What changed in this filing

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Item 7. Management’s Discussion and Analysis

2023-02-21 compared with 2022-02-22 · 92 added, 82 removed, 212 unchanged (45% of the section changed)

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This discussion should be read in conjunction with our financial statements and the accompanying notes to the financial statements.

A discussion of changes in our financial condition and the results of operations from the year ended December 31, 2021 to December 25, 2020 can be found in Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations of our Annual Report on Form 10-K for the year ended December 31, 2021.

Certain prior year disclosures have been revised to conform with current year reporting.

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Graco’s key strategies include developing and marketing new products, leveraging products and technologies into additional, growing end-user markets, expanding distribution globally and completing strategic acquisitions that provide additional channel and technologies.

Long-term financial growth targets accompany these strategies, including our expectation of 10 percent revenue growth and 12 percent consolidated net earnings growth per annum.

Long-term financial growth targets accompany these strategies, including our objectives of 10 percent revenue growth and 12 percent consolidated net earnings growth per annum.

We continue to develop new products in each operating division that are expected to drive incremental sales growth, as well as continued refreshes and upgrades of existing product lines.

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We also manufacture some of our products in Switzerland (Industrial segment), Italy (Industrial segment), the United Kingdom (Process segment), the People’s Republic of China (“P.R.C.”) (all segments), Belgium (all segments) and Romania (Industrial segment).

Our primary distribution facilities are located in the U.S., Belgium, Switzerland, United Kingdom, P.R.C., Japan, Italy, Korea, Australia and Brazil.

The ongoing global COVID-19 pandemic and related governmental, business and societal responses continue to have an impact on our operations, supply chains, distribution channels, and end-user customers.

The timing, duration, and extent of the impact from the pandemic in our major geographies is still uncertain and we cannot predict the magnitude of the impact to the results of our operations or financial position.

In 2021, the Company experienced logistical and production constraints associated with raw materials and purchased components.

These constraints were due to limited raw material and component availability, reduced freight capacity, shipping delays, and labor shortages as a result of responses to the COVID-19 pandemic and other supply chain disruptions.

We also experienced the effects of price inflation related to raw materials, purchased components, and freight and transportation costs.

The supply chain disruptions and associated effects of inflation have adversely impacted profitability in the near-term and limited our ability to satisfy strengthening customer demand, especially within our high-volume Contractor segment.

We expect these challenges to continue into at least the first half of 2022.

Our primary distribution facilities are located in the U.S., Belgium, Switzerland, United Kingdom, P.R.C., Japan, Italy, Korea, India, Australia and Brazil.

Russia's Invasion of Ukraine

The Company has historically sold products to customers located in or associated with Russia and Belarus.

In response to Russia's invasion of Ukraine, the United States, the United Kingdom, the European Union, Switzerland and others have implemented sanctions and export controls targeting Russia and Belarus and entities associated with those countries, which significantly limits our ability to sell certain products, serve certain customers and collect on our outstanding receivables in those countries.

In April of 2022, we decided to suspend sales into Russia and Belarus indefinitely.

Sales to Russia and Belarus accounted for approximately 1.5% of our 2021 net sales and were not material for 2022.

In connection with the effect of these sanctions and export controls, we recognized $3 million of allowances for credit losses on customer receivables in Russia in 2022.

The duration and extent to which trade sanctions against Russia and Belarus affect the Company's business will depend on future developments, which still remain uncertain.

Supply Chain and Inflation

In 2022, the Company experienced logistical and production constraints due to limited raw material and component availability, reduced freight capacity, shipping delays, labor shortages and other supply chain disruptions.

These supply chain disruptions have increased the Company's product costs and extended lead times.

The Company has undertaken steps to mitigate these impacts, including implementing interim price increases, maintaining higher inventory levels,

qualifying additional suppliers and making strategic component purchases.

While freight capacity and shipping delays improved by the end of 2022, we expect these other challenges to continue into 2023.

In connection with the supply chain disruptions described above, the Company has also experienced the effects of inflation related to raw materials, components and other expenses, including freight, labor and energy.

In 2022, the cost of raw materials and components was significantly higher compared to the cost of raw materials and components in 2021.

