Business context and reporting period
Graco Inc. designs, manufactures and markets fluid-handling and spraying systems and equipment. This unaudited Form 10-Q covers the 13 and 26 weeks ended July 1, 2011, compared with periods ended June 25, 2010. Its reportable segments are Industrial, Contractor and Lubrication.
Financial performance
| Metric | Q2 2011 | Q2 2010 | First half 2011 | First half 2010 |
|---|---|---|---|---|
| Net sales | $234.7 million | $192.1 million | $452.3 million | $356.8 million |
| Gross profit | $132.4 million | $101.9 million | $256.8 million | $191.2 million |
| Operating earnings | $58.3 million | $39.2 million | $115.3 million | $71.9 million |
| Net earnings | $38.1 million | $24.8 million | $75.4 million | $45.4 million |
| Diluted EPS | $0.61 | $0.41 | $1.22 | $0.74 |
| Operating cash flow | Not presented for quarter | $43.9 million | $28.0 million |
- Q2 sales increased 22%, net earnings 53% and diluted EPS 49%; first-half sales rose 27%, net earnings 66% and diluted EPS 65% year over year.
- Gross margin was 56.5% in Q2 and 57% for the first half, each up 3 percentage points from the comparable 2010 period. Higher volume, favorable translation and pricing helped; higher material costs partly offset gains.
- All three segments grew. Q2 sales were Industrial $129.3 million, Contractor $80.7 million and Lubrication $24.7 million. Their respective operating margins were 35%, 20% and 16%, compared with 29%, 18% and 10% in Q2 2010.
- Q2 sales growth by region was 14% in the Americas, 32% in Europe and 34% in Asia Pacific; at consistent translation rates, growth was 14%, 21% and 27%, respectively. Translation contributed about $4 million to Q2 earnings and $5 million year to date.
- First-half operating cash flow was $43.9 million, versus $28.0 million. Receivables rose $32.6 million and inventories $21.4 million in operating cash-flow adjustments, reflecting higher sales and inventory to meet demand.
Financial position, liquidity and material changes
- At July 1, cash and cash equivalents were $119.3 million, short-term bank notes $13.9 million and long-term debt $150.0 million. The company reported $261 million unused of $272 million in credit lines.
- Cash increased $109.7 million from year-end 2010, primarily alongside financing activity. First-half financing cash flow was $78.9 million provided; investing cash flow was $12.4 million used. Capital expenditures were $10.0 million and dividends paid were $25.3 million.
- In March, Graco issued $150 million of unsecured notes in two $75 million tranches, bearing 4.00% and 5.01%, maturing in 2018 and 2023. On July 26, after quarter end, it issued a further $150 million at 4.88% and 5.35%, maturing in 2020 and 2026; proceeds were invested in cash equivalents. Graco reported compliance with debt covenants at July 1.
- Current assets were $417.1 million and current liabilities $121.3 million at July 1, compared with $252.4 million and $119.8 million at December 31, 2010. The increase in assets included the higher cash balance, receivables and inventory.
- Operating expenses increased year over year, including $3 million of corporate expense related to the pending ITW finishing-business acquisition. The effective tax rate was 32% for Q2 and 33% year to date, versus 35% in 2010, mainly due to the federal R&D credit.
Outlook, risks and contingencies
- Management described global incoming orders as stable and expected generally favorable market conditions in the second half of 2011, except for challenging U.S. housing and commercial construction markets. It expected percentage growth to moderate as prior-year comparisons became more difficult.
- Graco agreed to acquire ITW’s finishing businesses for $650 million in cash. Closing was subject to regulatory review and customary conditions; the FTC’s July 5 second request extended the waiting period, and Graco was responding. Planned financing included a new $450 million revolving facility, available only after specified conditions, and long-term notes.
- If Graco terminates the purchase agreement before April 1, 2012 because regulatory approval is not obtained, it may owe a $20 million termination fee. Risks include approval and closing uncertainty, financing, integration, realization of expected benefits and compliance with financing covenants.
- Management cited economic conditions, currency fluctuations, political instability, regulatory changes and product demand as risks. The filing reported no material change in market-risk disclosures from the 2010 Form 10-K.
Important facts for investors to verify
- Whether and when the ITW acquisition receives regulatory clearance and closes, and the final financing and purchase-price allocation.
- Whether second-half demand and segment growth develop as management expected, particularly in U.S. housing and commercial construction.
- How higher receivables and inventory affect cash conversion and operating cash flow as sales growth continues.
- The impact of material costs, foreign-exchange translation and acquisition-related expenses on margins and earnings.
- Debt levels, covenant headroom and financing terms after the July note issuance and any completion of the acquisition.