Exhibit 10.3

NONEMPLOYEE DIRECTOR
NONSTATUTORY STOCK OPTION AGREEMENT
(NSO)

        THIS AGREEMENT, made this ____ day of ______________, 2____ by and
between Graco Inc., a Minnesota corporation (the “Company”) and «NAME» (the
“Nonemployee Director”).

        WITNESSETH THAT:

        WHEREAS, the Company pursuant to the Graco Inc. Stock Incentive Plan
(the “Plan”) wishes to grant this stock option to Nonemployee Director.

        NOW THEREFORE, in consideration of the premises and of the mutual
covenants herein contained, the parties agree as follows:

1.

Grant of Option

 

The Company grants to Nonemployee Director, the right and option (the “Option”)
to purchase all or any part of an aggregate of «Shares» shares of Common Stock
of the Company, par value $1.00 per share, at the price of «Price» per share on
the terms and conditions set forth herein. This is a nonstatutory stock Option
which does not qualify for special tax treatment under Sections 421 or 422 of
the Internal Revenue Code.

2.

Duration and Exercisability

  A.

This Option may not be exercised by the Nonemployee Director until the
expiration of one (1) year from the date of grant, and this Option shall in all
events terminate ten (10) years after the date of grant. During the first year
from the date of grant of this Option, no portion of this Option may be
exercised. Thereafter this Option shall become exercisable in four cumulative
installments of 25% as follows:

 
Date Total Portion of Option
Which is Exercisable         One Year after Date of Grant 25%         Two Years
after Date of Grant 50%         Three Years after Date of Grant 75%         Four
Years after Date of Grant 100%

 

In the event that Nonemployee Director does not purchase in any one year the
full number of shares of Common Stock of the Company to which he/she is entitled
under this Option, he/she may, subject to the terms and conditions of Section 3
hereof, purchase such shares of Common Stock in any subsequent year during the
term of this Option.

  B.

During the lifetime of the Nonemployee Director, the Option shall be exercisable
only by him/her and shall not be assignable or transferable by him/her otherwise
than by will or the laws of descent and distribution.

  C.

Under no circumstances may the Option granted by this Agreement be exercised
after the term of the Option expires.

3.

Effect of Termination of Membership on the Board

  A.

In the event Nonemployee Director ceases being a director of the Company for any
reason other than the reasons identified in Section 3B below, the Nonemployee
Director shall have the right to exercise the Option as follows:

  (1)

If the Nonemployee Director was a member of the Board of Directors of the
Company for five (5) or more years, the portion of the Option not yet
exercisable shall become immediately exercisable upon the date the Nonemployee
Director ceases being a director. The Nonemployee Director may exercise all or
any portion of the Option not yet exercised for a period of three (3) years from
the date the Nonemployee Director ceased being a director, provided that if the
Nonemployee Director dies before the three (3) year period has expired, the
Option may be exercised by the executor(s) or administrator(s) of the
Nonemployee Director’s estate, or any person(s) to whom the Option was
transferred by will or the applicable laws of distribution and descent, at any
time during a period beginning on the day after the date of Nonemployee
Director’s death and ending at 5:00 p.m. Central Time on the anniversary of
death one (1) year later.

  (2)

If the Nonemployee Director was a member of the Board of Directors of the
Company for less than five (5) years, the Nonemployee Director may exercise the
Option, to the extent the Option was exercisable at the date the Nonemployee
Director ceases being a member of the Board, for a period of thirty (30) days
following the date the Nonemployee Director ceased being a director, provided
that, if the Nonemployee Director dies before the thirty (30) day period has
expired, the Option may be exercised by the executor(s) or administrator(s) of
the Nonemployee Director’s estate, or any person(s) to whom the Option was
transferred by will or the applicable laws of distribution and descent, at any
time during a period beginning on the day after the date of Nonemployee
Director’s death and ending at 5:00 p.m. Central Time on the anniversary of
death one (1) year later.

