The Company has received from its lenders a waiver with respect to compliance with certain aspects of a covenant requiring minimum pension funding levels.

The Company is in compliance with all other financial covenants of its debt agreements.

Interest paid on debt during 2009, 2008 and 2007 and 2006 was $4.8 million, $8.1 million and $2.6 million and $0.9 million.

G. Shareholders’ Equity

At December 26, 2008,25, 2009, the Company had 22,549 authorized, but not issued, cumulative preferred shares, $100 par value. The Company also has authorized, but not issued, a separate class of 3 million shares of preferred stock, $1 par value.

The Company maintains a plan in which one preferred share purchase right (Right) exists for each common share of the Company. Each Right will entitle its holder to purchase one four-hundredth of a share of a new series of junior participating preferred stock at an exercise price of $180, subject to adjustment. The Rights are exercisable only if a person or group acquires beneficial ownership of 15 percent or more of the Company’s outstanding common stock. The Rights expire in March 2010 and may be redeemed earlier by the Board of Directors for $.001 per Right.

In February 2010, the Board of Directors approved a new share rights plan with features similar to the expiring plan, effective March 2010.

Components of accumulated other comprehensive income (loss) were:

(In thousands)

2008

2007 

Pension and postretirement medical liability adjustment

$(70,322)

$(5,672)

Gain (loss) on hedge contracts

(3,109)

(1,072)

Cumulative translation adjustment

(1,057)

48 

Total

$(74,488) 

$(6,696)

were (in thousands):
         
  2009  2008 
Pension and postretirement medical liability adjustment $(48,560) $(70,322)
Gain (loss) on interest rate hedge contracts  (2,344)  (3,109)
Cumulative translation adjustment  (823)  (1,057)
       
Total $(51,727) $(74,488)
       
H. Share-Based Awards, Purchase Plans and Compensation Cost
Stock Option and Award Plan.The Company has a stock incentive plan under which it grants stock options and share awards to directors, officers and other employees. Option price is the market price on the date of grant. Options become exercisable at such time, generally over three or four years, and in such installments as set by the Company, and expire ten years from the date of grant.

41


Restricted share awards have been made to certain key employees under the plan. The market value of restricted stock at the date of grant is charged to operations over the vesting period. Compensation cost charged to operations for restricted share awards was $287,000 in 2009, $280,000 in 2008 and $31,000 in 2007. There was no compensation cost related to restricted shares in 2006. Individual nonemployee directors of the Company may elect to receive, either currently or deferred, all or part of their annual retainer, and/or payment for attendance at Board or Committee meetings, in the form of shares of the Company’s common stock instead of cash. Under this arrangement, the Company issued 14,952 shares in 2009, 10,228 shares in 2008 and 10,338 shares in 2007 and 10,955 shares in 2006.2007. The expense related to this arrangement is not significant.

Options on common shares granted and outstanding, as well as the weighted average exercise price, are shown below (in thousands, except per share amounts):

 

Options

Weighted Average

Exercise Price

Options

Exercisable

Weighted Average

Exercise Price

                

Outstanding, December 30, 2005

3,615 

$20.85

2,017

$14.28

Granted

703 

41.11

 

 

Exercised

(324)

15.11

 

 

Canceled

(38)

34.29

 

 

 Weighted Weighted 
 Average Average 
 Option Exercise Options Exercise 
 Shares Price Exercisable Price 

Outstanding, December 29, 2006

3,956 

$24.79

2,272

$16.94

 3,956 $24.79 2,272 $16.94 

Granted

1,037 

40.08

 

 

 1,037 40.08 

Exercised

(836)

19.96

 

 

  (836) 19.96 

Canceled

(378)

38.98

 

 

  (378) 38.98 
         

Outstanding, December 28, 2007

3,779 

$28.63

2,228

$21.41

 3,779 $28.63 2,228 $21.41 

Granted

819 

35.56

 

 

 819 35.56 

Exercised

(419)

16.60

 

 

  (419) 16.60 

Canceled

(224)

38.81

 

 

  (224) 38.81 
         

Outstanding, December 26, 2008

3,955 

$30.77

2,186

$24.98

 3,955 $30.77 2,186 $24.98 
Granted 1,180 20.74 
Exercised  (164) 10.59 
Canceled  (158) 31.57 
         
Outstanding, December 25, 2009 4,813 $28.98 2,445 $28.38 
         

The following table summarizes information for options outstanding and exercisable at December 26, 200825, 2009 (in thousands, except per share and contractual term amounts):

                         
          Options           
          Outstanding           
          Weighted Avg.  Options      Options 
          Remaining  Outstanding      Exercisable 
Range of  Options  Contractual Term  Weighted Avg.  Options  Weighted Avg. 
Prices  Outstanding  in Years  Exercise Price  Exercisable  Exercise Price 
$  9-20   830   2  $14.55   825  $14.54 
   20-30   1,582   8   22.58   427   27.42 
   30-40   1,508   7   36.37   627   35.60 
   40-49   893   6   41.22   566   41.25 
                  
$  9-49   4,813   6  $28.98   2,445  $28.38 
                  
The aggregate intrinsic value of exercisable option shares was $8.6$13.8 million as of December 26, 2008,25, 2009, with a weighted average contractual term of 4.2 years. There were approximately 3.94.8 million vested share options and share options expected to vest as of December 26, 2008,25, 2009, with an aggregate intrinsic value of $8.6$24.3 million, a weighted average exercise price of $30.71$28.98 and a weighted average contractual term of 6.16.3 years.
Information related to options exercised follows:follows (in thousands):
             
  2009 2008 2007
Cash received $1,733  $6,950  $16,688 
Aggregate intrinsic value  2,173   8,734   17,465 
Tax benefit realized  800   3,100   6,500 

42

(In thousands)

2008

2007

2006

Cash received

$6,950

$16,688

$4,889

Aggregate intrinsic value

8,734

17,465

8,851

Tax benefit realized

3,100

6,500

3,200


Stock Purchase Plan.Under the Company’s Employee Stock Purchase Plan, the purchase price of the shares is the lesser of 85 percent of the fair market value on the first day or the last day of the plan year. The Company issued 216,047312,424 shares under this Plan in 2009, 216,047 shares in 2008 and 202,096 shares in 2007 and 204,478 shares in 2006.

2007.

Authorized Shares.Shares authorized for issuance under the stock option and purchase plans are shown below:

below (in thousands):

(In thousands)

 

Total Shares

Authorized

Available for Future Issuance as of

December 26, 2008

        
 Available for Future 
 Total Shares Issuance as of 
 Authorized December 25, 2009 

Stock Incentive Plan (2006)

7,375

3,228

 7,375 2,166 

Employee Stock Purchase Plan (2006)

2,000

1,784

 2,000 1,472 
     

Total

9,375

5,012

 9,375 3,638 
     

Amounts available for future issuance exclude outstanding options. Options outstanding as of December 26, 2008,25, 2009, include options granted under three plans that were replaced by the Stock Incentive Plan in 2001 and 2006. No shares are available for future grants under those plans.

Share-based Compensation.The Company recognized share-based compensation cost of $9.4 million in 2009, $9.1 million in 2008 and $8.6 million in 2007, which reduced net income by $7.3 million, or $0.12 per weighted common share in 2009, $6.7 million, or $0.11 per weighted common share in 2008 and $6.4 million, or $0.10 per weighted common share in 2007. As of December 26, 2008,25, 2009, there was $8.6$7.0 million of unrecognized compensation cost related to unvested options, expected to be recognized over a weighted average period of approximately two 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:

            

2008  

2007  

2006  

 2009 2008 2007

Expected life in years

6.0   

5.6   

6.3   

 6.0 6.0 5.6 

Interest rate

3.2%

4.2%

4.6%

  2.1%  3.2%  4.2%

Volatility

25.1%

25.1%

27.8%

  30.1%  25.1%  25.1%

Dividend yield

2.1%

1.7%

1.4%

  3.7%  2.1%  1.7%

Weighted average fair value per share

$8.28 

$10.55 

$12.97 

 $4.27 $8.28 $10.55 

Expected life is estimated based on vesting terms and exercise and termination history. Interest rate is based on the U.S Treasury rate on zero-coupon issues with a remaining term equal to the expected life of the option. Expected volatility is based on historical volatility over a period commensurate with the expected life of options.

