Graco Inc. — Q1 2016 Form 10-Q Summary
Reporting period: Thirteen weeks ended March 25, 2016; comparative period ended March 27, 2015. The interim financial statements are unaudited. Graco designs, manufactures and markets equipment and systems for moving, measuring, controlling, dispensing and spraying fluids and coatings. Its reportable segments are Industrial, Process and Contractor.
Financial results
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Net sales | $304.9 million | $306.5 million | Down 1% |
| Gross profit | $161.8 million | $162.1 million | Down 0.2% |
| Operating earnings | $60.9 million | $65.2 million | Down 7% |
| Net earnings, reported | $39.6 million | $68.8 million | Down 43% |
| Diluted EPS, reported | $0.70 | $1.14 | Down 39% |
Gross margin was approximately 53.1%, consistent with the prior-year quarter; operating margin was approximately 20.0%, versus 21.3%. The effective tax rate was 31%, compared with 22%. Management attributed the prior-year lower rate partly to post-tax dividend income from Liquid Finishing.
The reported earnings comparison is distorted by $29.5 million of held-separate investment income in Q1 2015, associated with the Liquid Finishing businesses sold in Q2 2015. Excluding that income and its tax effect, adjusted net earnings were $39.6 million in Q1 2016 versus $39.1 million in Q1 2015, and adjusted diluted EPS was $0.70 versus $0.65.
Segments and sales trends
- Industrial: Sales rose 3% to $147.1 million; operating margin increased to 31% from 30%, supported by improved gross margin and sales leverage.
- Process: Sales fell 5% to $64.3 million; operating margin declined to 11% from 16%. Management cited unfavorable expense leverage and continued oil and natural gas market headwinds.
- Contractor: Sales fell 2% to $93.5 million; operating margin declined to 18% from 20% on lower-volume expense leverage.
At constant currency, sales increased 1%; organic sales declined 1%. EMEA sales rose 10% and Asia Pacific 6%, while the Americas declined 6%. Acquisitions contributed $7 million, or 2 percentage points, to sales growth. Currency reduced reported sales growth.
Cash flow, balance sheet and capital allocation
- Operating cash flow was $25.6 million, down from $47.2 million. Capital expenditures were $13.1 million; operating cash flow less capital expenditures was approximately $12.5 million, versus $37.4 million.
- Cash and cash equivalents were $36.5 million, down from $52.3 million at year-end. An additional $9 million was restricted for self-insurance reserves.
- Long-term debt was $457.7 million and bank notes payable were $14.5 million. Combined borrowings were $472.2 million, up from $408.6 million at December 25, 2015.
- Total current assets were $495.8 million and current liabilities $161.8 million. The company reported $546 million in credit lines, of which $376 million was unused.
- Cash uses included $48.1 million of share repurchases and $18.3 million of dividends. The quarterly dividend declared was $0.33 per share, up from $0.30.
- Graco used $48.9 million for acquisitions of two related businesses, funded with revolving credit borrowings. Goodwill increased by $27.0 million from acquisitions.
Outlook, risks and other notable items
Management maintained its full-year outlook for low- to mid-single-digit organic constant-currency growth worldwide, with growth expected in every region and segment. It projected mid-single-digit growth in the Americas and low-single-digit growth in EMEA and Asia Pacific. Management acknowledged risk to Process from continued oil and natural gas weakness, but still expected organic constant-currency growth in that segment. It said it intended to continue investing in growth initiatives.
Management said prolonged or deeper oil and natural gas market weakness could put assets at risk of impairment. At year-end 2015, the Oil and Natural Gas reporting unit’s estimated fair value exceeded carrying value by 14%; the company concluded Q1 2016 did not require further impairment analysis. Other disclosed risks include economic and demand changes, currency movements, international operations, supply interruptions, acquisitions, litigation and regulatory matters, and reliance on certain large Contractor-segment customers. The filing reported no material changes to previously disclosed risk factors or market-risk disclosures. Disclosure controls were deemed effective, with no material change in internal control reported.
The company noted that new lease accounting requirements are effective for it in fiscal 2019 and new share-based payment accounting requirements in fiscal 2017; it was evaluating their effects.
Important facts for investors to verify
- Whether full-year organic growth guidance remains achievable, particularly given the Americas sales decline and Process segment exposure to oil and gas.
- Whether acquired businesses deliver expected growth and cash returns, and how acquisition-related debt and contingent consideration evolve.
- Whether operating cash generation improves and debt levels remain manageable after acquisitions, repurchases and dividends.
- Whether continued oil and gas weakness changes the impairment outlook for the reporting unit that had 14% fair-value headroom at year-end 2015.
- How results compare after accounting for the nonrecurring Liquid Finishing investment income in the prior-year quarter; reported year-over-year earnings declines alone are not directly comparable.