We expect cost increases from purchases of raw materials and components to moderate in 2023.

The supply chain disruptions and associated effects of inflation have adversely impacted profitability in the near-term and limited our ability to satisfy customer demand.

To the extent our pricing actions are unable to offset these supply chain disruptions and effects of inflation, our profitability could continue to be adversely impacted in 2023.

Results of Operations

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Diluted Net Earnings per Common Share, adjusted $ 2.63 $ 2.44

(1) Excludes impacts of pension settlement loss, prior year impairment, excess tax benefits from stock option exercises and certain non-recurring income tax provision adjustments.

See adjusted financial results below for a reconciliation of the adjusted non-GAAP financial measures to GAAP.

Multiple events in the last two years caused significant fluctuations in financial results.

Other expense for 2021 included a $12 million non-cash pension settlement loss.

In 2020, operating expenses included $35 million of non-cash impairment charges related to the sale of the Company's U.K.-based valve business (Alco).

(1) Excludes impacts of excess tax benefits from stock option exercises, prior year non-recurring tax provision adjustments and a prior year pension settlement loss.

See Financial Results Adjusted for Comparability below for a reconciliation of adjusted non-GAAP financial measures to GAAP.

Multiple events in the last two years caused fluctuations in financial results.

Excess tax benefits related to stock option exercises reduced income taxes by $5 million in 2022 and $12 million in 2021.

Other benefits from tax planning activities further reduced income taxes in 2021 and 2020.

Other expense for 2021 included a $12 million non-cash pension settlement loss.

Other benefits from tax planning activities further reduced income taxes in 2021.

Excluding the impacts of those items presents a more consistent basis for comparison of financial results.

A calculation of the non-GAAP measurements of adjusted operating earnings, earnings before income taxes, income taxes, effective income tax rates, net earnings and diluted earnings per share follows (in millions except per share amounts):

Operating earnings, as reported $ 531.3 $ 391.7

Impairment — 35.2

Operating earnings, adjusted $ 531.3 $ 426.9

A calculation of the non-GAAP measurements of earnings before income taxes, income taxes, effective income tax rates, net earnings and diluted earnings per share follows (in millions except per share amounts):

Earnings before income taxes, as reported $ 565.7 $ 508.5

Impairment — 35.2

Pension settlement loss — 12.0

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Income taxes, as reported $ 105.1 $ 68.6

Impairment tax benefit — 1.2

Pension settlement tax effect — 2.5

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Net Earnings, as reported $ 460.6 $ 439.9

Impairment, net — 34.0

Pension settlement loss, net — 9.5

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General and administrative 7.2 7.6

Impairment — 2.1

Operating earnings 26.7 26.7

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

Volume and Price Acquisitions/Divestitures Currency Total Volume and Price Acquisitions/Divestitures Currency Total

Volume and Price Acquisitions Currency Total Volume and Price Acquisitions/Divestitures Currency Total

Americas 11% 1% (1)% 11% 15% 0% 0% 15%

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Consolidated 11% 1% (4)% 8% 19% 0% 1% 20%

Improved global economic conditions drove a double-digit percentage increase in sales in 2021.

Sales growth was notably strong in the P.R.C.

and Western Europe.

Sales in the Americas were up solidly again in 2022, as economic conditions in North America remained broadly favorable.

Sales growth in EMEA varied between products and countries in 2022, as the region experienced unfavorable geopolitical conditions.

Solid sales growth to customers in Western Europe and emerging countries was partially offset by fewer sales to customers in Russia and Belarus.

Sales growth in Asia Pacific was more broadly based across products and countries, as pandemic-related restrictions eased in 2022 compared to 2021.

There were 52 weeks in 2022, compared to 53 weeks in 2021.

Gross profit margin rate for 2021 increased slightly compared to 2020, as increased volume, realized pricing and favorable changes in currency translation rates were able to offset higher product costs due to supply chain disruptions and the effects of inflation.

Gross profit margin rate for 2022 decreased approximately 3 percentage points compared to 2021, as realized pricing was unable to offset higher product costs and the adverse impacts of changes in currency translation rates.

