Exhibit 10.4

GRACO INC.

Nonemployee Director Stock Option Plan

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THIS DOCUMENT CONSTITUTES PART OF A PROSPECTUS COVERING SECURITIES THAT HAVE
BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933.

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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.

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June 18, 2004

GRACO INC. NONEMPLOYEE DIRECTOR STOCK OPTION PLAN

1.

Purpose

 

The purpose of the Graco Inc. Nonemployee Director Stock Option Plan (the
“Plan”) is to secure for Graco Inc. (the “Company”) and its shareholders the
benefits of the long-term incentives inherent in increased common stock
ownership by the members of the Board of Directors (the “Board”) of the Company
who are not employees of the Company or its Affiliates, by strengthening the
identification of Nonemployee Directors with the interests of all Graco
shareholders.

2.

Definitions

 

The terms defined in this Section 2 shall have the following meanings, unless
the context otherwise requires.

  a.

Affiliate shall mean any corporation, partnership, joint venture or other entity
in which the Company holds an equity, profit or voting interest of more than
fifty percent (50%).

  b.

Annual Meeting of Shareholders shall mean the annual meeting of shareholders of
the Company held each calendar year.

  c.

Code shall mean the Internal Revenue Code of 1986, as amended to date and as it
may be amended from time to time.

  d.

Company shall mean Graco Inc., a Minnesota corporation.

  e.

ERISA shall mean the Employee Retirement Income Security Act of 1974, as amended
to date and as it may be amended from time to time.

  f.

Fair Market Value per Share shall mean as of any day

  (1)

The fair market value of a share of the Company’s common stock is the last sale
price reported on the composite tape by the New York Stock Exchange on the
business day immediately preceding the date as of which fair market value is
being determined or, if there were no sales of shares of the Company’s common
stock reported on the composite tape on such day, on the most recently preceding
day on which there were sales, or

  (2)

if the shares of the Company’s stock are not listed or admitted to trading on
the New York Stock Exchange on the day as of which the determination is made,
the amount determined by the Board or its delegate to be the fair market value
of a share on such day.

  g.

Nonemployee Director shall mean a member of the Board of Directors of the
Company who is not also an officer or other employee of the Company or an
Affiliate.

  h.

Nonstatutory Stock Option (“NSO”) shall mean a stock option, which does not
qualify for special tax treatment under Sections 421 or 422 of the Internal
Revenue Code.

  i.

Option shall mean either a First Option or an Annual Option granted pursuant to
the provisions of Section 4 of this Plan.

  j.

Participant shall mean any person who holds an Option granted under this Plan.

  k.

Plan shall mean this Graco Inc. Nonemployee Director Stock Option Plan.

3.

Administration

  a.

The Plan shall be administered by the Board. The Board may, by resolution,
delegate part or all of its administrative powers with respect to the Plan.

  b.

The Board shall have all of the powers vested in it by the terms of the Plan,
such powers to include the authority, within the limits prescribed herein, to
establish the form of the agreement embodying grants of Options made under the
Plan.

  c.

The Board shall, subject to the provisions of the Plan, have the power to
construe the Plan, to determine all questions arising thereunder and to adopt
and amend such rules and regulations for the administration of the Plan as it
may deem desirable, such administrative decisions of the Board to be final and
conclusive.

  d.

The Board shall have no discretion to select the Nonemployee Directors to
receive Option grants under the Plan, to determine the number of shares of the
Company’s common stock subject to the Plan or to each grant, nor the exercise
price of the Options granted pursuant to the Plan.

  e.

The Board may authorize any one or more of their number or the Secretary or any
other officer of the Company to execute and deliver documents on behalf of the
Board. The Board hereby authorizes the Secretary to execute and deliver all
documents to be delivered by the Board pursuant to the Plan.

  f.

The expenses of the Plan shall be borne by the Company.

4.

Automatic Grants to Nonemployee Directors

  a.

As of the day upon which shareholders vote to elect directors at each annual
meeting of the Company, each Nonemployee Director of the Board shall be granted
an option to purchase two thousand five hundred (2,500) shares of the Company’s
common stock under the Plan (the “Annual Option”); and a Nonemployee Director
who has not previously been elected as a member of the Board of Directors of the
Company shall be granted a First Option; i.e., an option to purchase three
thousand (3,000) shares of the Company’s common stock under the Plan, on the
first business day of the Nonemployee Director’s election to the Board,
including election by the Board of Directors to fill a vacancy on the Board.

  b.

The automatic grants to Nonemployee Directors shall not be subject to the
discretion of any person.

  c.

Each Option granted under the Plan shall be evidenced by a written Agreement.
Each Agreement shall be subject to, and incorporate, by reference or otherwise,
the applicable terms of this Plan.

  d.

