Graco Inc. — Q2 2020 Form 10-Q
Reporting period: Quarter and six months ended June 26, 2020. 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. The unaudited interim statements should be read with the company’s 2019 Form 10-K.
Financial performance
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Net sales | $366.9 million | $428.3 million | $740.5 million | $833.2 million |
| Gross profit margin | 49.8% | 53.0% | 51.5% | 53.2% |
| Operating earnings | $44.8 million | $112.4 million | $134.6 million | $216.9 million |
| Net earnings | $28.8 million | $88.1 million | $101.7 million | $174.9 million |
| Diluted EPS | $0.17 | $0.51 | $0.59 | $1.02 |
| Operating cash flow | — | $142.6 million | $163.8 million |
Q2 sales declined 14%, reported operating earnings 60% and net earnings 67% year over year. For the first half, sales fell 11%, operating earnings 38% and net earnings 42%. Gross margin contracted 3.2 percentage points in Q2 and 1.7 points year to date. Management attributed margin pressure to lower factory volume, unfavorable product and channel mix, and currency translation; reduced high-margin Industrial sales and Contractor growth also weighed on mix.
Excluding the Alco impairment, management reported Q2 adjusted net earnings of $62.3 million and adjusted diluted EPS of $0.37, down 27% and 26%, respectively. First-half adjusted net earnings were $127.5 million and adjusted diluted EPS $0.74, down 23% and 24%. These are non-GAAP measures; reported results include the impairment and tax adjustments described in the filing.
Segments and material changes
- Industrial: Q2 sales fell 29% to $133.3 million; segment operating margin was 28%, versus 34%. First-half sales fell 23% to $292.0 million.
- Process: Q2 sales fell 9% to $77.8 million; margin was 15%, versus 22%. Acquisitions contributed about $7 million of Q2 sales. First-half sales declined 5% to $163.8 million.
- Contractor: Q2 sales increased 1% to $155.8 million; margin held at 26%. First-half sales were essentially flat at $284.7 million, with margin up one percentage point to 24%.
- Q2 and first-half results included a $35 million non-cash impairment charge related to the U.K.-based Alco valve business; the after-tax impact was $34 million, or $0.20 per diluted share. Graco completed the sale in Q3, subject to post-closing adjustments.
Liquidity, debt and capital allocation
At June 26, 2020, cash and cash equivalents were $432.7 million, compared with $221.0 million at year-end 2019. Current assets were $1.038 billion and current liabilities $310.4 million. Notes payable to banks were $20.6 million and long-term debt was $400.0 million, versus $7.7 million and $164.3 million, respectively, at year-end. The company borrowed $250 million under its $500 million revolver in March to preserve financial flexibility. It reported $326 million of unused credit lines within total lines of $595 million; it also had authority under a note agreement to issue up to $200 million of senior notes, none issued as of quarter-end.
First-half operating cash flow was $142.6 million. Investing cash outflows included $32.6 million of capital expenditures and $27.2 million for acquisitions. Financing included $102.1 million of share repurchases and $58.5 million of dividends paid. Management said cash and available financing were expected to support 2020 operating needs, capital expenditures, dividends, share repurchases and acquisitions.
Outlook, risks and unusual items
The filing provides no quantified revenue or earnings guidance. Management said recovery timing and shape were highly uncertain, while long-term strategic initiatives continued and could pressure near-term results. Organic, constant-currency incoming orders fell about 24% in April, then improved sequentially in May and June. Industrial and Process order rates had not returned to pre-pandemic levels; Contractor orders had grown, but the duration and level of that activity were uncertain.
COVID-19 adversely affected operations, supply chains, distributors, end-user demand and selling activities. Customer capital-equipment purchases were deferred, while supplier or distributor closures and operational changes could cause delays, added costs or reduced productivity. Management said current operating cash flows and available liquidity were sufficient at then-current order rates, but could not predict the pandemic’s ultimate financial impact. Other disclosed risks include global economic conditions, currency movements, demand changes, supply interruptions, acquisitions and potential impairments, and exposure to construction, automotive, mining, oil and natural gas markets.
The Q2 effective tax rate was 31.4%, primarily reflecting non-deductible impairment charges; the adjusted rate was 19.1%. First-half reported effective tax rate was 18.1%, compared with 16.1% a year earlier. A second-quarter business acquisition was described as not material to the consolidated financial statements.
Important facts for investors to verify
- Whether Industrial and Process orders and margins recover, and whether Contractor demand remains resilient.
- The final proceeds and post-closing adjustments from the Q3 Alco sale, and any further related costs.
- Cash generation, debt levels and borrowing capacity as the company funds dividends, repurchases, investment and acquisitions.
- The assumptions underlying management’s COVID-19 and recovery commentary, particularly supply-chain, channel and customer-demand risks.
- The reconciliation and comparability of management’s adjusted, non-GAAP earnings measures with reported GAAP results.