Graco Inc. — Q1 2013 Form 10-Q
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 weeks ended March 29, 2013; income and cash flow are compared with the 13 weeks ended March 30, 2012. Balance-sheet changes are compared with December 28, 2012. Amounts below are in millions except per-share data.
Financial performance
| Metric | Q1 2013 | Q1 2012 |
|---|
| Net sales | $269.0 | $234.1 |
| Gross profit / gross margin | $150.6 / 56.0% | $132.2 / 56.5% |
| Operating earnings | $71.5 | $58.0 |
| Earnings before taxes | $71.1 | $54.0 |
| Net earnings | $52.1 | $35.4 |
| Diluted EPS | $0.84 | $0.58 |
| Operating cash flow | $39.2 | $23.5 |
- Sales increased 15%; net earnings rose 47% and diluted EPS rose 45%. Management attributed earnings growth to higher sales, strong gross-margin rates, lower acquisition-related costs, Liquid Finishing dividend income and favorable tax adjustments.
- Gross margin declined about 0.5 percentage point. Lower margins at acquired Powder Finishing operations were partly offset by pricing and manufacturing cost improvements.
- The effective tax rate was 27%, down 8 percentage points year over year. The 2013 rate reflected the retroactive renewal of the federal R&D credit and the tax effect of Liquid Finishing dividends.
- Operating cash flow was $39.2 million. Investing activities used $1.0 million and financing activities used $32.5 million; cash increased $5.9 million to $37.0 million.
Segments and material changes
| Segment | Sales, Q1 2013 vs. Q1 2012 | Operating earnings, Q1 2013 vs. Q1 2012 | Reported context |
|---|
| Industrial | $164.2 vs. $134.1 | $55.2 vs. $48.3 | Sales included $32 million from Powder Finishing. Legacy sales declined 2%; segment operating margin rate fell, partly due to Powder Finishing’s lower rate. |
| Contractor | $77.6 vs. $72.0 | $16.4 vs. $12.5 | Sales rose 8%, led by the Americas; pricing, factory efficiencies and expense leverage improved margin rate. |
| Lubrication | $27.2 vs. $28.0 | $5.1 vs. $6.1 | Sales fell 3%; prior-year large Asia Pacific transactions did not recur, reducing earnings. |
- Powder Finishing contributed 14 percentage points of consolidated sales growth. Excluding it, legacy sales were up 4% in the Americas, down 4% in EMEA and flat in Asia Pacific.
- Regional sales growth was 10% in the Americas, 26% in EMEA and 16% in Asia Pacific; acquisition contribution was a significant factor, especially in EMEA.
- Operating expenses increased $5 million overall, including $9 million from Powder Finishing; acquisition and divestiture costs declined $4 million year over year. Prior-year corporate expense included $4 million of acquisition-related costs.
Financial position, liquidity and debt
- At March 29, 2013, cash was $37.0 million, current assets $803.5 million and current liabilities $146.9 million. Long-term debt was $521.0 million and bank notes payable were $6.6 million. Long-term debt declined from $556.5 million at year-end.
- Credit lines totaled $484 million, of which $258 million was unused. Management expected internally generated funds and available financing to meet 2013 liquidity needs.
- Accounts receivable increased to $184.0 million from $172.1 million and inventory to $130.3 million from $121.5 million; management attributed the increases to first-quarter business activity.
- Shareholders’ equity was $506.9 million, up from $454.1 million. The quarterly dividend declared was $0.25 per share, compared with $0.23 a year earlier.
Outlook, risks and unusual items
- Management aimed for year-over-year sales growth in every region in 2013. It expected double-digit growth in Contractor Americas, low-to-mid single-digit growth in Industrial Americas, and modest growth in EMEA and Asia Pacific. The U.S. housing recovery was expected to support Contractor; Western European and Asia Pacific macroeconomic conditions remained headwinds.
- The FTC had issued a proposed order requiring Graco to divest the acquired Liquid Finishing business assets within 180 days after the order becomes final. No final order had been issued by quarter-end. Graco was required to keep the assets separate and provide resources to maintain their viability and competitiveness.
- Graco reported a $426.0 million cost-method investment in the held-separate Liquid Finishing businesses and concluded it was not impaired at March 29. Graco received $4 million in dividends in the quarter; Liquid Finishing’s own $63.2 million sales and $13.6 million operating earnings were not consolidated into Graco’s results.
- Management cited economic conditions, acquisition integration, completion and timing of the Liquid Finishing divestiture, international and currency risks, supply interruptions, demand changes, competition, litigation and regulatory reviews, and Contractor exposure to large customers and construction/remodeling activity among forward-looking risks. The filing reported no material change in risk factors from the 2012 Form 10-K.
- Other comprehensive income included an $8.5 million cumulative translation loss. No shares were repurchased in the quarter. The filing reported disclosure controls as effective and no material change in internal control over financial reporting.
Important facts for investors to verify
- Final FTC order, divestiture timetable, sale proceeds and any ongoing funding obligations for Liquid Finishing.
- Whether growth and earnings remain strong after separating acquisition contributions, especially given Industrial legacy weakness and softer Lubrication results.
- Powder Finishing’s effect on consolidated gross and segment margins, and whether expected regional growth is achieved.
- Recoverability and carrying value of the $426 million Liquid Finishing investment, alongside Graco’s debt, cash and available credit capacity.
- Sustainability of the lower effective tax rate, including the R&D credit and Liquid Finishing dividend income.
