Graco Inc. — Q2 2013 Form 10-Q Summary
Business context and period: Graco designs, manufactures and markets equipment and systems for moving, measuring, controlling, dispensing and spraying fluids and coatings. This unaudited report covers the 13 and 26 weeks ended June 28, 2013, compared with the periods ended June 29, 2012. Graco reports Industrial, Contractor and Lubrication segments.
Financial performance
Amounts are in millions except per-share data. Percentages are approximate where calculated from reported figures.
| Metric | Q2 2013 | Q2 2012 | First half 2013 | First half 2012 |
|---|---|---|---|---|
| Net sales | $286.0 (+7%) | $268.2 | $555.1 (+11%) | $502.3 |
| Gross profit | $158.7 | $139.5 | $309.4 | $271.7 |
| Gross margin | 55.5% | 52.0% | 55.5% | 54.1% |
| Operating earnings | $75.2 | $52.5 | $146.7 | $110.4 |
| Operating margin | 26.3% | 19.6% | 26.4% | 22.0% |
| Net earnings | $57.8 (+68%) | $34.4 | $110.0 (+58%) | $69.7 |
| Diluted EPS | $0.92 (+64%) | $0.56 | $1.76 (+56%) | $1.13 |
- Segment sales, Q2: Industrial $159.7 million (+1%); Contractor $98.5 million (+20%); Lubrication $27.9 million (flat). Contractor growth was led by the Americas, supported by expanded home-center offerings and a recovering U.S. housing market.
- Segment sales, first half: Industrial $323.8 million (+11%), including acquisition contribution; Contractor $176.1 million (+14%); Lubrication $55.1 million (-1%).
- Cash flow, first half: Operating cash flow was $100.2 million, versus $64.7 million. Capital expenditures were $9.4 million; operating cash flow less capital expenditures was approximately $90.7 million. Investing activities used $7.1 million; financing activities used $98.4 million, including $90.7 million net repayments on long-term credit lines and $30.5 million of dividends paid. Cash declined $3.6 million to $27.6 million.
- Liquidity and debt at June 28: Current assets were $810.6 million and current liabilities $154.9 million. Long-term debt was $465.8 million and bank notes payable were $7.8 million, compared with $556.5 million and $8.1 million, respectively, at year-end 2012. Credit lines totaled $500 million, of which $328 million was unused.
- Dividends and shares: Declared dividends were $0.25 per share in Q2 and $0.50 year-to-date. The company repurchased 114,928 shares during the final reported quarter period under its authorization.
Material changes and drivers
- Sales growth was strongest in Contractor. Q2 regional sales rose 14% in the Americas and 2% in EMEA, while Asia Pacific declined 6%. First-half sales rose across all regions.
- First-half sales growth included approximately 6 percentage points from the full-year impact of the Powder Finishing acquisition completed in April 2012. Management attributed earnings growth to higher sales, stronger gross margins, lower acquisition-related costs, greater Liquid Finishing dividend income and a lower effective tax rate.
- Prior-year gross margin was reduced by approximately $7 million of inventory purchase-accounting effects—about 3 percentage points in Q2 and 1.5 points year-to-date. Acquisition and divestiture costs also declined year over year.
- Q2 other income included $11 million of dividends from the Liquid Finishing businesses held separate; first-half dividends totaled $15 million. These dividends materially contributed to reported earnings.
Outlook, risks and unusual items
- Management expected full-year sales growth in every region and continued to expect modest full-year growth in EMEA and Asia Pacific, despite no expected improvement in those regions’ macroeconomic conditions. It cited easier second-half comparisons and strategic initiatives, and expected the U.S. housing recovery to remain a tailwind. No specific full-year growth or earnings target was provided.
- The FTC had issued a proposed order requiring Graco to divest the Liquid Finishing business assets within 180 days after the order becomes final. As of the filing, the FTC had not issued its final order. Graco was marketing the businesses and was required to maintain them separately as viable and competitive.
- Graco carried its investment in Liquid Finishing at approximately $426 million and reported no impairment at June 28, 2013. Under the hold-separate order, Graco may need to provide resources, including working capital and reimbursement of losses; the timing and outcome of the divestiture remained uncertain.
- Other disclosed risks include economic conditions, international and currency exposure, supply interruptions, changes in product demand, customer concentration in Contractor, construction and remodeling activity, intellectual-property issues, litigation and regulatory proceedings. Management reported no material change to risk factors or market-risk disclosures from its 2012 Form 10-K.
- The interim financial statements were unaudited and included only normal recurring adjustments; management cautioned that interim results are not necessarily indicative of full-year results.
Important facts for investors to verify
- Progress and final terms of the FTC order and the timing, price and completion of the required Liquid Finishing divestiture.
- The carrying value and ongoing funding obligations of the Liquid Finishing investment, and whether future dividends are sustainable.
- How much reported earnings growth reflects recurring segment operations versus acquisition-related comparisons, dividends and tax-rate effects.
- Whether Contractor growth—partly associated with expanded home-center offerings and the U.S. housing recovery—continues, and whether the weaker Asia Pacific trend persists.
- Working-capital requirements, available credit capacity and debt repayment needs as business activity and inventory grow.