During the lifetime of a Participant, each Option shall be exercisable only by
the Participant. No Option granted under the Plan shall be assignable or
transferable by the Participant, except by will or by the laws of descent and
distribution.

5.

Shares of Stock Subject to the Plan

  a.

Subject to adjustment as provided in Section 11 of the Plan, an aggregate of
four hundred fifty thousand (450,000) shares of the Company’s common stock,
$1.00 par value, shall be available for issuance to Nonemployee Directors under
the Plan. No fractional shares shall be issued.

  b.

First Option Grants and Annual Option Grants shall reduce the shares available
for issuance under the Plan by the number of shares subject thereto. The shares
deliverable upon exercise of any First Option Grant or Annual Option Grant may
be made available from authorized but unissued shares or shares reacquired by
the Company, including shares purchased in the open market or in private
transactions. If any unexercised First Option Grant or Annual Option Grant shall
terminate for any reason, the shares subject to, but not delivered under, such
First Option Grant or Annual Option Grant shall be available for other First
Option Grants or Annual Option Grants.

6.

Nonstatutory Options.

  a.

All Options granted to Nonemployee Directors pursuant to the Plan shall be NSOs.

7.

Exercise Price.

  a.

The price per share of the shares of the Company’s common stock which may be
purchased upon exercise of an Option (“Exercise Price”) shall be one hundred
percent (100%) of the Fair Market Value per Share on the date the Option is
granted and shall be payable in full at the time the Option is exercised as
follows:

  (1)

in cash or by certified 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, or

  (3)

by delivery to the 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.

  b.

Such price shall be subject to adjustment as provided in Section 11 hereof.

8.

Duration and Vesting of Options.

  a.

The term of each Option granted to a Nonemployee Director shall be for ten (10)
years from the date of grant, unless terminated earlier pursuant to the
provisions of Section 10 hereof.

  b.

Each Option shall vest and become exercisable according to the following
schedule:

  (1)

twenty-five percent (25%) of the total number of shares covered by the Option
shall become exercisable beginning with the first anniversary date of the grant
of the Option;

  (2)

thereafter twenty-five percent (25%) of the total number of shares covered by
the Option shall become exercisable on each subsequent anniversary date of the
grant of the Option until the fourth anniversary date of the grant of the Option
upon which the total number of shares covered by Option shall become
exercisable.

9.

Change of Control

  a.

Notwithstanding Section 8b(1) and (2) hereof, all outstanding Options not yet
exercisable 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 their 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 9, 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 subsection (4) below; 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 subsection a(1) of
this Section 9 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 subsections (4) or (5) of this section by a group,
acting in concert, that includes that Nonemployee Director.

10.

Effect of Termination of Membership on the Board.

  a.

The right to exercise an Option granted to a Nonemployee Director shall be
limited as follows, provided the actual date of exercise is in no event after
the expiration of the term of the Option:

  (1)

If a Nonemployee Director ceases being a director of the Company for any reason
other than the reasons identified in subparagraph (2) of this Section 10, the
Nonemployee Director shall have the right to exercise the Options as follows,
subject to the condition that no Option shall be exercisable after the
expiration of the term of the Option:

  (a)

If the Nonemployee Director was a member of the Board of Directors of the
Company for five (5) or more years, all outstanding Options become immediately
exercisable upon the date the Nonemployee Director ceases being a director. The
Nonemployee Director may exercise the Options for a period of thirty-six months
(36) from the date the Nonemployee Director ceased being a director, provided
that if the Nonemployee Director dies before the thirty-six (36) month period
has expired, the Options may be exercised by the Nonemployee Director’s legal
representative or any person who acquires the right to exercise an Option by
reason of the Nonemployee Director’s death for a period of twelve (12) months
from the date of the Nonemployee Director’s death.

  (b)

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
Options, to the extent they were 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 Options may be exercised by the Nonemployee Director’s legal
representative, or any person who acquires the right to exercise an Option by
reason of the Nonemployee Director’s death, for a period of twelve (12) months
from the date of the Nonemployee Director’s death.

  (c)

If the Nonemployee Director dies while a member of the Board, the Options, to
the extent exercisable by the Nonemployee Director at the date of death, may be
exercised by the Nonemployee Director’s legal representative, or any person who
acquires the right to exercise an Option by reason of the Nonemployee Director’s
death, for a period of twelve (12) months from the date of the Nonemployee
Director’s death.

  (d)

In the event any Option is exercised by the executors, administrators, legatees,
or distributees of the estate of a deceased optionee, the Company shall be under
no obligation to issue stock thereunder unless and until the Company is
satisfied that the person or persons exercising the Option are the duly
appointed legal representatives of the deceased optionee’s estate or the proper
legatees or distributees thereof.

