Graco Inc. — Q1 2014 Form 10-Q
Business context and period. Graco designs, manufactures and markets fluid-handling and coating equipment through its Industrial, Contractor and Lubrication segments. This unaudited report covers the 13 weeks ended March 28, 2014, compared with the 13 weeks ended March 29, 2013. Dollar amounts below are in millions unless stated otherwise.
Financial performance
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Net sales | $290.0 | $269.0 | +8% |
| Gross profit / margin | $159.3 / 54.9% | $150.6 / 56.0% | Margin down 1.1 points |
| Operating earnings / margin | $74.7 / 25.8% | $71.5 / 26.6% | Earnings +4% |
| Net earnings | $50.7 | $52.1 | -3% |
| Diluted EPS | $0.81 | $0.84 | -4% |
| Operating cash flow | $28.2 | $39.2 | Down $11.0 |
Gross margin was pressured by acquisition-related inventory charges, lower margins at acquired operations and product mix. The effective tax rate was 31%, four percentage points higher year over year; the prior-year rate benefited from a retroactive federal R&D tax credit. Q1 2014 included $4 million of dividends from the held-separate Liquid Finishing businesses, recorded in other income.
Segments and geography
- Industrial: Sales $176.4 million, up 7%; operating earnings $55.2 million, essentially flat. Operating margin declined to 31% from 34%, reflecting acquired-operation margins, inventory valuation adjustments and expansion investments.
- Contractor: Sales $84.9 million, up 9%; operating earnings $18.3 million, up 11%. Margin held at 21%; growth was strongest in the Americas, with strong paint-store and home-center channels.
- Lubrication: Sales $28.6 million, up 5%; operating earnings $6.5 million, up 27%. Margin rose to 23% from 19% on improved gross margin, volume and expense leverage.
- Sales increased 15% in the Americas and 7% in EMEA, and declined 7% in Asia Pacific. Acquisitions contributed $7 million, or about three percentage points, to consolidated sales growth.
Financial position and capital allocation
- At March 28, 2014, cash was $24.1 million; current assets were $835.4 million and current liabilities $168.9 million. The current ratio was approximately 5.0.
- Notes payable to banks were $11.0 million and long-term debt $503.0 million, versus $9.6 million and $408.4 million, respectively, at year-end 2013. Cash and unused financing sources were expected to meet 2014 liquidity needs.
- Credit lines totaled $503 million, of which $290 million was unused. The company reported a $422.3 million investment in businesses held separate, carried at cost.
- Operating cash flow was $28.2 million. Investing cash outflow was $72.0 million, including $65.2 million for an acquisition. Financing cash inflow was $48.2 million, including net long-term borrowings; the company repurchased $47.5 million of stock and paid $16.8 million in dividends.
Material changes, outlook and risks
In Q1, Graco paid approximately $65 million for a manufacturer of fluid-management solutions serving environmental monitoring and remediation markets. The acquisition expands the Industrial segment; purchase-price allocation included approximately $37 million of goodwill, $22 million of identifiable intangible assets and $6 million of net tangible assets.
Management maintained its 2014 outlook and said it remained confident of full-year growth in all segments and regions. It expected low-double-digit full-year growth in Contractor Americas, driven by residential construction, despite a slower-than-anticipated start to U.S. housing activity. Management cited geopolitical and currency headwinds in some emerging EMEA economies, uneven capital-equipment demand in China, and an improving developed-market environment.
The FTC’s proposed order requires divestiture of the Liquid Finishing businesses, subject to final order and approval. Graco continued marketing the businesses and must maintain them separately and support their viability; completion timing remained uncertain. The company reported no impairment of its investment at quarter-end. Other cited risks include economic and political conditions, acquisition and divestiture execution, demand and industry cycles, customer concentration, supply interruptions, international operations, litigation and regulatory matters, and cybersecurity and natural disasters. No material changes to previously disclosed risk factors or market-risk disclosures were reported. Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting.
Important facts for investors to verify
- Progress, timing and potential financial consequences of the FTC-required Liquid Finishing divestiture, including the carrying value and continued dividend income.
- Whether acquired-business contributions and margins develop as expected, and how acquisition-related costs and purchase accounting affect Industrial profitability.
- Drivers of the decline in operating cash flow, particularly receivables, inventory and accrued compensation, and the sustainability of working-capital needs.
- Debt levels, interest costs and available credit following acquisition financing, share repurchases and dividends.
- Whether management’s full-year segment and regional growth outlook is supported by housing, developed-market demand, China conditions and emerging-market risks.