Graco Inc. — Q1 2010 Form 10-Q
Business context and period: Graco designs, manufactures and markets equipment and systems for moving, measuring, controlling, dispensing and spraying fluid materials. This unaudited report covers the 13 weeks ended March 26, 2010; comparisons are with the 13 weeks ended March 27, 2009 unless otherwise stated. Its segments are Industrial, Contractor and Lubrication.
Financial performance
| Metric | Q1 2010 | Q1 2009 | Change |
|---|---|---|---|
| Net sales | $164.7 million | $137.9 million | +19% |
| Gross profit / margin | $89.3 million / 54% | $64.3 million / 47% | Margin +7 percentage points |
| Operating earnings / margin | $32.7 million / 19.9% | $6.1 million / 4.4% | |
| Net earnings | $20.6 million | $2.8 million | +640% as reported |
| Diluted earnings per share | $0.34 | $0.05 | +580% as reported |
| Operating cash flow | $16.0 million | $27.7 million | Down $11.7 million |
| Cash and cash equivalents | $11.6 million | $5.4 million at Dec. 25, 2009 | |
| Debt: bank notes plus long-term debt | $94.1 million | $98.3 million at Dec. 25, 2009 | |
| Current assets / current liabilities | $222.1 million / $117.4 million | $189.0 million / $103.8 million at Dec. 25, 2009 | Current ratio about 1.9 |
| Cash dividends declared per share | $0.20 | $0.19 |
Gross margin improved with higher production volume, lower material and pension costs, price increases and favorable currency translation. Operating expenses were down 3%. The effective tax rate was 34.5%, about 1 percentage point higher than a year earlier; the federal R&D credit had not been renewed for 2010.
Material changes and segment performance
- Sales increased in all segments and geographic regions. Currency translation contributed approximately $5 million to sales and $2 million to net earnings.
- By geography, sales were $86.7 million in the Americas, $41.8 million in Europe, Africa and the Middle East, and $36.2 million in Asia Pacific. Asia Pacific sales rose 65% reported (55% at consistent translation rates), accounting for more than half of the total sales increase.
- Industrial sales were $96.8 million, up from $75.2 million; segment operating earnings were $30.5 million, compared with $11.5 million. Operating margin increased to 31% from 15%.
- Contractor sales were $50.8 million, up from $47.4 million; operating earnings were $4.9 million, compared with $1.2 million. North American sales were flat; management noted continued weakness in construction markets.
- Lubrication sales were $17.1 million, up from $15.2 million; operating earnings were $1.7 million versus a $1.4 million loss. Management said further volume growth is needed to return to historical margins.
- Last year’s first-quarter results included $4 million of workforce-reduction costs, which reduced the 2009 gross margin rate by about 2 percentage points. Cost reductions from 2008 and 2009 also supported this quarter’s performance.
Cash, debt and liquidity
Operating cash flow was $16.0 million, with working-capital investment a significant use: accounts receivable increased $19.6 million and inventories increased $7.8 million in the cash-flow statement. Management attributed balance-sheet increases since year-end to higher sales and inventory to higher demand. Investing activities used $2.9 million, including $2.8 million for property and equipment. Financing activities used $6.7 million; the company paid $12.0 million in dividends and reduced long-term-line borrowings by $6.3 million, while short-term-line borrowings increased.
At March 26, 2010, Graco had $270 million in credit lines, of which $178 million was unused. Management expected internally generated funds and unused financing sources to provide flexibility for 2010 liquidity needs.
Outlook, risks and unusual items
- No numerical earnings or sales guidance was provided. Management remained cautious about near-term Contractor prospects in North America and Western Europe because residential construction recovery remained weak and commercial construction markets depressed. New product introductions could provide some upside as the year progressed.
- Management viewed Lubrication’s improvement as encouraging, but said significant additional volume would be needed to restore historical operating margins. It reaffirmed investment in product development, international sales resources and distribution, while noting these investments weigh on short-term profitability.
- Key stated risks include economic conditions, currency fluctuations, political instability, changes in laws and regulations, and changes in product demand. The filing reported no material changes to the company’s previously disclosed risk factors or market-risk disclosures.
- The company had interest-rate swaps fixing rates on $80 million of variable-rate borrowings through December 2010 and January 2011; related first-quarter net amounts paid or payable were $0.9 million. Seven foreign-currency contracts had aggregate notional value of $16 million. Management said counterparty credit risk was not significant.
- Financial statements were unaudited and subject to normal recurring adjustments; interim results are not necessarily indicative of full-year results. Disclosure controls were reported effective, with no material change in internal controls during the quarter.
Important facts for investors to verify
- Whether the sales and margin recovery continues, particularly in Asia Pacific and Industrial, and whether it offsets ongoing construction-market weakness.
- Whether higher receivables and inventory convert to cash; operating cash flow fell despite substantially higher net earnings.
- Whether Contractor product launches and Lubrication volume growth deliver the improvement management anticipates.
- Future financing costs and exposure as the $80 million interest-rate swaps approach expiration, as well as the availability and terms of credit lines.
- The effect of the absent federal R&D tax credit and any renewal, and the ongoing costs of growth investments, pension obligations and intangible-asset amortization.