Graco Inc. — Q2 2016 Form 10-Q
Business and period: Graco designs, manufactures and markets equipment and systems for moving, measuring, controlling, dispensing and spraying fluids and coatings. The quarter ended June 24, 2016 (13 weeks); year-to-date covers 26 weeks. The unaudited results are for Industrial, Process and Contractor segments.
Financial results
Amounts in millions except per-share data and percentages. Prior-year earnings included income from the Liquid Finishing investment and its 2015 sale; adjusted figures below exclude that income and its tax effect.
| Metric | Q2 2016 | Q2 2015 | First half 2016 | First half 2015 |
|---|---|---|---|---|
| Net sales | $348.1 | $335.5 | $653.0 | $641.9 |
| Operating earnings | $78.3 | $83.9 | $139.3 | $149.1 |
| Net earnings, reported | $50.9 | $172.6 | $90.5 | $241.5 |
| Net earnings, adjusted | $50.9 | $62.9 | $90.5 | $102.0 |
| Diluted EPS, reported | $0.89 | $2.90 | $1.59 | $4.02 |
| Diluted EPS, adjusted | $0.89 | $1.05 | $1.59 | $1.70 |
| Gross margin | 53.2% | 53.8% | 53.1% | 53.4% |
| Operating margin | 22.5% | 25.0% | 21.3% | 23.2% |
Margins are approximate calculations from reported figures. Sales rose 4% in Q2 and 2% year to date; operating earnings fell 7% in both periods. Gross margin was slightly lower as lower factory volume and unfavorable product and channel mix outweighed realized pricing. Higher operating expenses also weighed on operating earnings. The effective tax rate was 31% in both 2016 periods, versus 28% in Q2 2015 and 26% year to date; prior-year rates benefited from nonrecurring tax items.
Cash flow and liquidity: First-half operating cash flow was $88.0, compared with $96.7 in 2015; the prior-year figure included $23 million associated with Liquid Finishing. Investing cash outflow was $74.3, including $49.1 for acquisitions and $26.0 for capital expenditures. Financing cash outflow was $20.6, including $48.1 of share repurchases and $36.7 of dividends. Cash ended at $43.9, including $9 million restricted for self-insurance reserves. Available credit lines totaled $547 million, of which $405 million was unused. Current assets were $518.2 and current liabilities $169.8.
Debt and balance sheet: Notes payable to banks and long-term debt totaled $442.8 at June 24, versus $408.6 at December 25, 2015. Total assets were $1,450.9 and shareholders’ equity $676.1. Long-term fixed-rate notes had a $300 million carrying amount and $335 million estimated fair value.
Material changes and segment performance
- Industrial: Q2 sales increased 2% to $157.0; operating earnings were $51.1 and margin was 33%, consistent with the prior year. Americas sales were weaker, offset by growth in EMEA and Asia Pacific.
- Process: Q2 sales fell 10% to $64.7 and operating earnings fell to $7.6 from $14.0; margin declined to 12% from 19%, primarily due to unfavorable expense leverage. Sales weakened across all regions.
- Contractor: Q2 sales increased 15% to $126.4, led by 19% growth in the Americas. Operating earnings rose to $29.4, but margin decreased to 23% from 25%, reflecting new-product launch costs.
- Acquisitions contributed $5 million of Q2 sales and $11 million year to date. Currency translation reduced first-half sales by about $7 million and earnings by about $2 million; Q2 impact was not significant.
Outlook, risks and unusual items
Management lowered its 2016 full-year outlook from low-to-mid single-digit growth to low single-digit growth after modest first-half organic growth. It expects Process headwinds to persist, and no longer expects growth in every segment and region. The Americas outlook was reduced to low single digits; EMEA was raised to low-to-mid single digits after a strong first half; Asia Pacific outlook remained low single digits. Management cited choppy end markets and continued commitment to product development, distribution expansion and entry into adjacent markets.
The sharp decline in reported year-over-year net earnings primarily reflects the prior-year Liquid Finishing gain and related investment income: 2015 included a $147 million pretax sale gain and $12 million of Q2 dividend income. Management’s adjusted comparison excludes net investment income and related tax effects. The company acquired two related businesses in the first half using revolving-credit borrowings; the acquisitions were described as not material to the consolidated financial statements.
Oil and Natural Gas reporting-unit goodwill was $150 million. Despite continuing market weakness, management concluded in Q2 that further impairment analysis was not required, but warned prolonged or deeper weakness could lead to impairment. Other disclosed risks include economic and end-market volatility, currency movements, acquisition performance and possible asset impairment, supply interruptions, international operations, and potential indemnification claims related to the Liquid Finishing asset sale. The filing reported no material changes to previously disclosed risk factors or market-risk disclosures. Management stated disclosure controls were effective and reported no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether low single-digit 2016 growth guidance is achieved, especially given continued Process weakness and the lowered Americas outlook.
- Whether Process sales and margins stabilize, and whether Contractor growth can offset weakness elsewhere.
- Oil and Natural Gas goodwill exposure, including the $150 million balance and sensitivity to further market deterioration.
- Use of revolving-credit borrowings for acquisitions, cash generation, debt levels and the $405 million of unused credit capacity.
- Reported versus adjusted year-over-year earnings: the prior-year divestiture gain and investment income materially distort the reported comparison.