The fair value of employees’ purchase rights under the Employee Stock Purchase 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:
             
  2009 2008 2007
Expected life in years  1.0   1.0   1.0 
Interest rate  0.7%  1.5%  4.9%
Volatility  51.5%  27.1%  24.4%
Dividend yield  4.5%  2.1%  1.6%
Weighted average fair value per share $5.60  $8.14  $9.79 

43

 

2008  

2007  

2006  

Expected life in years

1.0   

1.0   

1.0   

Interest rate

1.5%

4.9%

4.6%

Volatility

27.1%

24.4%

24.0%

Dividend yield

2.1%

1.6%

1.4%

Weighted average fair value per share

$8.14 

$9.79 

$10.18 


I. Earnings per Share

The following table sets forth the computation of basic and diluted earnings per share:

share (in thousands, except per share amounts):

(In thousands, except per share amounts)

2008

2007

2006

Numerator

Net earnings available to common shareholders

 

$120,879

 

$152,836

 

$149,766

Denominators

 

 

 

Weighted average shares outstanding for basic earnings per share

60,264

65,043

67,807

Dilutive effect of stock options computed based on the treasury

 

 

 

stock method using the average market price

571

941

1,170

Denominator for diluted earnings per share

60,835

65,984

68,977

Basic earnings per share

$      2.01

$      2.35

$      2.21

Diluted earnings per share

$      1.99

$      2.32

$      2.17

             
  2009  2008  2007 
Net earnings available to common shareholders $48,967  $120,879  $152,836 
          
Weighted average shares outstanding for basic earnings per share  59,865   60,264   65,043 
Dilutive effect of stock options computed based on the treasury stock method using the average market price  364   571   941 
          
Weighted average shares outstanding for diluted earnings per share  60,229   60,835   65,984 
          
Basic earnings per share $0.82  $2.01  $2.35 
Diluted earnings per share $0.81  $1.99  $2.32 

Stock options to purchase 2,941,0002.4 million, 2.9 million and 1,142,000 common1.1 million shares were not included in the 2009, 2008 and 2007 calculationscomputations of diluted earnings per share, respectively, because they would have been anti-dilutive.

J. Retirement Benefits

The Company has a defined contribution plan, under Section 401(k) of the Internal Revenue Code, which provides retirement benefits to most U.S. employees. For all employees who choose to participate, the Company matches employee contributions at a 100 percent rate, up to 3 percent of the employee’s compensation. For employees not covered by a defined benefit plan, the Company contributes an amount equal to 1.5 percent of the employee’s compensation. Employer contributions totaled $2.7 million in 2009, $3.1 million in 2008 and $3.0 million in 2007 and $2.6 million in 2006.

2007.

The Company’s postretirement medical plan provides certain medical benefits for retired U.S. employees. Employees hired before January 1, 2005, are eligible for these benefits upon retirement and fulfillment of other eligibility requirements as specified by the plan.

The Company has both funded and unfunded noncontributory defined benefit pension plans that together cover most U.S. employees hired before January 1, 2006, certain directors and some of the employees of the Company’s non-U.S. subsidiaries. For U.S. plans, benefits are based on years of service and the highest five consecutive years’ earnings in the ten years preceding retirement. The Company funds annually in amounts consistent with minimum funding requirements and maximum tax deduction limits.

Investment policies and strategies of the funded pension plan are based on a long-term view of economic growth and heavily weighted toward equity securities. The primary goal of the plan’s investments is to ensure that the plan’s liabilities are met over time. In developing strategic asset allocation guidelines, an emphasis is placed on the long-term characteristics of individual asset classes, and the benefits of diversification among multiple asset classes. The plan invests primarily in common stocks and bonds, including the Company’s common stock. The marketTarget allocations for plan assets are 80 percent equity securities, 15 percent fixed income securities and 5 percent real estate investments. Plan assets by category and fair value measurement level as of the plan’s investment in the common stock of the Company was $8.3 million at December 26, 2008, and $13.0 million at December 28, 2007. For the funded pension plan, asset allocations at year-end25, 2009 were as follows:follows (in thousands):
                 
  Total  Level 1  Level 2  Level 3 
Equity                
Graco common stock $10,448  $10,448  $  $ 
U.S. Large Cap  58,836   21,597   37,239    
U.S. Small Cap  24,465   24,465       
International  28,731   2,063   26,668    
             
Total Equity  122,480   58,573   63,907    
Fixed income  35,967   25,305   10,662    
Real estate and other  7,642   956      6,686 
             
Total $166,089  $84,834  $74,569  $6,686 
             
                 
Levels within fair value hierarchy:
Level 1 — based on quoted prices in active markets for identical assets
Level 2 — based on significant observable inputs
Level 3 — based on significant unobservable inputs

44

 

2008

2007

Graco common stock

6%

6%

Other equity securities

62%

72%

Debt securities

20%

15%

Real estate

9%

6%

Cash

3%

1%

Total

100%

100%


The Company uses a year-end measurement date for all of its plans. The following provides a reconciliation of the changes in the plans’ benefit obligations and fair value of assets over the periods ending December 26, 2008,25, 2009, and December 28, 2007,26, 2008, and a statement of the funded status as of the same dates.

 

Pension Benefits

Postretirement Medical Benefits

(In thousands)

2008    

2007 

2008

 2007  


dates (in thousands):

Change in benefit obligation

 

 

 

 

 

Obligation, beginning of year

$202,182 

$202,578 

 

$ 23,596 

$ 21,416 

Service cost

4,968 

5,618 

 

557 

537 

Interest cost

12,223 

11,504 

 

1,381 

1,345 

Actuarial loss (gain)

4,960 

(10,615)

 

393 

1,772 

Plan amendments

514 

 

385 

873 

Exchange rate changes

(317)

914 

 

—    

—  

Benefit payments

(9,376)

(7,817)

 

(2,530)

(2,347)

Obligation, end of year

$215,154 

$202,182 

 

$23,782 

$23,596 

Change in plan assets

 

 

 

 

 

Fair value, beginning of year

$215,378 

$212,819 

 

$       — 

$       — 

Actual return on assets

(78,935)

9,492 

 

— 

— 

Employer contributions

1,653 

884 

 

2,530 

2,347 

Benefit payments

(9,376)

(7,817)

 

(2,530)

(2,347)

Fair value, end of year

$128,720 

$215,378 

 

$       —  

$        — 

Funded status

$(86,434)

$  13,196 

 

$(23,782)

$(23,596)

Amounts recognized in consolidated balance sheets

 

 

 

 

 

Non-current assets

$       — 

$  31,823 

 

$ —   

 $ —   

Current liabilities

726 

645 

 

2,222 

2,344  

Non-current liabilities

85,708 

17,982 

 

21,560 

21,252  

Net assets (liabilities)

$(86,434) 

$  13,196 

 

$(23,782)

$(23,596) 

 
                 
  Pension Benefits  Postretirement Medical Benefits 
  2009  2008  2009  2008 
Change in benefit obligation                
Obligation, beginning of year $215,154  $202,182  $23,782  $23,596 
Service cost  4,718   4,968   565   557 
Interest cost  12,305   12,223   1,313   1,381 
Actuarial loss (gain)  (4,961)  4,960   (848)  393 
Plan amendments     514      385 
Exchange rate changes  210   (317)      
Benefit payments  (9,229)  (9,376)  (2,086)  (2,530)
             