  (3)

If the Nonemployee Director dies while a member of the Board of Directors of the
Company, the Option, to the extent exercisable by the Nonemployee Director at
the date of death, may be exercised by the executor(s) or administrator(s) of
the Nonemployee Director’s estate, or any person(s) to whom the Option was
transferred by will or the applicable laws of distribution and descent, at any
time during a period beginning on the day after the date of Nonemployee
Director’s death and ending at 5:00 p.m. Central Time on the anniversary of
death one (1) year later.

  (4)

In the event the Option is exercised by the executors, administrators, legatees,
or distributees of the estate of the Nonemployee Director, the Company shall be
under no obligation to issue stock thereunder unless and until the Company is
satisfied that the person(s) exercising the Option is the duly appointed legal
representative of the Nonemployee Director’s estate or the proper legatee or
distributee thereof.

  B.

If a Nonemployee Director ceases being a director of the Company by reason of
Nonemployee Director’s gross and willful misconduct, including but not limited
to, (i) fraud or intentional misrepresentation; (ii) embezzlement,
misappropriation or conversion of assets or opportunities of the Company or any
affiliate of the Company; (iii) breach of fiduciary duty, or (iv) any other
gross or willful misconduct, as determined by the Board, in its sole and
conclusive discretion, the unexercised portion of the Option granted to such
Nonemployee Director shall immediately be forfeited as of the time of the
misconduct. If the Board determines subsequent to the time Nonemployee Director
ceases being a director of the Company for whatever reason, that Nonemployee
Director engaged in conduct while a member of the Board of Directors of the
Company that would constitute gross and willful misconduct, the Option shall
terminate as of the time of such misconduct. Furthermore, if the Option is
exercised in whole or in part and the Board thereafter determines that
Nonemployee Director engaged in gross and willful misconduct while a member of
the Board of Directors of the Company at any time prior to the date of such
exercise, the Option shall be deemed to have terminated as of the time of the
misconduct and the Company may elect to rescind the Option exercise.

4.

Manner of Exercise

  A.

Nonemployee Director or other proper party may exercise the Option only by
delivering within the term of the Option written notice to the Company at its
principal office in Minneapolis, Minnesota, stating the number of shares as to
which the Option is being exercised and, except as provided in Sections 4B(2)
and 4C, accompanied by payment in full of one hundred percent (100%) of the
Option price.

  B.

The Nonemployee Director may, at his/her election, pay the Option price as
follows:

  (1)

by cash or check (bank check, certified check, or personal check),

  (2)

by delivery of shares of Common Stock to the Company, which shall have been
owned for at least six (6) months and have a fair market value per share on the
date of surrender equal to the exercise price.

 

For purposes of Section 4B(2), the fair market value of the Company’s Common
Stock shall be the closing price of the Common Stock on the day immediately
preceding the date of exercise on the New York Stock Exchange (the “NYSE”) or on
the principal national securities exchange on which such shares are traded if
the shares are not then traded on the NYSE. If there is not a quotation
available for such day, then the closing price on the next preceding day for
which such a quotation exists shall be determinative of fair market value. If
the shares are not then traded on an exchange, the fair market value shall be
the average of the closing bid and asked prices of the Common Stock as reported
by the National Association of Securities Dealers Automated Quotation System. If
the Common Stock is not then traded on NASDAQ or on an exchange, then the fair
market value shall be determined in such manner as the Company shall deem
reasonable.

  C.

The Nonemployee Director may, with the consent of the Company, pay the Option
price by delivery to Company of a properly executed exercise notice, together
with irrevocable instructions to a broker to promptly deliver to the Company
from sale or loan proceeds the amount required to pay the exercise price.

5.

Change of Control

  A.