  (2)

If a Nonemployee Director ceases being a director of the Company due to an act
of

  (a)

fraud or intentional misrepresentation or

  (b)

embezzlement, misappropriation or conversion of assets or opportunities of the
Company or any Affiliate of the Company or

  (c)

any other gross or willful misconduct

 

as determined by the Board, in its sole and conclusive discretion, all Options
granted to such Nonemployee Director shall immediately be forfeited as of the
date of the misconduct.

11.

Adjustments and Changes in the Stock

  a.

If there is any change in the common stock of the Company by reason of any stock
dividend, stock split, spin-off, split-up, merger, consolidation,
recapitalization, reclassification, combination or exchange of shares, or any
other similar corporate event, the aggregate number of shares available under
the Plan, and the number and the price of shares of common stock subject to
outstanding Options, shall be appropriately adjusted automatically.

  b.

No right to purchase fractional shares shall result from any adjustment in
Options pursuant to this Section 11. In case of any such adjustment, the shares
subject to the Option shall be rounded down to the nearest whole share.

  c.

Notice of any adjustment shall be given by the Company to each holder of any
Option which shall have been so adjusted and such adjustment (whether or not
such notice is given) shall be effective and binding for all purposes of the
Plan.

12.

Effective Date of the Plan

  a.

The Plan shall become effective on the date it is approved by the shareholders
of the Company.

  b.

Any amendment to the Plan shall become effective when adopted by the Board,
unless specified otherwise, but no Option granted under any increase in shares
authorized to be issued under this Plan shall be exercisable until the increase
is approved in the manner prescribed in Section 13 of this Plan.

13.

Amendment of the Plan

  a.

The Board of Directors may amend, suspend or terminate the Plan at any time, but
without shareholder approval, no amendment shall materially increase the maximum
number of shares which may be issued under the Plan (other than adjustments
pursuant to Section 11 hereof), materially increase the benefits accruing to
Participants under the Plan, materially modify the requirements as to
eligibility for participation or extend the term of the Plan. Approval of the
shareholders may be obtained, at a meeting of shareholders duly called and held,
by the affirmative vote of a majority of the holders of the Company’s voting
stock who are present or represented by proxy and are entitled to vote on the
Plan.

  b.

It is intended that the Plan meet the requirements of Rule 16b-3 or any
successor thereto promulgated by the Securities and Exchange Commission under
the Securities Exchange Act of 1934, as amended, including any applicable
requirements regarding shareholder approval. Amendments to the Plan shall be
subject to approval by the shareholders of the Company to the extent determined
by the Board of Directors to be necessary to satisfy such requirements as in
effect from time to time.

  c.

Rights and obligations under any Option granted before any amendment of this
Plan shall not be materially and adversely affected by amendment of the Plan,
except with the consent of the person who holds the Option, which consent may be
obtained in any manner that the Board or its delegate deems appropriate.

14.

Termination of the Plan

  a.

The Plan, unless sooner terminated, shall terminate at the end of ten (10) years
from the date the Plan is approved by the shareholders of the Company. No Option
may be granted under the Plan while the Plan is suspended or after it is
terminated.

  b.

Rights or obligations under any Option granted while the Plan is in effect,
including the maximum duration and vesting provisions, shall not be altered or
impaired by suspension or termination of the Plan, except with the consent of
the person who holds the Option, which consent may be obtained in any manner
that the Board or its delegate deems appropriate.

15.

Registration, Listing, Qualification, Approval of Stock and Options

  a.

If the Board shall determine, in its discretion, that it is necessary or
desirable that the shares of common stock subject to any Option

  (1)

be registered, listed or qualified on any securities exchange or under any
applicable law, or

  (2)

be approved by any governmental regulatory body, or

 

        (3)     approved by the shareholders of the Company,

 

as a condition of, or in connection with, the granting of such Option, or the
issuance or purchase of shares upon exercise of the Option, the Option may not
be exercised in whole or in part unless such registration, listing,
qualification or approval has been obtained free of any condition not acceptable
to the Board of Directors.

16.

No Right to Option or as Shareholder

  a.

No Nonemployee Director or other person shall have any claim or right to be
granted an Option under the Plan, except as expressly provided herein. Neither
the Plan nor any action taken hereunder shall be construed as giving any
Nonemployee Director any right to be retained in the service of the Company.

  b.

Neither a Nonemployee Director, the Nonemployee Director’s legal representative,
nor any person who acquires the right to exercise an Option by reason of the
Nonemployee Director’s death 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 any Option granted under this Plan, in whole or
in part, unless and until, either (i) an entry reflecting the issuance of the
common shares to the recipient is made on the books of the Company (or its
transfer agent), or (ii) a certificate or certificates representing the common
shares is issued to the recipient.

17.

Governing Law

 

The validity, construction, interpretation, administration and effect of this
Plan and any rules, regulations and actions relating to this Plan will be
governed by and construed exclusively in accordance with the laws of the State
of Minnesota.