Obligation, end of year $218,197  $215,154  $22,726  $23,782 
             
Change in plan assets                
Fair value, beginning of year $128,720  $215,378  $  $ 
Actual return on assets  30,757   (78,935)      
Employer contributions  15,841   1,653   2,086   2,530 
Benefit payments  (9,229)  (9,376)  (2,086)  (2,530)
             
Fair value, end of year $166,089  $128,720  $  $ 
             
Funded status $(52,108) $(86,434) $(22,726) $(23,782)
             
Amounts recognized in consolidated balance sheets                
Current liabilities $672  $726  $2,006  $2,222 
Non-current liabilities  51,436   85,708   20,720   21,560 
             
Total liabilities $52,108  $86,434  $22,726  $23,782 
             

The accumulated benefit obligation as of year-end for all defined benefit pension plans was $202 million for 2009 and $195 million for 2008 and $182 million for 2007.2008. Information for plans with an accumulated benefit obligation in excess of plan assets follows:

follows (in thousands):

(In thousands)

2008

2007

        
 2009 2008 

Projected benefit obligation

$215,154

$18,628

 $218,197 $215,154 

Accumulated benefit obligation

195,307

15,806

 201,628 195,307 

Fair value of plan assets

128,720

 166,089 128,720 

The components of net periodic benefit cost for the plans for 2009, 2008 2007 and 20062007 were as follows:follows (in thousands):
                         
  Pension Benefits  Postretirement Medical Benefits 
  2009  2008  2007  2009  2008  2007 
Service cost-benefits earned during the period $4,718  $4,968  $5,618  $565  $557  $537 
Interest cost on projected benefit obligation  12,305   12,223   11,504   1,313   1,381   1,345 
Expected return on assets  (10,857)  (18,981)  (18,795)         
Early retirement incentives     530         385    
Amortization of prior service cost (credit)  183   232   244   (658)  (658)  (739)
Amortization of net loss (gain)  8,757   176   236   598   641   811 
Cost of pension plans which are not significant and have not adopted SFAS No. 87  73   136   478   N/A   N/A   N/A 
                   
Net periodic benefit cost (credit) $15,179  $(716) $(715) $1,818  $2,306  $1,954 
                   

45

 

Pension Benefits

 

Postretirement Medical Benefits

(In thousands)

2008 

2007 

2006 

 

2008 

2007 

2006 

Service cost – benefits earned during the period

$ 4,968 

$ 5,618 

$ 5,444 

 

$ 557 

$ 537 

$ 849 

Interest cost on projected benefit obligation

12,223 

11,504 

10,541 

 

1,381 

1,345 

1,511 

Expected return on assets

(18,981)

(18,795)

(16,582)

 

—  

— 

— 

Early retirement incentives

530 

— 

— 

 

385 

— 

— 

Amortization of prior service cost (credit)

232 

244 

147 

 

(658)

(739)

(161)

Amortization of net loss (gain)

176 

236 

535 

 

641 

811 

595 

Cost of pension plans which are not significant

 

 

 

 

 

 

 

 and have not adopted SFAS No. 87

136 

478 

320 

 

N/A 

N/A 

N/A 

Net periodic benefit cost (credit)

$ (716)

$ (715)

$ 405 

 

$2,306 

$1,954 

$2,794 


Amounts recognized in other comprehensive (income) loss in 20082009 and 20072008 were as follows:

follows (in thousands):

Pension Benefits

Postretirement Medical Benefits

                

(In thousands)

2008 

2007 

2008 

2007 

 Pension Benefits Postretirement Medical Benefits 
 2009 2008 2009 2008 

Prior service cost (credit) arising during the period

    $      514 

$      — 

   $    385 

$    873 

 $ $514 $ $385 

Net loss (gain) arising during the period

102,755 

(1,218)

393 

1,772 

  (24,848) 102,755  (848) 393 

Amortization of prior service credit (cost)

(232)

(244)

658 

739 

  (183)  (232) 658 658 

Amortization of net gain (loss)

(706)

(236)

(1,026)

(811)

  (8,757)  (706)  (598)  (1,026)
         

Total

$102,331 

$(1,698)

$ 410 

$2,573 

 $(33,788) $102,331 $(788) $410 
         

Amounts included in accumulated other comprehensive (income) loss as of December 26, 200825, 2009 and December 28, 2007,26, 2008, that had not yet been recognized as components of net periodic benefit cost, were as follows:

 

          Pension Benefits

Postretirement Medical Benefits

(In thousands)

2008 

2007  

2008  

2007  

follows (in thousands):
                
 Pension Benefits Postretirement Medical Benefits 
 2009 2008 2009 2008 

Prior service cost (credit)

$      431 

$   742 

$(5,732) 

  $(6,390) 

 $251 $431 $(5,074) $(5,732)

Net loss

107,605 

4,963 

9,352  

9,600  

 73,994 107,605 7,907 9,352 
         

Net before income taxes

108,036 

5,705 

3,620  

3,210  

 74,245 108,036 2,833 3,620 

Income taxes

(39,995)

(2,055)

(1,338) 

(1,188) 

  (27,470)  (39,995)  (1,048)  (1,338)
         

Net

$ 68,041 

$3,650 

$2,282  

$2,022  

 $46,775 $68,041 $1,785 $2,282 
         

Amounts included in accumulated other comprehensive (income) loss that are expected to be recognized as components of net periodic benefit cost in 20092010 were as follows:

follows (in thousands):

(In thousands)

Pension Benefits

Postretirement Medical Benefits

        
 Postretirement 
 Pension Medical 
 Benefits Benefits 

Prior service cost (credit)

     $    182 

              $(658)

 $113 $(658)

Net loss (gain)

      9,362 

              673 

 5,868 569 
     

Net before income taxes

      9,544 

              15 

 5,981  (89)

Income taxes

      (3,531)

              (6)

  (2,213) 33 
     

Net

      $ 6,013 

             $     9 

 $3,768 $(56)
     

Assumptions used to determine the Company’s benefit obligations are shown below:

                

Pension Benefits

Postretirement Medical Benefits

 Pension Benefits Postretirement Medical Benefits

Weighted average assumptions

2008  

2007  

2008  

2007  

 2009 2008 2009 2008

Discount rate

6.0%

6.2%

6.0%

6.3%

  6.0%  6.0%  6.0%  6.0%

Rate of compensation increase

3.8%

N/A

N/A

  3.8%  3.8% N/A N/A 

Assumptions used to determine the Company’s net periodic benefit cost are shown below:

                        

Pension Benefits

 

Postretirement Medical Benefits

 Pension Benefits Postretirement Medical Benefits

Weighted average assumptions

2008 

2007 

2006 

 

2008 

2007 

2006 

 2009 2008 2007 2009 2008 2007 

Discount rate

6.2%

5.7%

5.5%

 

6.3%

5.8%

5.5%

  6.0%  6.2%  5.7%  6.0%  6.3%  5.8%

Expected return on assets

9.0%

 

N/A

  8.5%  9.0%  9.0% N/A N/A N/A 

Rate of compensation increase

3.8%

 

N/A

  3.8%  3.8%  3.8% N/A N/A N/A 

Several sources of information are considered in determining the expected rate of return assumption, including the allocation of plan assets, the input of actuaries and professional investment advisors, and historical long-term returns. In setting the return assumption, the Company recognizes that historical returns are not always indicative of future returns and also considers the long-term nature of its pension obligations.

46


The Company’s U.S. retirement medical plan limits the annual cost increase that will be paid by the Company. In 2006, the annual cost increase limitation was changed to 5 percent for 2007, 4 percent for 2008 and 3 percent thereafter. In 2007, the Company made changes in the administration of the plan to facilitate compliance with the cost limitation provisions. The Company also amended the plan to remove the 30-year service cap applied to the calculation of service-based credits provided to future retirees for postretirement health care costs. In measuring the accumulated postretirement benefit obligation (APBO), the annual trend rate for health care costs was assumed to be 9 percent for 2009,2010, decreasing by one-half percentage pointratably each year to a constant rate of 54.5 percent in 20172025 and thereafter, subject to the plan’s annual increase limitation.