Notwithstanding Section 2A hereof, the entire Option shall become immediately
and fully exercisable on the day following a “Change of Control” and shall
remain fully exercisable until either exercised or expiring by its terms. A
“Change of Control” means:

  (1)

acquisition by any individual, entity, or group (within the meaning of Section
13(d)(3) or 14(d)(2) of the Exchange Act of 1934), (a “Person”), of beneficial
ownership (within the meaning of Rule 13d-3 under the 1934 Act) which results in
the beneficial ownership by such Person of 25% or more of either

  (a)

the then outstanding shares of Common Stock of the Company (the “Outstanding
Company Common Stock”) or

  (b)

the combined voting power of the then outstanding voting securities of the
Company entitled to vote generally in the election of directors (the
“Outstanding Company Voting Securities”);

 

provided, however, that the following acquisitions will not result in a Change
of Control:

  (i)

an acquisition directly from the Company,

  (ii)

an acquisition by the Company,

  (iii)

an acquisition by an employee benefit plan (or related trust) sponsored or
maintained by the Company or any corporation controlled by the Company,

  (iv)

an acquisition by any Person who is deemed to have beneficial ownership of the
Company Common Stock or other Company voting securities owned by the Trust Under
the Will of Clarissa L. Gray (“Trust Person”), provided that such acquisition
does not result in the beneficial ownership by such Person of 32% or more of
either the Outstanding Company Common Stock or the Outstanding Company Voting
Securities, and provided further that for purposes of this Section 5, a Trust
Person shall not be deemed to have beneficial ownership of the Company Common
Stock or other Company voting securities owned by The Graco Foundation or any
employee benefit plan of the Company, including, without limitations, the Graco
Employee Retirement Plan and the Graco Employee Stock Ownership Plan,

  (v)

an acquisition by the Nonemployee Director or any group that includes the
Nonemployee Director, or

  (vi)

an acquisition by any corporation pursuant to a transaction that complies with
clauses (a), (b), and (c) of Section 5A(4); and

 

provided, further, that if any Person’s beneficial ownership of the Outstanding
Company Common Stock or Outstanding Company Voting Securities is 25% or more as
a result of a transaction described in clause (i) or (ii) above, and such Person
subsequently acquires beneficial ownership of additional Outstanding Company
Common Stock or Outstanding Company Voting Securities as a result of a
transaction other than that described in clause (i) or (ii) above, such
subsequent acquisition will be treated as an acquisition that causes such Person
to own 25% or more of the Outstanding Company Common Stock or Outstanding
Company Voting Securities and be deemed a Change of Control; and provided
further, that in the event any acquisition or other transaction occurs which
results in the beneficial ownership of 32% or more of either the Outstanding
Company Common Stock or the Outstanding Company Voting Securities by any Trust
Person, the Incumbent Board may by majority vote increase the threshold
beneficial ownership percentage to a percentage above 32% for any Trust Person;
or

  (2)

Individuals who, as of the date hereof, constitute the Board of Directors of the
Company (the “Incumbent Board”) cease for any reason to constitute at least a
majority of said Board; provided, however, that any individual becoming a
director subsequent to the date hereof whose election, or nomination for
election by the Company’s shareholders, was approved by a vote of at least a
majority of the directors then comprising the Incumbent Board will be considered
as though such individual were a member of the Incumbent Board, but excluding,
for this purpose, any such individual whose initial membership on the Board
occurs as a result of an actual or threatened election contest with respect to
the election or removal of directors or other actual or threatened solicitation
of proxies or consents by or on behalf of a Person other than the Board; or

  (3)

The commencement or announcement of an intention to make a tender offer or
exchange offer, the consummation of which would result in the beneficial
ownership by a Person of 25% or more of the Outstanding Company Common Stock or
Outstanding Company Voting Securities; or

  (4)

The approval by the shareholders of the Company of a reorganization, merger,
consolidation, or statutory exchange of Outstanding Company Common Stock or
Outstanding Company Voting Securities or sale or other disposition of all or
substantially all of the assets of the Company (“Business Combination”) or, if
consummation of such Business Combination is subject, at the time of such
approval by stockholders, to the consent of any government or governmental
agency, the obtaining of such consent (either explicitly or implicitly by
consummation) excluding, however, such a Business combination pursuant to which