Operating Expenses

Total operating expenses for 2021 were $39 million higher than 2020, including the non-cash impairment charge of $35 million in 2020.

Excluding the impairment charge, total operating expenses for 2021 increased $75 million.

This increase includes $29 million of increases in sales and earnings-based expenses, $5 million related to foreign currency translation, and other volume and rate-related increases as pandemic-related restrictions eased in 2021 compared to 2020.

Investment in new product development was $80 million in 2021, up 10 percent over 2020.

Total operating expenses for 2022 decreased $18 million compared to 2021.

Reductions of $16 million from lower sales and earnings-based expenses and $14 million from the impact of currency translation were partially offset by $3 million of allowances for credit losses on customer receivables in Russia and volume and rate related increases.

Investment in new product development in 2022 was $80 million, approximately 4 percent of sales.

Operating Earnings

Operating earnings as a percentage of sales were 3 percentage points higher than 2020.

Excluding the prior year non-cash impairment charge, operating earnings as a percentage of sales increased 1 percentage point primarily due to the effects of higher gross margin.

Sales growth led to an 8 percent increase in operating earnings.

Operating earnings as a percentage of sales in 2022 was flat compared to 2021 as higher product costs and unfavorable changes in currency translation rates were offset by lower sales and earnings-based costs and the effects of expense leverage.

Other Expense

Other expense for 2021 included a non-cash pension settlement loss of $12 million in connection with the transfer of certain pension obligations to an insurance company.

Other expense increased $7 million for 2021 as favorable market valuation changes on investments held to fund certain retirement benefits liabilities partially offset the pension settlement loss.

The effective income tax rate for 2021 was 13 percent, up 1 percentage point from 2020.

The increase was primarily due to a decrease in excess tax benefits from stock option exercises partially offset by increased foreign-related tax benefits.

Other expense decreased $16 million for 2022.

Other expense in 2021 included a non-cash pension settlement loss of $12 million in connection with the transfer of certain pension obligations to an insurance company.

Increased investment income in 2022 further reduced other expense by $4 million.

The effective income tax rate for 2022 was 19 percent, up 6 percentage points from 2021.

The increase was due to non-recurring foreign-related tax benefits in 2021, a decrease in excess tax benefits from stock option exercises and the unfavorable effects of foreign earnings taxed at higher rates than the U.S.

Segment Results

The Company has six operating segments which are aggregated into three reportable segments:

Industrial, Process and Contractor.

The Company has five operating segments which are aggregated into three reportable segments:

Contractor, Industrial and Process.

Refer to Part I Item 1.

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The following table presents net sales and operating earnings by reporting segment (in millions):

Contractor $ 999.1 $ 987.6

Industrial 649.3 602.4

Process 495.1 397.6

Contractor 749.7 646.3

Total $ 2,143.5 $ 1,987.6

Operating Earnings

Contractor $ 249.9 $ 266.2

Industrial 231.3 199.8

Process 122.3 91.0

Contractor 169.5 164.5

Unallocated corporate (expense) (1)

(30.8) (25.7)

Impairment $ — $ (35.2)

Total $ 572.7 $ 531.3

(1) Unallocated corporate (expense) includes such items as stock compensation, certain acquisition transaction items, bad debt expense, charitable contributions, and certain facility expenses.

Industrial Segment

The following table presents net sales and operating earnings as a percentage of sales for the Industrial segment (dollars in millions):

Contractor Segment

The following table presents net sales and operating earnings as a percentage of sales for the Contractor segment (dollars in millions):

Americas $ 739.1 $ 694.1

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Operating Earnings as a Percentage of Sales 25 % 27 %

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

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

Volume and Price Acquisitions Currency Total Volume and Price Acquisitions Currency Total

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Segment Total 4% 0% (3)% 1% 15% 1% 1% 17%

Improved worldwide economic activity drove Industrial segment sales higher for 2021, particularly in general industry, construction, automotive, electrical equipment and alternative energy end markets.

For 2021, the operating margin rate increased as higher production volume, favorable product and channel mix and realized pricing were able to offset the adverse impacts of higher product costs.

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 Swiss franc, the Canadian dollar, the Chinese renminbi and various other Asian currencies.