At December 26, 2008,25, 2009, a one percent change in assumed health care cost trend rates would have no significant impact on the service and interest cost components of net periodic postretirement health care benefit cost or the APBO for health care benefits.

The Company expects to contribute $0.7 million to its unfunded pension plans and $2.2$2.0 million to the postretirement medical plan in 2009.2010. The Company expects that no contribution to the funded pension plan will be required in 2009.2010. Estimated future benefit payments are as follows:

follows (in thousands):

(In thousands)

Pension Benefits

   Postretirement Medical Benefits

2009

$ 9,200             

$2,200

        
 Postretirement
 Pension Medical
 Benefits Benefits

2010

9,900             

2,100

 $9,873 $2,006 

2011

10,600             

2,000

 10,489 1,909 

2012

11,300             

1,800

 11,182 1,759 

2013

12,100            

1,700

 11,942 1,682 

Years 2014 – 2018

73,500            

8,000

2014 12,814 1,704 
Years 2015 - 2019 75,269 9,262 

K. Commitments and Contingencies

Lease Commitments.Aggregate annual rental commitments under operating leases with noncancelable terms of more than one year were $7.2$3.9 million at December 26, 2008,25, 2009, payable as follows:

follows (in thousands):

 

Vehicles &

 

            

(In thousands)

Buildings

Equipment

Total

2009

$1,210 

$1,868  

$3,078

 Vehicles &   
 Buildings Equipment Total 

2010

745 

1,010  

1,755

 $396 $1,256 $1,652 

2011

326 

485  

811

 85 839 924 

2012

300 

179  

479

 28 408 436 

2013

256 

57  

313

 22 136 158 
2014 22 57 79 

Thereafter

728 

43  

771

 626  626 
       

Total

$3,565 

  $3,642  

$7,207

 $1,179 $2,696 $3,875 
       

Total rental expense was $3.1 million for 2009, $2.6 million for 2008 and $2.3 million for 2007 and $1.8 million for 2006.

2007.

Other Commitments.The Company is committed to pay suppliers under the terms of open purchase orders issued in the normal course of business totaling approximately $15$19 million at December 26, 2008.25, 2009. The Company also has commitments with certain suppliers to purchase minimum quantities, and under the terms of certain agreements, the Company is committed for certain portions of the supplier’s inventory. The Company does not purchase, or commit to purchase quantities in excess of normal usage or amounts that cannot be used within one year. The Company estimates that the maximum commitment amount under such agreements does not exceed $20$16 million. In addition, the Company could be obligated to perform under standby letters of credit totaling $2 million at December 26, 2008.25, 2009. The Company has also guaranteed the debt of its subsidiaries for up to $7$30 million.

Contingencies.The Company is party to various legal proceedings arising in the normal course of business. The Company is actively defending these matters and has recorded an estimate of the probable costs. Management does not expect that resolution of these matters will have a material adverse effect on the Company, although the ultimate outcome cannot be determined based on available information.

47


L. Acquisitions

In February 2008, the Company acquired GlasCraft Inc. for approximately $35 million cash. GlasCraft had sales of approximately $18 million in 2007. It designs, manufacturesdesigned, manufactured and sellssold spray systems for the composites manufacturing industry and high performance dispense systems for the polyurethane foam and polyurea coatings industries. The products, brands, distribution channels and engineering capabilities of GlasCraft expandexpanded and complementcomplemented the Company’s Industrial Equipment business. GlasCraft operations were moved from Indiana to Company facilities in Ohio, South Dakota and Minnesota in 2008.

In September 2008, the Company acquired certain assets of Lubrication Scientifics, Inc. (LubeSci) for approximately $5 million cash. LubeSci designed and manufactured automated lubrication equipment used in industrial markets and had sales of approximately $3 million in 2007. LubeSci operations were moved to Company facilities in Minnesota from California in 2008.

In October 2008, the Company acquired the Airlessco assets of Durotech Co. in Moorpark, California, for approximately $15 million cash. Airlessco is a line of spray-painting equipment that generated approximately $14 million of sales in 2007, and complements the Company’s Contractor Equipment business.

The move of Airlessco operations to other existing Company facilities will be completed in 2010.

The purchase price of each acquisition was allocated based on estimated fair values as follows:

(In thousands)

GlasCraft

LubeSci

Airlessco

follows (in thousands):
            
 GlasCraft LubeSci Airlessco 

Accounts receivable and prepaid expenses

$ 2,200   

$   —    

$ 2,400 

 $2,200 $ $2,400 

Inventories

3,700   

500  

3,000 

 3,700 500 3,000 

Deferred income taxes

700   

—    

—  

 700   

Property, plant and equipment

700   

600  

500 

 700 600 500 

Identifiable intangible assets

18,200   

900  

5,500 

 18,200 900 5,500 

Goodwill

17,700   

2,500  

4,800 

 17,700 2,500 4,800 
       

Total purchase price

43,200   

4,500  

16,200 

 43,200 4,500 16,200 

Current liabilities assumed

(1,000)  

—    

(800)

  (1,000)   (800)

Deferred income taxes

(6,900)  

—    

—�� 

  (6,900)   
       

Net assets acquired

$35,300   

$4,500  

$15,400 

 $35,300 $4,500 $15,400 
       

Identifiable intangible assets and estimated useful life were as follows:

         GlasCraft

         LubeSci

      Airlessco



follows (in thousands):
            
 GlasCraft LubeSci Airlessco 

Product documentation (5 years)

$    900          

$  —         

$  —           

 $900 $ $ 

Customer relationships (5 – 6 years)

14,100          

600         

4,600         

Proprietary technology (3 – 5 years)

500          

300         

—          

Customer relationships (5 - 6 years) 14,100 600 4,600 
Proprietary technology (3 - 5 years) 500 300  

Tradenames and trademarks (3 years)

—           

—          

800         

   800 

Patents (3 years)

—           

—          

100         

   100 
       

Total (6 years, weighted average)

15,500          

900         

5,500         

 15,500 900 5,500 

Brand names (indefinite useful life)

2,700          

—          

 2,700   
       

Total identifiable intangible assets

$18,200          

$900         

$5,500        

 $18,200 $900 $5,500 
       

None of the GlasCraft goodwill or identifiable intangible assets is deductible for tax purposes. Goodwill and identifiable intangible assets from the acquisitions of LubeSci and Airlessco are deductible for tax purposes.

48


Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

None.

Item 9A. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

As of the end of the fiscal year covered by this report, the Company carried out an evaluation of the effectiveness of the design and operation of its disclosure controls and procedures. This evaluation was done under the supervision and with the participation of the Company’s President and Chief Executive Officer, the Chief Financial Officer and Treasurer, the Vice President 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 in gathering, analyzing and disclosing information needed to satisfy the Company’s disclosure obligations under the Exchange Act.

effective.

Management’s Annual Report on Internal Control Over Financial Reporting

The information under the heading “Management’s Report on Internal Control Over Financial Reporting” in Part II, Item 8, of this 20082009 Annual Report on Form 10-K is incorporated herein by reference.

Reports of Independent Registered Public Accounting Firm

The information under the heading “Reports of Independent Registered Public Accounting Firm: Internal Control Over Financial Reporting” in Part II, Item 8, of this 20082009 Annual Report on Form 10-K is incorporated herein by reference.

Changes in Internal Control Over Financial Reporting

During the fourth 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.

Item 9B. Other Information

Not applicable.

PART III

Item 10. Directors, Executive Officers and Corporate Governance

The information under the heading “Executive Officers of the Company” in Part I of this 20082009 Annual Report on Form 10-K and the information under the headings “Election of Directors-NomineesDirectors,” and Other Directors,” “Director Qualifications and Selection Process” and “Section 16(a) Beneficial Ownership Reporting Compliance” of our Company’s Proxy Statement for its 20092010 Annual Meeting of Shareholders, to be held on April 24, 200923, 2010 (the “Proxy Statement”), is incorporated herein by reference.

