Business context and reporting period
Graco Inc. designs and manufactures equipment for moving, measuring, controlling, dispensing and spraying fluids and coatings. This Form 10-K covers the 52-week fiscal year ended December 28, 2018; quarterly figures below are unaudited. Its worldwide reportable segments are Industrial, Process and Contractor. Approximately 51% of sales were to customers outside the United States.
Financial performance and key metrics
| Metric | FY 2018 | FY 2017 |
|---|---|---|
| Net sales | $1,653.3 million | $1,474.7 million |
| Operating earnings | $436.4 million | $378.7 million |
| Net earnings | $341.1 million | $252.4 million |
| Diluted EPS | $1.97 | $1.45 |
| Gross margin | 53.4% | 53.9% |
| Operating margin | 26.4% | 25.7% |
| Net margin | 20.6% | 17.1% |
| Operating cash flow | $368.0 million | $337.9 million |
For Q4 2018, sales were $406.4 million versus $374.9 million in Q4 2017, up about 8%. Net earnings were $73.7 million versus $36.4 million; diluted EPS was $0.43 versus $0.21. Q4 gross margin was approximately 51.4%, compared with 53.6% a year earlier.
Annual sales increased 12%, driven by 8% volume and price, 3% acquisitions and 1% currency. Segment sales and operating margins: Industrial, $781.0 million and 35% (up from 34%); Process, $338.0 million and 20% (up from 18%); Contractor, $534.3 million and 23% (unchanged). Sales grew in all three segments.
Cash and cash equivalents were $132.1 million at year-end. Total debt was $277.5 million, including $266.4 million long-term debt and $11.1 million of notes payable; shareholders’ equity was $751.9 million. Working capital was $423.4 million and the current ratio was 2.4. The company had $518 million of unused committed credit. Capital expenditures were $53.9 million; share repurchases were $244.8 million and cash dividends paid were $88.8 million.
Material changes versus the prior comparable period
- Sales rose 12% and operating earnings rose 15% year over year. Adjusted net earnings, a non-GAAP measure, increased to $326.1 million from $249.4 million; adjusted diluted EPS rose to $1.88 from $1.43.
- Reported net earnings benefited from the lower effective tax rate: 17% in 2018 versus 27% in 2017. The Tax Cuts and Jobs Act lowered the 2018 rate, and stock-option tax benefits and other tax items also affected comparability. Q4 2017 earnings included $36 million of tax-reform charges.
- Gross margin declined 0.5 percentage point, as lower acquired-business margins, higher factory spending and material costs outweighed pricing and currency benefits. Tariffs and input-cost pressure weighed on Contractor margins in the second half.
- Operating cash flow increased by about $30 million despite a voluntary $40 million pension contribution. The company repurchased 5.7 million shares in 2018, versus 2.6 million in 2017.
Outlook, risks and unusual items
Management forecast mid-single-digit 2019 sales growth on an organic, constant-currency basis, with growth expected in every region and segment. At January 2019 exchange rates, currency movements were expected to reduce 2019 sales by approximately 1% and net earnings by 3%, with the greatest effect in the first two quarters. Management’s long-term targets are 10% revenue growth and 12% consolidated net earnings growth. Backlog was not considered a reliable indicator of future business.
Management cited solid demand entering 2019, but noted reliance on successful product launches, distribution expansion, price realization and stable exchange rates. Risks include economic and end-market weakness, foreign currency movements, tariffs and commodity costs, global sourcing and supply interruptions, customer concentration, acquisitions and integration, cybersecurity, intellectual property, regulation and litigation. Sherwin-Williams represented more than 10% of consolidated sales in each of 2016–2018. The company reported no material unresolved legal proceedings and no impairment charges in 2018; the 2016 Oil and Natural Gas impairment was $192 million pre-tax.
Management expected 2019 capital expenditures of approximately $140–$150 million, planned dividends of about $106 million, and was considering potential early retirement of $75 million of notes due January 2020. The company was in compliance with debt covenants. Adoption of the lease accounting standard in 2019 was expected to record about $35 million of right-of-use assets and lease liabilities, with no notable liquidity or earnings impact anticipated.
Investor verification priorities
- Reconcile reported earnings growth with the lower tax rate and compare using the company’s non-GAAP adjusted figures.
- Assess whether organic sales growth and price realization can offset tariffs, material-cost pressures and the expected currency headwind.
- Review the substantial Q4 year-over-year earnings increase against the prior-year tax-reform charge and Q4 margin decline.
- Monitor share repurchases, planned capital spending, pension funding and the $75 million note maturity in 2020 relative to cash flow and debt.
- Evaluate customer concentration, particularly Sherwin-Williams, and performance of acquired businesses and their margins.