Graco Inc. — Q3 2015 Form 10-Q
Business context and period. Graco designs, manufactures and markets fluid and coating systems and equipment. This unaudited report covers the 13 weeks ended September 25, 2015, and year-to-date results for the 39 weeks ended that date; comparisons are with the periods ended September 26, 2014. Reporting segments are Industrial, Process and Contractor.
Financial performance
| Metric | Q3 2015 | Q3 2014 | 39 weeks 2015 | 39 weeks 2014 |
|---|---|---|---|---|
| Net sales | $319.0m | $302.6m | $960.9m | $915.1m |
| Operating earnings | $76.9m | $78.9m | $226.0m | $239.5m |
| Net earnings | $50.7m | $59.6m | $292.2m | $176.5m |
| Diluted EPS | $0.86 | $0.97 | $4.90 | $2.85 |
- Sales grew 5% in both periods. Approximate gross margin was 53.4% in Q3 and year to date, versus 54.8% in each prior-year period. Operating margin was approximately 24.1% in Q3 (24.1% prior year) and 23.5% year to date (26.2% prior year). Lower gross margins, higher operating expenses and currency effects pressured operating results.
- Reported year-to-date net earnings and EPS include the Liquid Finishing asset sale and related investment income. Excluding held-separate investment income and expense, management’s non-GAAP adjusted net earnings were $49.1m in Q3 versus $50.9m, and $151.2m year to date versus $153.2m; adjusted diluted EPS was $0.84 versus $0.83 and $2.54 versus $2.47, respectively.
- Operating cash flow was $135.2m year to date, down from $170.4m. Capital spending was $28.9m; acquisitions used $187.9m. Sale proceeds of $610.2m supported debt repayment. The company repurchased $224.7m of stock and paid $52.7m in dividends.
- At September 25, cash was $51.9m; current assets were $519.9m and current liabilities $204.3m. Notes payable to banks were $9.2m and long-term debt $375.0m, compared with $5.0m and $615.0m at year-end 2014. Credit lines totaled $546m, of which $463m was unused. Restricted cash of $8m was held for self-insured loss reserves.
Changes and notable items
- Q3 operating earnings declined 3% and net earnings declined 15%; year-to-date operating earnings declined 6%, while reported net earnings increased 66%, mainly because of the Liquid Finishing transaction.
- In April, Graco sold the Liquid Finishing assets for $610m, recording a $149m pretax gain net of transaction and related expenses. Year-to-date after-tax gain and dividends totaled $141m, or $2.36 per diluted share; no further dividends are expected. The quarter included a $2m after-tax post-closing adjustment.
- Process sales rose 23% in Q3 and 27% year to date, aided by acquisitions; its operating margin fell to 16% from 23% in Q3 and to 17% from 24% year to date. Industrial sales grew 1% in Q3 but declined 2% year to date; Contractor sales grew 3% and 4%, respectively.
- Acquisitions included High Pressure Equipment for $160m and White Knight Fluid Handling, acquired for $16m cash plus contingent consideration valued at $8m. Acquired operations contributed $19m of Q3 sales and $53m year-to-date sales.
Outlook, risks and management commentary
Management continued to target mid-single-digit organic sales growth at constant exchange rates for 2015, with growth across regions and segments, but said recent demand, macroeconomic headwinds and uneven emerging-market capital-equipment conditions could limit growth to the lower end of expectations. At then-current exchange rates, currency was expected to reduce full-year sales by approximately 5% and earnings by 11%. Management cited solid Contractor demand in the Americas and ongoing expansion initiatives.
- Risks include foreign-exchange movements, economic conditions and uneven demand, particularly in EMEA and Asia Pacific, oil and natural gas market weakness, customer concentration in Contractor, supply interruptions, international operating and compliance risks, and litigation or indemnification claims related to acquisitions and the divestiture.
- Management said recent oil and gas market weakness had not required additional goodwill impairment analysis, but prolonged or deeper weakness could create impairment risk. The filing reported no material change in market-risk disclosures or internal controls; disclosure controls were assessed as effective.
- The quarter’s effective tax rate was 31%, versus 28%; the year-to-date rate was 27%, down two percentage points, reflecting foreign-earnings tax treatment, dividend income, a $2m nonrecurring tax benefit and the tax impact of the asset sale.
Key facts for investors to verify
- Reconcile reported earnings growth with the $149m pretax sale gain and review the company’s non-GAAP adjusted results and reconciliation.
- Track organic sales, acquisition contributions and currency impacts separately, especially in Process and in EMEA and Asia Pacific.
- Assess whether lower segment margins, acquisition-related costs and elevated operating expenses persist.
- Monitor cash conversion and working-capital growth, debt repayment, remaining liquidity and capital returns.
- Review oil and gas exposure for potential goodwill impairment, and monitor litigation, indemnification and other disclosed contingencies.