New York Stock Exchange Rule 303A.12

Our Company’s Annual CEO Certification as required by NYSE Rule 303A.12(a) was filed with the New York Stock Exchange on or about May 15, 2008. The certifications of the President and Chief Executive Officer and Chief Financial Officer and Treasurer under Section 302 of the Sarbanes-Oxley Act of 2002, regarding the quality of our Company’s disclosure in this 2008 Annual Report on Form 10-K, have been filed as exhibits 31.1 and 31.2 hereto.

Audit Committee Members and Audit Committee Financial Expert

The information under the heading “Committees of the Board of Directors” of our Company’s Proxy Statement is incorporated herein by reference.

Corporate Governance Guidelines, Committee Charters and Code of Ethics

Our Company has adopted Corporate Governance Guidelines and Charters for the Audit, Governance, and Management Organization and Compensation Committees of the Board of Directors. We have also issued Code of Ethics and Business Conduct (Code of Ethics) that applies to our principal executive officer, principal financial officer, principal accounting officer, all officers, directors, and employees of Graco Inc. and all of its subsidiaries and branches worldwide. The Corporate Governance Guidelines, Committee Charters, and Code of Ethics, with any amendments or waivers thereto, may be accessed free of charge by visiting the Graco website at www.graco.com. Copies of these documents are also available in print by written request directed to Secretary, Graco Inc., P.O. Box 1441, Minneapolis, MN 55440-1441.

49


Our Company intends to post on the Graco website any amendment to, or waiver from, a provision of the Code of Ethics that applies to our principal executive officer, principal financial officer, principal accounting officer, controller and other persons performing similar functions within four business days following the date of such amendment or waiver.

Section 16(a) Reporting Compliance

The information under the heading “Section 16(a) Beneficial Ownership Reporting Compliance” of the Company’s Proxy Statement is incorporated herein by reference.

Item 11. Executive Compensation

The information contained under the headings “Director Compensation,” “Executive Compensation,” “Compensation Committee Interlocks and Insider Participation” and “Report of the Management Organization and Compensation Committee” of the Proxy Statement is incorporated herein by reference.

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

The information contained under the headings “Equity Compensation Plan Information” and “Beneficial Ownership of Shares” of the Proxy Statement is incorporated herein by reference.

Item 13. Certain Relationships and Related Transactions and Director Independence

The information under the headings “Related Person Transaction Approval Policy” and “Director Independence” of the Proxy Statement is incorporated herein by reference.

Item 14. Principal Accounting Fees and Services

The information under the headings “Independent Registered Public Accounting Firm Fees and Services” and “Pre-Approval Policies” of the Proxy Statement is incorporated herein by reference.

50


PART IV

Item 15. Exhibits and Financial Statement Schedule
(a)The following documents are filed as part of this report:
         
 (1) Financial Statements
See Part II
    
         
 (2) Financial Statement Schedule
Schedule II — Valuation and Qualifying Accounts
  52 
         
    All other schedules are omitted because they are not applicable, or are not required, or because the required information is included in the Consolidated Financial Statements or Notes thereto.    
         
 (3) Management Contract, Compensatory Plan or Arrangement. (See Exhibit Index)
Those entries marked by an asterisk are Management Contracts, Compensatory Plans or Arrangements.
  54 

51

(a)       The following documents are filed as part of this report:


Schedule II — Valuation and Qualifying Accounts
Graco Inc. and Subsidiaries
(in thousands)
                     
      Additions          
  Balance at  charged to  Deductions  Other  Balance at 
  beginning  costs and  from  add  end 
  of year  expenses  reserves1  (deduct)2  of year 
Year ended                    
December 25, 2009                    
Allowance for doubtful accounts $2,200  $900  $1,000  $  $2,100 
Allowance for returns and credits  4,400   8,900   8,900      4,400 
                
  $6,600  $9,800  $9,900  $  $6,500 
                
                     
December 26, 2008                    
Allowance for doubtful accounts $2,500  $  $400  $100  $2,200 
Allowance for returns and credits  4,000   12,000   11,600      4,400 
                
  $6,500  $12,000  $12,000  $100  $6,600 
                
                     
December 28, 2007                    
Allowance for doubtful accounts $2,600  $200  $400  $100  $2,500 
Allowance for returns and credits  3,200   12,400   11,600      4,000 
                
  $5,800  $12,600  $12,000  $100  $6,500 
                

     (1)  Financial Statements

           See Part II

     (2)  Financial Statement Schedule51

           Schedule II - Valuation and Qualifying Accounts

           All other schedules are ommitted because they are not applicable, or are not required, or because the

           required information is included in the Consolidated Financial Statements or Notes thereto.

     (3)  Management Contract, Compensatory Plan or Arrangement (See Exhibit Index)53
           Those entries marked by an asterisk are Management Contracts, Compensatory Plans or Arrangements.


Schedule II - Valuation and Qualifying Accounts

Graco Inc. and Subsidiaries

 

 

 

Description

 

Balance at beginning

of year

Additions charged to costs and expenses

 

Deductions

from

reserves1

 

Other

add (deduct) 2

 

Balance

at end of

year

Year ended December 26, 2008

 

 

 

 

 

Allowance for doubtful accounts

$2,500

$       —

   $     400

$ 100

$2,200

Allowance for returns and credits

4,000

12,000

11,600

4,400

 

$6,500

$12,000

$12,000

$ 100

$6,600

Year ended December 28, 2007

 

 

 

 

 

Allowance for doubtful accounts

$2,600

$     200

$     400

$ 100

$2,500

Allowance for returns and credits

3,200

12,400

11,600

4,000

 

$5,800

$12,600

$12,000

$ 100

$6,500

Year ended December 29, 2006

 

 

 

 

 

Allowance for doubtful accounts

$2,300

$       —

$       —

$ 300

$2,600

Allowance for returns and credits

3,600

10,400

10,900

100

3,200

 

$5,900

$10,400

$10,900

$ 400

$5,800

1

For doubtful accounts, represents amounts determined to be uncollectible and charged against reserve, net of collections on accounts previously charged against reserves. For returns and credits, represents amounts of credits issued and returns processed.

2

Includes amounts assumed or established in connection with acquisitions and effects of foreign currency translation.

52

Signatures


Signatures
Pursuant to the requirements of Section 13 or 15(d) 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.

/s/PATRICKPatrick J.MCHALE McHale

Patrick J. McHale

February 16, 2009

15, 2010
President and Chief Executive Officer

Patrick J. McHale

   President and Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

/s/PATRICKJ.MCHALE

February 16, 2009

/s/Patrick J. McHale

Patrick J. McHale
February 15, 2010
   President and Chief Executive Officer
(Principal Executive Officer)

President and Chief Executive Officer

(Principal Executive Officer)
/s/JAMES A. GRANER

February 16, 2009

James A. Graner

James A. Graner
February 15, 2010
Chief Financial Officer and Treasurer
(Principal Financial Officer)

/s/CAROLINE M. CHAMGERS

February 16, 2009

Caroline M. Chambers

Caroline M. Chambers
February 15, 2010
Vice President and Controller
(Principal Accounting Officer)
Lee R. Mitau                        Director, Chairman of the Board

William J. Carroll

Director

Lee R. MitauDirector, Chairman of the Board
William J. CarrollDirector
Jack W. Eugster

Director

J. Kevin Gilligan

Director

Patrick J. McHale

Director

Marti Morfitt

Director

Mark H. Rauenhorst

Director

William G. Van Dyke

Director

R. William Van Sant

Director

Patrick J. McHale, by signing his name hereto, does hereby sign this document on behalf of himself and each of the above named directors of the Registrant pursuant to powers of attorney duly executed by such persons.

