Graco Inc. — Q3 2011 Form 10-Q
Reporting period: Quarter ended September 30, 2011 (13 weeks); year-to-date period covers 39 weeks. Financial statements are unaudited. Amounts below are in millions except per-share data.
Business context and performance
Graco designs, manufactures and markets equipment and systems for moving, measuring, controlling, dispensing and spraying fluids. It reports Industrial, Contractor and Lubrication segments. In Q3, sales grew across all segments and geographic regions, driven primarily by higher volume; currency translation also contributed to reported growth and earnings.
Key financial metrics
| Metric | Q3 2011 | Q3 2010 | 39 weeks 2011 | 39 weeks 2010 |
|---|---|---|---|---|
| Net sales | $227.3 | $190.0 | $679.7 | $546.8 |
| Gross profit | $126.3 | $104.6 | $383.2 | $295.8 |
| Gross margin | 55.6% | 55.0% | 56.4% | 54.1% |
| Operating earnings | $56.8 | $43.4 | $172.1 | $115.3 |
| Operating margin | 25.0% | 22.9% | 25.3% | 21.1% |
| Net earnings | $36.6 | $30.4 | $111.9 | $75.8 |
| Diluted EPS | $0.60 | $0.50 | $1.82 | $1.25 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $108.8 | $62.4 |
Q3 sales and net earnings each increased 20%; year-to-date sales increased 24%, net earnings 48%, and diluted EPS 46%. Gross margin was reported as 56% for both Q3 and year-to-date, with improvement over the comparable 2010 periods. Higher volume, expense leverage and favorable translation helped margins; higher material costs partly offset gains.
Year-to-date operating cash flow was $108.8 million. Investing cash outflow was $21.3 million, including $17.3 million of property and equipment additions. Financing provided $177.4 million, principally reflecting net long-term borrowing, partly offset by $35.3 million of share repurchases and $38.1 million of dividends paid. Cash rose to $274.8 million from $9.6 million at year-end 2010.
At September 30, cash was $274.8 million, current assets $565.2 million and current liabilities $128.5 million. Debt included $300.0 million of long-term notes and $8.1 million of bank notes payable; cash less these reported debt balances was approximately $33.3 million net cash. The company reported $264 million unused across its existing $270 million credit lines and was compliant with debt covenants. Dividends declared were $0.21 per share for the quarter and $0.63 year-to-date.
Segment and period comparisons
- Industrial: Q3 sales $124.5 million, up about 25%; operating earnings $42.6 million versus $31.2 million. Segment operating margin was 34% versus 31%.
- Contractor: Q3 sales $77.8 million, up about 11%; operating earnings $16.7 million versus $13.8 million. Margin was 21% versus 20%. Europe sales declined 2%, partly against a prior-year quarter with substantial new-product stocking shipments.
- Lubrication: Q3 sales $25.1 million, up about 23%; operating earnings $4.4 million versus $2.8 million. Margin was 17% versus 14%.
- Q3 regional sales growth was 13% in the Americas, 18% in Europe and 41% in Asia Pacific. At consistent translation rates, consolidated Q3 growth was 16%, versus 20% reported.
- Q3 interest expense increased to $3.1 million from $1.0 million. The effective tax rate was 32% versus 28%; the prior-year quarter benefited from tax rulings and expiring statutes of limitations.
Outlook, transaction, risks and unusual items
Management expected generally favorable global demand in Q4 compared with the prior year, except for U.S. housing and commercial construction, which remained at historic lows. It was monitoring European demand amid the Eurozone financial crisis. Management expected lower Q4 percentage growth because of tougher comparisons and an extra shipment week in Q4 2010. No numerical full-year earnings or sales guidance was provided.
Graco agreed to acquire ITW’s finishing businesses for $650 million in cash. Closing remained subject to regulatory review and customary conditions. Both companies had certified substantial compliance with FTC information requests by October 18, 2011, and agreed to extend the waiting period by another 30 days. Graco planned to use a new $450 million revolving facility and funds available under its long-term notes. The facility could not be drawn until specified conditions were met, including closing and at least $75 million of proceeds from additional long-term notes. A $20 million termination fee could apply if Graco terminated before April 1, 2012 because regulatory approval was not obtained. Acquisition-related expenses were $3 million in Q3 and $6 million year-to-date.
In 2011, Graco issued $300 million in unsecured notes, with fixed rates of 4.00%–5.35% and maturities from 2018 to 2026. The notes’ reported fair value was $320 million at September 30. The company also acquired Eccentric Pumps for approximately $2.1 million cash. Other relevant pressures include rising material and production costs, foreign-exchange movements, economic and political conditions, and potential acquisition financing, integration and covenant risks. Management reported no material change in market-risk disclosures and no material change to internal control over financial reporting; disclosure controls were judged effective.
Important facts for investors to verify
- Whether and when the FTC and other required approvals allow the $650 million ITW transaction to close, and whether financing conditions are satisfied.
- How the acquisition affects debt, interest expense, covenant headroom, and the expected realization of benefits and accretion.
- Whether demand trends—particularly in Europe and U.S. construction—match management’s Q4 outlook, and how much reported growth reflects currency translation.
- Whether higher material costs, working-capital needs and share repurchases affect future margins and cash generation.
- Confirm the filing’s stated $264 million of unused existing credit lines separately from the conditional $450 million acquisition facility.