  (a)

all or substantially all of the individuals and entities who were the beneficial
owners of the Outstanding Company Common Stock or Outstanding Company Voting
Securities immediately prior to such Business Combination beneficially own,
directly or indirectly, more than 80% of, respectively, the then outstanding
shares of Common Stock and the combined voting power of the then outstanding
voting securities entitled to vote generally in the election of directors, as
the case may be, of the corporation resulting from such Business Combination
(including, without limitation, a corporation that as a result of such
transaction owns the Company or all or substantially all of the Company’s
assets, either directly or through one or more subsidiaries), in substantially
the same proportions as their ownership, immediately prior to such Business
Combination of the Outstanding Company Common Stock or Outstanding Company
Voting Securities,

  (b)

no Person [excluding any employee benefit plan (or related trust) of the Company
or such corporation resulting from such Business Combination] beneficially owns,
directly or indirectly, 25% or more of the then outstanding shares of Common
Stock of the corporation resulting from such Business Combination or the
combined voting power of the then outstanding voting securities of such
corporation except to the extent that such ownership existed prior to the
Business Combination, and

  (c)

at least a majority of the members of the board of directors of the corporation
resulting from such Business Combination were members of the Incumbent Board at
the time of the execution of the initial agreement, or of the action of the
Board, providing for such Business Combination; or

  (5)

approval by the stockholders of the Company of a complete liquidation or
dissolution of the Company.

  B.

A Change of Control shall not be deemed to have occurred with respect to a
Nonemployee Director if:

  (1)

the acquisition of the 25% or greater interest referred to in Section 5A(1) is
by a group, acting in concert, that includes the Nonemployee Director or

  (2)

if at least 25% of the then outstanding Common Stock or combined voting power of
the then outstanding Company voting securities (or voting equity interests) of
the surviving corporation or of any corporation (or other entity) acquiring all
or substantially all of the assets of the Company shall be beneficially owned,
directly or indirectly, immediately after a reorganization, merger,
consolidation, statutory share exchange, disposition of assets, liquidation or
dissolution referred to in Sections 5A(4) or 5A(5) by a group, acting in
concert, that includes that Nonemployee Director.

6.

Adjustments and Changes in the Stock

 

If there shall be any change in the number or character of the Common Stock of
the Company through merger, consolidation, reorganization, recapitalization,
dividend in the form of stock (of whatever amount), stock split or other change
in the corporate structure of the Company, and all or any portion of the Option
shall then be unexercised and not yet expired, appropriate adjustments in the
outstanding Option shall be made by the Company, in order to prevent dilution or
enlargement of Nonemployee Director’s Option rights. Such adjustments shall
include, where appropriate, changes in the number of shares of Common Stock and
the price per share subject to the outstanding Option.

7.

Miscellaneous

  A.

This Option is issued pursuant to the Plan and is subject to its terms. The
terms of the Plan are available for inspection during business hours at the
principal offices of the Company.

  B.

Neither the Plan nor any action taken hereunder shall be construed as giving
Nonemployee Director any right to be retained in the service of the Company.

  C.

Neither Nonemployee Director, the Nonemployee Director’s legal representative,
nor the executor(s) or administrator(s) of the Nonemployee Director’s estate, or
any person(s) to whom the Option was transferred by will or the applicable laws
of distribution and descent shall be, or have any of the rights or privileges
of, a shareholder of the Company in respect of any shares of Common Stock
receivable upon the exercise of this Option, in whole or in part, unless and
until such shares shall have been issued upon exercise of this Option.

  D.

The Company shall at all times during the term of the Option reserve and keep
available such number of shares as will be sufficient to satisfy the
requirements of this Agreement.

  E.

This Agreement will be governed by and constructed exclusively in accordance
with the laws of the State of Minnesota.

IN WITNESS WHEREOF, the parties have caused this Agreement to be executed on the
day and year first above written.

  GRACO INC.          

    By      

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Its Vice President, General Counsel
   and Secretary    

   

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<<NAME>>
Nonemployee Director