/s/PATRICKJ.MCHALE

February 16, 2009

/s/Patrick J. McHale

Patrick J. McHale
February 15, 2010
(For himself and as attorney-in-fact)
(For himself and as attorney-in-fact)

53


Exhibit Index

Exhibit

Number

Description

2.1

Exhibit
NumberDescription
2.1Stock Purchase Agreement By and Among PMC Global, Inc. Gusmer Machinery Group, Inc. and Graco Inc., dated as of February 4, 2005 (Incorporated by reference to Exhibit 2.1 to the Company’s Report on Form 8-K dated February 10, 2005.)

2.2

2.2Stock Purchase Agreement By and Among PMC Europe Investments, S.L. and Graco Inc. dated as of February 4, 2005. (Incorporated by reference to Exhibit 2.2 to the Company’s Report on Form 8-K dated February 10, 2005.)

3.1

3.1Restated Articles of Incorporation as amended June 14, 2007. (Incorporated by reference to Exhibit 3.1 to the Company’s Report on Form 10-Q for the thirteen weeks ended June 29, 2007.)

3.2

3.2Restated Bylaws as amended June 13, 2002. (Incorporated by reference to Exhibit 3 to the Company’s Report on Form 10-Q for the thirteen weeks ended June 28, 2002.)

4.1

4.1Share Rights Agreement dated as of February 25, 2000, between the Company and Wells Fargo, formerly known as Norwest Bank Minnesota, National Association, as Rights Agent. (Incorporated by reference to Exhibit 1 to the Company’s Registration Statement on Form 8-A dated March 9, 2000.)

4.2

4.2Credit Agreement dated July 12, 2007, between the Company and U.S. Bank National Association, JPMorgan Chase Bank, N.A., Wells Fargo Bank, National Association, and Bank of America, N.A. (Incorporated by reference to Exhibit 10.1 to the Company’s Report on Form 8-K dated July 12, 2007.)

*10.1

Executive Officer Bonus Plan as amended and restated December 23, 2008.

(Incorporated by reference to Exhibit 10.1 to the Company’s 2008 Annual Report on Form 10-K.)

*10.2

Executive Officer Annual Incentive Bonus Plan as amended and restated December 23, 2008.

(Incorporated by reference to Exhibit 10.2 to the Company’s 2008 Annual Report on Form 10-K.)

*10.3

Graco Inc. Nonemployee Director Stock Option Plan, as amended and restated June 18, 2004. (Incorporated by reference to Exhibit 10.4 to the Company’s Report on Form 10-Q for the thirteen weeks ended April 1, 2005.)

*10.4

Long Term Stock Incentive Plan, as amended and restated June 18, 2004. (Incorporated by reference to Exhibit 10.1 to the Company’s Report on Form 10-Q for the thirteen weeks ended April 1, 2005.)

*10.5

Graco Inc. Amended and Restated Stock Incentive Plan (2006). (Incorporated by reference to the Company’s Definitive Proxy Statement on Schedule 14A filed March 14, 2006.)

10.6

10.6Employee Stock Incentive Plan, as amended and restated June 18, 2004. (Incorporated by reference to Exhibit 10.3 to the Company’s Report on Form 10-Q for the thirteen weeks ended April 1, 2005.)

*10.7

Deferred Compensation Plan Restated, effective December 1, 1992. (Incorporated by reference to Exhibit 2 to the Company’s Report on Form 8-K dated March 11, 1993.) First Amendment dated September 1, 1996. (Incorporated by reference to Exhibit 10.2 to the Company’s Report on Form 10-Q for the twenty-six weeks ended June 27, 1997.) Second Amendment dated May 27, 2000. (Incorporated by reference to Exhibit 10.7 to the Company’s 2005 Annual Report on Form 10-K.) Third Amendment adopted on December 19, 2002. (Incorporated by reference to Exhibit 10.7 to the Company’s 2005 Annual Report on Form 10-K.) Fourth Amendment adopted June 14, 2007. (Incorporated by reference to Exhibit 10.2 to the Company’s Report on Form 10-Q for the thirteen weeks ended June 29, 2007.)

*10.8

Deferred Compensation Plan (2005 Statement) as amended and restated on April 4, 2005. (Incorporated by reference to Exhibit 10.1 of the Company’s Report on Form 10-Q for the thirteen weeks ended July 1, 2005.) Second Amendment dated November 1, 2005. (Incorporated by reference to Exhibit 10.8 to the Company’s 2005 Annual Report on Form 10-K.) Third Amendment adopted on December 29, 2008.

(Incorporated by reference to Exhibit 10.8 to the Company’s 2008 Annual Report on Form 10-K.)

10.9

10.9CEO Award Program. (Incorporated by reference to Exhibit 10.9 to the Company’s 2005 Annual Report on Form 10-K.)

54


Exhibit
NumberDescription
*10.10

Retirement Plan for Nonemployee Directors. (Incorporated by reference to Attachment C to Item 5 to the Company’s Report on Form 10-Q for the thirteen weeks ended March 29, 1991.) First Amendment adopted on December 29, 2008.

(Incorporated by reference to Exhibit 10.10 to the Company’s 2008 Annual Report on Form 10-K.)

*10.11

Graco Restoration Plan (2005 Statement). (Incorporated by reference to Exhibit 10.1 to the Company’s Report on Form 10-Q for the thirteen weeks ended September 29, 2006.) First Amendment adopted December 8, 2006. (Incorporated by reference to Exhibit 10.12 to the Company’s 2006 Annual Report on Form 10-K.) Second Amendment adopted August 15, 2007. (Incorporated by reference to Exhibit 10.1 to the Company’s Report on Form 10-Q for the thirteen weeks ended September 28, 2007.) Third Amendment adopted March 27, 2008. (Incorporated by reference to Exhibit 10.1 to the Company’s Report on Form 10-Q for the thirteen weeks ended March 28, 2008.) Fourth Amendment adopted December 29, 2008.

(Incorporated by reference to Exhibit 10.11 to the Company’s 2008 Annual Report on Form 10-K.)

*10.12

Stock Option Agreement. Form of agreement used for award of nonstatutory stock options to nonemployee directors under the Nonemployee Director Stock Option Plan. (Incorporated by reference to Exhibit 10.11 to the Company’s 2001 Annual Report on Form 10-K.)

*10.13

Stock Option Agreement. Form of agreement used for award of nonstatutory stock options to nonemployee directors under the Graco Inc. Stock Incentive Plan. (Incorporated by reference to Exhibit 10.22 to the Company’s 2002 Annual Report on Form 10-K.) Amended form of agreement for awards made to nonemployee directors. (Incorporated by reference to Exhibit 10.3 to the Company’s Report on Form 10-Q for the thirteen weeks ended March 26, 2004.)

*10.14

Stock Option Agreement. Form of agreement used for award of nonstatutory stock options to nonemployee directors under the Graco Inc. Amended and Restated Stock Incentive Plan (2006). (Incorporated by reference to Exhibit 10.3 to the Company’s Report on Form 10-Q for the thirteen weeks ended June 29, 2007.) Amended form of agreement for awards made to nonemployee directors in 2008. (Incorporated by reference to Exhibit 10.2 to the Company’s Report on Form 10-Q for the thirteen weeks ended June 27, 2008.)

Amended and restated form of agreement for awards made to nonemployee directors in 2009.

*10.15

Stock Option Agreement. Form of agreement used for award of non-incentive stock options to executive officers under the Long Term Stock Incentive Plan. (Incorporated by reference to Exhibit 10.12 to the Company’s 2001 Annual Report on Form 10-K.)