Process Segment

The following table presents net sales and operating earnings as a percentage of sales for the Process segment (dollars in millions):

Contractor segment sales growth slowed in 2022, as the on-going favorable construction market environment in North America moderated due to increases in interest rates and lower levels of new construction activity.

The operating margin rate decreased 2 percentage points in 2022 primarily due to higher product costs and the adverse impacts of currency translation.

Sales in the Americas represents the substantial majority of sales for the Contractor segment.

Management regularly reviews economic and financial indicators in North America, including levels of residential, commercial and institutional 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 and other currencies.

Industrial Segment

The following table presents net sales and operating earnings as a percentage of sales for the Industrial segment (dollars in millions):

Americas $ 239.3 $ 213.4

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Operating Earnings as a Percentage of Sales 36 % 33 %

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

Volume and Price Acquisitions/Divestitures Currency Total Volume and Price Acquisitions/Divestitures Currency Total

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

Volume and Price Acquisitions Currency Total Volume and Price Acquisitions Currency Total

Americas 13% 0% (1)% 12% 24% 0% 1% 25%

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Segment Total 14% 0% (6)% 8% 22% 0% 3% 25%

The Process segment had organic sales growth in all product applications in 2021, reflecting favorable conditions in many end markets, such as vehicle services, industrial pumps, industrial lubrication, semi-conductors and mining.

Operating margin rates for this segment improved by 3 percentage points for 2021, as increased production volume and expense leverage more than offset the adverse effects of higher product costs and increased sales and earnings-based expenses.

Although the Americas represent the substantial majority of sales for the Process segment, and indicators in that region are the most significant, management monitors indicators such as levels of gross domestic product, capital investment, industrial production, oil and natural gas markets and mining activity worldwide.

Contractor Segment

The following table presents net sales and operating earnings as a percentage of sales for the Contractor segment (dollars in millions):

The Industrial segment experienced solid sales growth in all regions for the year.

Generally favorable economic activity across many end markets, including general industry, automotive, electrical equipment and alternative energy drove demand in all regions.

Finishing system sales contributed to sales growth in the Americas and EMEA, while improvement in automotive end markets contributed to sales growth in Asia Pacific.

The operating margin rate increased for the year as strong realized pricing and expense leverage more than offset higher product costs and the adverse impacts of currency translation.

dollar versus the euro, the Swiss franc, the Canadian dollar, the Chinese renminbi and various other Asian currencies.

Process Segment

The following table presents net sales and operating earnings as a percentage of sales for the Process segment (dollars in millions):

Americas $ 303.5 $ 242.7

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Operating Earnings as a Percentage of Sales 25 % 23 %

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

Volume and Price Acquisitions Currency Total Volume and Price Acquisitions Currency Total

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

Volume and Price Acquisitions Currency Total Volume and Price Acquisitions/Divestitures Currency Total

Americas 22% 3% 0% 25% 17% 0% 1% 18%

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Segment Total 25% 2% (2)% 25% 23% (3)% 2% 22%

Contractor segment sales increased for the quarter and year due to continued strength in North American construction markets and improved demand in the EMEA and Asia Pacific regions.

Higher product costs due to supply chain and inflationary challenges led to a 2 percentage point decrease in operating margin for 2021.

In this segment, sales in all regions are significant and management reviews economic and financial indicators in each region, including levels of residential, commercial and institutional 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 and other currencies.

The Process segment had double-digit sales growth in all product applications in 2022, reflecting favorable conditions in many end markets, such as vehicle services, industrial pumps, oil and gas, mining, industrial lubrication and semi-conductors.

Sales from acquired operations contributed approximately $9 million of growth in the Process segment.

The operating margin rate for this segment increased 2 percentage points for the year as increased volume and expense leverage offset higher product costs and the adverse impacts of currency translation.

Financial Condition and Cash Flow

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Inventory turnover (LIFO) 2.5 2.8

Higher cash and cash equivalent balances primarily drove the increases in working capital in 2021.

The current ratio decreased primarily due to a change in classification of a debt obligation from long-term to current.

The debt obligation was repaid subsequent to December 31, 2021 (See Note F , Debt).

