GRACO INC

The Company has five operating segments which are aggregated into three reportable segments: Contractor, Industrial and Process. Refer to Part I Item 1. Business, for a description of the Company’s three reportable segments. Management assesses performance of segments by reference to operating earnings excluding unallocated corporate expenses and asset impairments.

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

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

Contractor Segment

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

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

Contractor segment sales decreased 1 percent for the year. Favorable response to new product offerings was more than offset for the year by slower economic activity in worldwide construction markets. The operating margin rate for this segment improved 4 percentage points for the year. Realized pricing drove most of the improvement in the operating margin rate for the year.

Sales in the Americas represents the majority of sales for the Contractor segment. Management regularly reviews economic and financial indicators for 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):

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

Industrial segment sales increased 2 percent for the year as continued strength in the automotive, industrial and machinery end markets in the Americas was mostly offset by lower finishing system sales in EMEA and Asia Pacific. The operating margin rate for this segment decreased 1 percentage point for the year as realized pricing and lower product costs were offset by unfavorable changes in currency translation rates and higher operating expenses.

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):

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

Process segment sales increased in all businesses and regions for the year, reflecting continued favorable conditions in many end markets, such as vehicle services, industrial pumps, oil and gas, mining, industrial lubrication and semi-conductors. The operating margin rate for this segment increased 5 percentage points for the year, primarily due to realized pricing, lower product costs and expense leverage.

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