*10.16

Stock Option Agreement. Form of agreement used for award of non-incentive stock options to executive officers under the Graco Inc. Stock Incentive Plan. (Incorporated by reference to Exhibit 10.2 to the Company’s Report on Form 10-Q for the thirteen weeks ended March 29, 2002.) Amended form of agreement for awards made to Chief Executive Officer in 2001 and 2002. Amended form of agreement for awards made to executive officers in 2003. (Incorporated by reference to Exhibit 10.15 of the Company’s 2003 Annual Report on Form 10-K.) Amended form of agreement for awards made to executive officers in 2004. Amended form of agreement for awards made to Chief Executive Officer in 2004. (Incorporated by reference to Exhibit 10.2 and 10.4 to the Company’s Report on Form 10-Q for the thirteen weeks ended March 26, 2004.)

*10.17

Stock Option Agreement. Form of agreement used for award in 2007 of non-incentive stock options to executive officers under the Graco Inc. Amended and Restated Stock Incentive Plan (2006). (Incorporated by reference to Exhibit 10.1 to the Company’s Report on Form 10-Q for the thirteen weeks ended March 30, 2007.) Amended form of agreement for awards made to executive officers in 2008 (Incorporated by reference to Exhibit 10.2 to the Company’s Report on Form 10-Q for the thirteen weeks ended March 28, 2008.)

*10.18

Stock Option Agreement. Form of agreement used for award in 2007 of non-incentive stock options to chief executive officer under the Graco Inc. Amended and Restated Stock Incentive Plan (2006). (Incorporated by reference to Exhibit 10.1 to the Company’s Report on Form 10-Q for the thirteen weeks ended March 30, 2007.) Amended form of agreement for awards made to chief executive officer in 2008 (Incorporated by reference to Exhibit 10.2 to the Company’s Report on Form 10-Q for the thirteen weeks ended March 28, 2008.)

*10.19

Executive Deferred Compensation Agreement. Form of supplementary agreement entered into by the Company which provides a retirement benefit to one executive officer, as amended by First Amendment, effective September 1, 1990. (Incorporated by reference to Exhibit 3 to the Company’s Report on Form 8-K dated March 11, 1993.) As

55


Exhibit
NumberDescription
further amended by agreement, effective December 4, 2008.

(Incorporated by reference to Exhibit 10.19 to the Company’s 2008 Annual Report on Form 10-K.)

*10.20

Executive Officer Restricted Stock Agreement. Form of agreement used to award restricted stock to selected executive officers. (Incorporated by reference to Exhibit 10.20 to the Company’s 2007 Annual Report on Form 10-K.)

*10.21

Election Form. Form of agreement used for the issuance of stock or deferred stock in lieu of cash payment of retainer and/or meeting fees to nonemployee directors under the Graco Inc. Stock Incentive Plan. (Incorporated by reference to Exhibit 10.17 to the Company’s 2004 Annual Report on Form 10-K.) Amended form of agreement used for the 2006 plan year. (Incorporated by reference to Exhibit 10.4 to the Company’s Report on Form 10-Q for the thirteen weeks ended June 29, 2007.)

*10.22

Election Form. Form of agreement used for the 2007 plan year for the issuance of stock or deferred stock in lieu of cash payment of retainer and/or meeting fees to nonemployee directors under the Graco Inc. Amended and Restated Stock Incentive Plan (2006). (Incorporated by reference to Exhibit 10.5 to the Company’s Report on Form 10-Q for the thirteen weeks ended June 29, 2007.) Amended form of agreement used for the 2008 plan year. (Incorporated by reference to Exhibit 10.22 to the Company’s 2007 Annual Report on Form 10-K.) Amended form of agreement used for 2009 plan year.

(Incorporated by reference to Exhibit 10.22 to the Company’s 2008 Annual Report on Form 10-K.) Amended form of agreement used for 2010 plan year.

*10.23

Key Employee Agreement. Form of agreement used with chief executive officer. (Incorporated by reference to Exhibit 10.24 to the Company’s 2007 Annual Report on Form 10-K.)

*10.24

Key Employee Agreement. Form of agreement used with executive officers reporting to the chief executive officer. (Incorporated by reference to Exhibit 10.25 to the Company’s 2007 Annual Report on Form 10-K.)

*10.25

Key Employee Agreement. Form of agreement used with executive officer reporting to an executive officer other than the chief executive officer. (Incorporated by reference to Exhibit 10.26 to the Company’s 2007 Annual Report on Form 10-K.)

*10.26

Executive Group Long-Term Disability Policy as revised in 1995. (Incorporated by reference to Exhibit 10.23 to the Company’s 2004 Annual Report on Form 10-K.) As enhanced by Supplemental Income Protection Plan in 2004. (Incorporated by reference to Exhibit 10.28 to the Company’s Annual Report on Form 10-K.)

      11

*10.27Amendment to the 2003 through 2006 Nonstatutory Stock Option Agreements of one nonemployee director.
11Statement of Computation of Earnings per share included in Note I on page 43.

44.

21

21Subsidiaries of the Registrant included herein on page 56.

58.

23

23Independent Registered Public Accounting Firm’s Consent included herein on page 57.

59.

24

24Power of Attorney included herein on page 58.

60.

31.1

31.1Certification of President and Chief Executive Officer pursuant to Rule 13a-14(a) included herein on page 59.

61.

31.2

31.2Certification of Chief Financial Officer and Treasurer pursuant to Rule 13a-14(a) included herein on page 60.

62.

32

32Certification of President and Chief Executive Officer and Chief Financial Officer and Treasurer pursuant to Section 1350 of Title 18, U.S.C. included herein on page 61.

63.

99

99Cautionary Statement Regarding Forward-Looking Statements included herein on page 62.

64.

Except as otherwise noted, all documents incorporated by reference above relate to File No. 001-09249.
Management Contracts, Compensatory Plans or Arrangements.

56


*Management Contracts, Compensatory Plans or Arrangements.

Pursuant to Item 601(b)(4)(iii) of Regulation S-K, copies of certain instruments defining the rights of holders of certain long-term debt of the Company and its subsidiaries are not filed as exhibits because the amount of debt authorized under any such instrument does not exceed 10 percent of the total assets of the Company and its subsidiaries. The Company agrees to furnish copies thereof to the Securities and Exchange Commission upon request.

Exhibit 21

Subsidiaries of Graco Inc.

The following are subsidiaries of the Company as of December 26, 2008.

       Subsidiary

Jurisdiction                        of                      Organization

Percentage of Voting                      Securities Owned by                                the Company

GlasCraft, Inc.

United States

100%7

Graco Australia Pty Ltd.

Australia

100%3

Graco California Inc.

United States

100%

Graco Canada Inc.

Canada

100%

Graco do Brasil Limitada

Brazil

100%1

Graco Fluid Equipment (Shanghai) Co., Ltd.

China (PRC)

100%

Graco Fluid Equipment (Suzhou) Co., Ltd.

China (PRC)

100%6

Graco GmbH

Germany

100%

Graco Hong Kong Ltd.

Hong Kong

100%

Graco Indiana Inc.

United States

100%

Graco K.K.

Japan

100%

Graco Korea Inc.

Korea

100%

Graco Ltd.

England

100%

Graco Minnesota Inc.

United States

100%

Graco N.V.

Belgium

100%1

Graco Ohio Inc.

United States

100%

Graco S.A.S.

France

100%

Gusmer Corporation

United States

100%

Gusmer Canada Ltd.

Canada

100%4

Gusmer Europe, S.L.

Spain

100%4

Gusmer Sudamerica S.A.

Argentina

100%5

Liquid Control Ltd.

England

100%2

1

Includes shares held by executive officer of the Company or the relevant subsidiary to satisfy the requirements of local law.

2Shares 100% held by Graco Ohio Inc.
3Shares 100% held by Graco Hong Kong Ltd.
4Shares 100% held by Gusmer Corporation.
5Shares held by Gusmer Corporation and by executive officer of the Company to satisfy the requirements of local law.
6Shares 100% owned by Graco Minnesota Inc.
7Shares 100% owned by Graco Indiana.