Increases in accounts receivable were consistent with higher sales levels and inventories increased to meet higher demand and service levels.

Lower cash and cash equivalent balances primarily drove decreases in working capital in 2022.

receivables were consistent with higher sales levels.

Inventories increased to meet higher demand and service levels and to accommodate for disruptions in the supply chain.

The current ratio increased in 2022 due to increases in receivables and inventories as well as lower sales and earnings based accruals.

The repayment of a current debt obligation in 2022 partially offset the increase in the current ratio.

Capital Structure.

At December 31, 2021, the Company’s capital structure included current notes payable of $43 million, long-term debt, including current portion, of $150 million and shareholders’ equity of $1,709 million.

At December 30, 2022, the Company’s capital structure included current notes payable of $21 million, long-term debt of $75 million and shareholders’ equity of $1,860 million.

Shareholders’ equity increased by $150 million in 2022.

The increase from current year earnings of $440 million was offset by dividends of $131 million and restricted stock issuances of $2 million.

The increase from current year earnings of $461 million was offset by share repurchases of $233 million and dividends of $146 million.

Increases related to shares issued, stock compensation and other comprehensive income totaled $69 million.

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The Company has no significant off-balance sheet debt or other unrecorded obligations.

The Company believes it has the ability to meet its long-term cash requirements by using available cash and internally generated funds and to borrow under its committed and uncommitted credit facilities.

In December 2022, the Board of Directors increased the Company’s regular quarterly dividend to $0.235 from $0.21 per share, an increase of 12 percent.

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Cash Flows From Operating Activities .

Net cash provided by operating activities was $457 million in 2021, up $63 million compared to 2020.

The impact of the increase in net earnings in 2021 was partially offset by increases in working capital that reflect growth in business activity.

Net cash provided by operating activities was $377 million in 2022, down $80 million compared to 2021.

The impact of the increase in net earnings in 2022 was offset by increases in working capital that reflect growth in business activity.

Cash Flows Used in Investing Activities.

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Cash Flows Used in Financing Activities .

Cash flows used in financing activities totaled $434 million in 2022 and included share repurchases of $233 million (partially offset by net proceeds from share issuances of $36 million), dividends of $142 million, and net payments on long-term debt and outstanding lines of credit of $93 million.

Cash flows used in financing activities totaled $57 million in 2021 and included dividends of $127 million and net proceeds from share issuances totaling $51 million.

Cash flows used in financing activities totaled $139 million in 2020 and included dividends of $117 million and net payments from share repurchases and issuances totaling $21 million.

On April 24, 2015, the Board of Directors authorized the purchase of up to 18 million shares of common stock, primarily through open market transactions.

There were approximately 3.3 million shares remaining under the authorization on December 7, 2018, when the Board of Directors authorized the purchase of up to an additional 18 million shares.

The authorizations are for an indefinite period of time or until terminated by the Board.

As of December 31, 2021, approximately 18.5 million shares remain available for purchase under the authorizations.

The Company did not repurchase and retire shares in 2021, compared to 2.3 million shares that were repurchased and retired in 2020.

On December 7, 2018, the Board of Directors authorized the purchase of up to 18 million shares of common stock, primarily through open market transactions.

The authorization is for an indefinite period of time or until terminated by the Board.

As of December 30, 2022, approximately 15 million shares remain available for purchase under the authorization.

The Company repurchased and retired 3.6 million shares in 2022.

The Company did not repurchase and retire shares in 2021, and repurchased and retired 2.3 million shares in 2020.

The Company has made and may continue to make opportunistic share repurchases in 2023 via open market transactions or short-dated accelerated share repurchase (“ASR”) programs.

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For 2023, the Company will use an investment return assumption of 7.60 percent for the funded U.S.

plan, down 0.05 percentage points from the rate assumed for 2021.

plan, up 1.35 percentage points from the rate assumed for 2022.

Mortality rates are based on current common group mortality tables for males and females.

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In 2022, we completed our annual impairment testing of goodwill and other intangible assets in the fourth quarter.

No impairment charges were recorded as a result of that review.

No impairment charges were recorded as a result of that test.

Income Taxes.

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis