GORMAN RUPP CO quarterly report, Q2 FY2017

Business context and reporting period

The Gorman-Rupp Company designs, manufactures and markets pumps and pump systems for water, wastewater, construction, industrial, petroleum and other liquid-handling markets. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2017; financial amounts below are in millions of dollars unless stated otherwise.

Financial results and position

For the first half, the effective tax rate was 32.5%, compared with 31.7% a year earlier. Cash and cash equivalents were $67.0 million at June 30, versus $57.6 million at year-end 2016. Total current assets were $215.5 million and current liabilities $48.0 million; working capital was $167.5 million. The company reported no bank debt and $22.4 million available under bank lines after $8.6 million of letters of credit. Total liabilities were $79.1 million and total equity $314.4 million.

First-half investing cash use was $9.3 million, including $6.0 million of short-term investment purchases and $3.3 million of capital expenditures. Dividends paid were $6.0 million. The company’s non-GAAP adjusted free cash flow was $20.6 million, versus $18.6 million in the prior-year period; this measure is defined as adjusted EBITDA less capital expenditures and dividends. The quarterly dividend was $0.115 per share, authorized July 27, 2017.

Material changes versus the prior comparable period

• Q2 sales increased 1.7%; excluding the prior-year New Orleans Permanent Canal Closures & Pumps (PCCP) project, sales rose 4.4%. Domestic sales excluding PCCP grew 3.0%, and international sales grew 7.1%.
• First-half reported sales declined 3.1%, largely reflecting PCCP project timing. Excluding PCCP sales of $0.5 million in 2017 and $7.9 million in 2016, first-half sales increased 0.7%. Ex-PCCP domestic sales declined 1.4%, while international sales rose 4.8%.
• Reported gross margin improved 2.6 percentage points in Q2 and 1.4 points for the first half. Operating margin rose 1.8 points in Q2 and 0.2 points for the first half, despite a pension settlement charge in 2017.
• First-half operating cash flow fell to $24.0 million from $33.6 million. Management cited, among other factors, lower commissions payable due to product mix and payment timing. Cash nevertheless increased by $9.4 million, compared with a $25.8 million increase in first-half 2016.
• Backlog was $103.6 million at June 30, down from $107.7 million a year earlier and up from $98.8 million at December 31, 2016. Excluding PCCP, backlog was down 1.6% year over year.

Outlook, commentary, risks and unusual items

Management gave no specific earnings or sales guidance. It described 2017 as challenging amid uncertainty around oil production and prices and low commodity prices, and cautioned that PCCP project completion affects 2017 comparisons. It cited possible support from proposed infrastructure, military, pipeline and domestic manufacturing activity, and noted improving capital spending in oil- and gas-related industries. Management said it would focus on efficiency and expense control and viewed the balance sheet as supporting acquisitions and product development. Full-year 2017 capital spending was planned at $8 million to $10 million, expected to be funded internally.

A non-cash pension settlement charge totaled $3.4 million pretax in the first half: $2.2 million in cost of products sold and $1.2 million in SG&A. It reduced reported first-half EPS by $0.09; management’s non-GAAP adjusted EPS was $0.58 versus $0.49 a year earlier. Q2 adjusted EPS was $0.35 versus $0.25. Management attributed underlying margin improvement principally to favorable sales mix and labor efficiency/costs; Q2 also benefited from lower warranty and depreciation expense. First-half SG&A as a share of sales increased partly because lower sales reduced leverage.

Disclosed risks include competitive markets, raw-material availability, cybersecurity, acquisition integration, foreign exchange and overseas conditions, environmental and trade-law compliance, goodwill impairment, pension settlement expense and family ownership. Currency risk is principally in the euro, Canadian dollar, South African rand and British pound; the company primarily manages it by invoicing customers in the currency of product sourcing. Management reported effective disclosure controls at June 30, 2017, no material change in internal controls, and no material changes to previously reported legal proceedings or risk factors.

The company was assessing the impact of the forthcoming revenue-recognition standard and planned to adopt it using the modified retrospective method. It did not expect a material impact from the new lease standard, citing immaterial future minimum lease commitments. Interim results are not necessarily indicative of full-year results.

Important facts for investors to verify

• How sales, orders and backlog develop after adjusting for PCCP project timing, especially in domestic markets and challenged fire protection, agriculture and petroleum segments.
• Whether margin improvements persist as the pension settlement charge does not recur on the same basis, and how pension costs and healthcare expenses evolve.
• Why operating cash flow declined despite higher adjusted free cash flow, including the effects of commissions, inventory, taxes and working-capital timing.
• Whether planned capital expenditures, acquisition opportunities and dividends remain consistent with cash generation and the company’s financial flexibility.
• The eventual financial-statement and disclosure effects of adopting the revenue-recognition standard.