Exhibit 23

Consent of Independent Registered Public Accounting Firm

We consent to the incorporation by reference in Registration Statements No. 333-17691, No. 333-03459, No. 333-75307, No. 333-63128, No. 333-123813, No. 333-134162, and No. 333-140848 on Form S-8 of our reports dated February 16, 2009, relating to the financial statements and financial statement schedule of Graco Inc. and Subsidiaries (the “Company”), and the effectiveness of the Company’s internal control over financial reporting, appearing in this Annual Report on Form 10-K of Graco Inc. and Subsidiaries for the year ended December 26, 2008.

DELOITTE & TOUCHE LLP

Minneapolis, Minnesota

February 16, 2009


Exhibit 24

Power of Attorney

Know all by these presents, that each person whose signature appears below hereby constitutes and appoints Patrick J. McHale or James A. Graner, that person’s true and lawful attorney-in-fact and agent, with full power of substitution and re-substitution for that person and in that person’s name, place and stead, in any and all capacities, to sign the Report on Form 10-K for the year ended December 26, 2008, of Graco Inc. (and any and all amendments thereto) and to file the same with the Securities and Exchange Commission, granting unto said attorney-in-fact and agent, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as that person might or could do in person, hereby ratifying and confirming all that said attorney-in-fact and agent, or his substitutes, may lawfully do or cause to be done by virtue hereof.

In witness whereof, the following persons have signed this Power of Attorney on the date indicated.

Date

/s/WILLIAM J. CARROLLFebruary 13, 2009
William J. Carroll
/s/JACK W. EUGSTERFebruary 13, 2009
Jack W. Eugster
/s/J. KEVIN GILLIGANFebruary 13, 2009
J. Kevin Gilligan
/s/PATRICK J. MCHALEFebruary 13, 2009
Patrick J. McHale
/s/LEE R. MITAUFebruary 13, 2009
Lee R. Mitau
/s/MARTI MORFITTFebruary 13, 2009
Marti Morfitt
/s/MARK H. RAUENHORSTFebruary 13, 2009
Mark H. Rauenhorst
/s/WILLIAM G. VAN DYKEFebruary 13, 2009
William G. Van Dyke
/s/R. WILLIAM VAN SANT

February 13, 2009

R. William Van Sant

Exhibit 31.1

Certification

I, Patrick J. McHale, certify that:

1.

I have reviewed this annual report on Form 10-K of Graco Inc.;

2.

Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.

Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.

The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a)

Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b)

Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c)

Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d)

Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.

The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors:

a)

All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b)

Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date:

February 16, 2009

/s/PATRICKJ.MCHALE

Patrick J. McHale                                                             President and Chief Executive Officer

Exhibit 31.2

Certification

I, James A. Graner, certify that:

1.

I have reviewed this annual report on Form 10-K of Graco Inc.;

2.

Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.

Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.

The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a)

Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b)

Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c)

Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d)

Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.

The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors:

a)

All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b)

Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date:

February 16, 2009

/s/JAMES A. GRANER

James A. Graner                                                                      Chief Financial Officer and Treasurer

Exhibit 32

Certification Under Section 1350

Pursuant to Section 1350 of Title 18 of the United States Code, each of the undersigned certifies that this periodic report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in this periodic report fairly presents, in all material respects, the financial condition and results of operations of Graco Inc.

Date:

February 16, 2009

/s/PATRICKJ.MCHALE

Patrick J. McHale                                                             President and Chief Executive Officer

Date:

February 16, 2009

/s/JAMES A. GRANER

James A. Graner                                                                      Chief Financial Officer and Treasurer

Exhibit 99

Cautionary Statement Regarding Forward-Looking Statements

Graco Inc. (our “Company”) wishes 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 Company’s Form 10-K, Form 10-Q and Form 8-K, its Annual Report to Shareholders, and press releases, 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. Such 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. Among the factors which management believes could affect our Company’s operating results are the following:

With respect to our Company’s business as a whole, our Company’s prospects and operating results may be affected by:57

changes in world economies, including expansions, downturns or recessions and fluctuations in gross domestic product, capital goods investment activity, interest rates, and foreign currency exchange rates;

the ability of our Company to successfully integrate acquisitions;

the ability of our Company to successfully divest or discontinue incompatible or unprofitable lines of business;

the ability to locate and access reasonably priced financing;

the ability of our Company to successfully maintain quality, customer service and inventory levels in light of the longer lead times created by the establishment of assembly operations in Suzhou, People’s Republic of China, and the expanding use of foreign sources for materials and components, especially in Asia;

the ability of our Company to successfully recruit, hire and retain employees with required or desired skills, training and education;

international trade factors, including changes in international trade policy, such as export controls, trade sanctions, increased tariff barriers and other restrictions; weaker protection of our Company’s proprietary technology in certain foreign countries; the burden of complying with foreign laws and standards; and potentially burdensome taxes;

the ability of our Company to: develop new products and technologies; maintain and enhance its market position relative to its competitors; maintain and enhance its distribution channels; identify and enter into new markets; realize productivity and product quality improvements; react expeditiously to fluctuations in demand by adjusting our cost structure; offset cost pressures from labor, materials and overhead with price increases; and control expenses;

disruption in operations, transportation, communication, customer operations, distribution, payment or sources of supply, including the cost and availability of skilled labor, materials and energy, caused by political or economic instability, acts of God, labor disputes, war, embargo, weather, flood, fire, infectious disease, or other cause beyond its reasonable control, including military conflict in the Middle East or on the Korean peninsula, and terrorist activity throughout the world;

cost pressure and lack of availability of key materials used in the manufacture of products;

worldwide competition from low-cost manufacturers, including those that copy our Company’s products;

security breaches, breakdown, interruption in or inadequate upgrading or maintenance of our Company’s information processing software, hardware or networks;

implementation of an enterprise resource planning software system throughout our Company;

changes in the markets in which our Company participates, including consolidation of competitors and major customers, price competition, and products demanded;

changes in accounting standards or in the application by our Company of critical accounting policies;

compliance with corporate governance requirements;

growth in either the severity or magnitude of the products liability claims against our Company; and

changes in the return on investments in the Company’s retirement plan.

The prospects and operating results of our Company’s Contractor Equipment segment may be affected by: variations in the level of residential, commercial and institutional building and remodeling activity; the loss of, or significant reduction in sales to large customers; the pricing power of large customers; the availability and cost of construction financing; changes in the environmental regulation of coatings; consolidation in the paint equipment manufacturing industry and paint manufacturing industry; changes in the technology of paint and coating applications; changes in the buying and channel preferences of the end user; the Company’s success in converting painters outside North America from brush and roller to spray equipment; changes in the business practices (including inventory management) of the major distributors of equipment; changes in construction materials and techniques; changes in the cost of labor in foreign markets; the regional market strength of certain competitors; the level of government spending on infrastructure development and road construction, maintenance and repair; and the nature and extent of highway safety regulation.

The prospects and operating results of our Company’s Industrial Equipment segment may be affected by: the capital equipment spending levels of customers; the availability and cost of financing; changes in the environmental regulation of coatings; changes in the technical and performance characteristics of materials, including powder coatings; changes in application technology; the ability of our Company to meet changing customer requirements; consolidation or other change in the channels of distribution; the pricing strategies of competitors; consolidation in the fluid handling equipment manufacturing industry; changes in the worldwide procurement practices of major manufacturers; changes in manufacturing processes; and consolidation in the manufacturing industry worldwide.

The prospects and operating results of our Company’s Lubrication Equipment segment may be affected by: consolidation in the oil production industry; the development of extended life lubricants for vehicles; the reduction in the need for changing vehicle lubricants; the successful development of vehicles that use power sources other than the internal combustion engine; consolidation of automotive dealerships; trends in spending by state and local governments; variations in the equipment spending levels of the major oil companies; and the ability to develop and profitably market innovative high-quality products and meet competitive challenges in our industrial lubrication business.