Graco Inc. — Q3 2020 Form 10-Q
Reporting period: Quarter and nine months ended September 25, 2020; unaudited consolidated results. Graco designs, manufactures and markets equipment and systems for moving, measuring, controlling, dispensing and spraying fluids and coatings. Its reportable segments are Industrial, Process and Contractor.
Financial performance
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Net sales | $439.3 million | $400.6 million | $1,179.8 million | $1,233.8 million |
| Gross margin | 52.1% | 51.8% | 51.7% | 52.7% |
| Operating earnings | $125.0 million | $103.4 million | $259.6 million | $320.3 million |
| Operating margin | 28.5% | 25.8% | 22.0% | 26.0% |
| Net earnings | $114.1 million | $84.1 million | $215.8 million | $259.0 million |
| Diluted EPS | $0.66 | $0.49 | $1.26 | $1.51 |
Q3 sales rose 10% year over year, led by Contractor growth; Industrial and Process sales declined. Gross margin improved slightly in the quarter as pricing, lower product costs and favorable currency effects offset unfavorable product and channel mix. Nine-month sales fell 4%, and operating earnings fell 19%, including a $35.2 million impairment charge. Reported Q3 and nine-month effective tax rates were 5.7% and 12.0%, respectively; tax benefits affected reported net earnings. Management’s adjusted, non-GAAP diluted EPS was $0.59 for Q3 versus $0.45, and $1.34 for the nine months versus $1.42.
Segment performance
- Industrial: Q3 sales were $172.8 million, down 1%; nine-month sales were $464.8 million, down 16%. Q3 operating margin rose to 35% from 33%; nine-month margin declined to 32% from 34%.
- Process: Q3 sales were $78.8 million, down 6%; nine-month sales were $242.6 million, down 5%. Operating margin was 21% for Q3 and 19% year to date, versus 22% in both prior-year periods.
- Contractor: Q3 sales were $187.7 million, up 33%; nine-month sales were $472.4 million, up 11%. Operating margin increased to 29% for Q3 and 26% year to date. The filing attributes growth to new products and strength in construction and home improvement markets.
Cash flow, balance sheet and liquidity
- Nine-month operating cash flow was $262.7 million, down from $299.5 million. Accounts receivable and inventory increases contributed to the decline.
- Investing cash outflow was $73.4 million, including $45.8 million of capital expenditures and $27.6 million for acquisitions. Financing cash inflow was $12.9 million; the company repurchased $102.1 million of stock and paid $87.7 million of dividends.
- At September 25, cash and equivalents were $424.7 million, versus $221.0 million at year-end 2019. Current assets were $1,061.2 million and current liabilities $326.5 million.
- Reported borrowings comprised $44.0 million of notes payable to banks and $275.0 million of long-term debt, compared with $7.7 million and $164.3 million, respectively, at year-end. The company borrowed $250 million on its $500 million revolving facility in March and repaid $125 million in August. Of $596 million in total credit lines, $429 million was unused at quarter end.
Material changes, outlook and risks
In July, Graco sold its U.K.-based Alco valve business. The company recorded $35.2 million of year-to-date impairment charges related to the sale. A $24 million foreign-currency translation loss was reclassified from accumulated other comprehensive income upon sale; a previously recorded reserve offset its effect on net earnings.
COVID-19 continued to affect operations, supply chains, distribution and customers. Industrial and Process order rates had not recovered to pre-pandemic levels; Contractor orders had strengthened, but the duration and extent of that demand were uncertain. Management said available cash, operating cash flow and financing capacity were sufficient to support operations at current order rates, and did not expect a significant pandemic effect on liquidity. No numerical earnings or sales guidance was provided.
Management remained committed to product development, channel expansion and entering new markets, while cautioning that these initiatives may pressure short-term results. Principal uncertainties include the pandemic and economic recovery, customer demand and capital spending, supplier or distributor disruptions, currency movements, acquisitions and potential impairment, and exposure to cyclical end markets. The filing reported no material changes in market-risk disclosures and stated that disclosure controls were effective.
Important facts for investors to verify
- Whether Industrial and Process orders recover, and whether Contractor demand remains strong.
- The effect of COVID-19, including supply, distribution, customer-payment and operating disruptions.
- The Alco disposal and impairment accounting, including the translation-loss reserve offset.
- How much reported earnings reflect tax benefits and impairment; compare GAAP results with the company’s adjusted non-GAAP measures.
- Working-capital needs, revolving-credit borrowings, cash deployment, and future repurchases, dividends, capital spending and acquisitions.
- Potential customer concentration in Contractor and sensitivity to construction, automotive, mining, and oil and natural gas activity.