Graco Inc. — Q1 2015 Form 10-Q
Reporting period: Thirteen weeks ended March 27, 2015; comparisons are to the thirteen weeks ended March 28, 2014. Figures are in U.S. dollars; financial statement amounts below are in millions unless stated otherwise.
Business context and results
Graco designs and sells equipment and systems to move, measure, control, dispense and spray fluids and coatings. It reports Industrial, Process and Contractor segments. Segment presentation was revised in 2015, with prior-period information restated.
- Sales: $306.5 million, up 6%. Organic sales at consistent exchange rates rose 5%; acquisitions contributed 5 percentage points of growth, while currency reduced sales by about $13 million.
- Profit and margins: Gross profit was $162.1 million, with gross margin of about 52.9%, down approximately 2 percentage points. Operating earnings fell 13% to $65.2 million; operating margin was about 21.3%, versus 25.8% a year earlier. Net earnings rose 36% to $68.8 million; diluted EPS was $1.14, up 41%.
- Investment-income effect: Earnings included $30 million of dividends from the Liquid Finishing investment held separate from Graco’s operating businesses. Excluding net held-separate investment income, adjusted net earnings were $39.1 million versus $46.9 million, and adjusted diluted EPS was $0.65 versus $0.75. The reported earnings increase therefore does not reflect improvement in ongoing operating earnings.
- Cash flow: Operating cash flow was $47.2 million, versus $28.2 million. Investing activities used $192.7 million, including $182.9 million for acquisitions. Financing provided $148.0 million. Cash ended the quarter at $27.7 million.
- Debt and liquidity: At March 27, short-term bank notes were $52.0 million and long-term debt was $767.0 million, totaling $819.1 million, versus $620.0 million at year-end. Graco reported $588 million in credit lines, of which $70 million was unused. Current assets of $905.3 million included the $421.8 million held-separate investment.
- Shareholder returns: The company repurchased $46.9 million of stock and paid $17.7 million in dividends during the quarter. The declared dividend was $0.30 per share, versus $0.28.
Material changes and segment performance
- Industrial: Sales decreased 6% to $143.3 million; operating earnings fell to $42.9 million from $49.1 million. Currency and higher expenses relative to sales pressured margin.
- Process: Sales increased 28% to $67.7 million, largely due to acquisitions; operating earnings fell to $10.5 million from $12.6 million. Currency and investment in oil and gas products reduced margin.
- Contractor: Sales rose 12% to $95.5 million, led by the Americas; operating earnings increased to $19.4 million from $18.3 million. Margin declined about 1 percentage point amid currency effects and higher marketing and launch spending.
- Total operating expenses increased $12 million, or 15%, including acquired-operation expenses and spending on regional expansion, product initiatives, Contractor marketing, pensions, stock compensation and a new central warehouse. Purchase accounting costs and product mix also weighed on gross margin.
- Graco acquired High Pressure Equipment Holdings (HiP) for $160 million cash and White Knight Fluid Handling for $16 million cash plus contingent consideration valued at $8 million. The quarter also included $7 million of HiP sales. These acquisitions expanded the Process segment.
Outlook, risks and unusual items
- Management remained committed to mid-single-digit organic sales growth at constant currency for full-year 2015, with growth in every reportable segment and geography. It cautioned that continued growth investments would hamper near-term profitability.
- At then-current exchange rates, management estimated full-year currency headwinds of approximately 5% on sales and 11% on earnings. Geopolitical instability and currency movements were cited as concerns.
- The Liquid Finishing asset sale closed on April 1, 2015, after quarter-end, for $590 million cash, subject to customary adjustments. Graco said it used proceeds to repay approximately $500 million of debt, including a $40 million short-term borrowing, and expected to use remaining proceeds for share repurchases and strategic acquisitions.
- Other disclosed risks include economic conditions, international operations, customer demand, supply interruptions, regulation and litigation, intellectual-property infringement, security breaches, and possible reduced purchases by large Contractor customers. The filing reported no material change to market-risk disclosures or risk factors other than deletion of the Liquid Finishing divestiture risk. Management stated disclosure controls were effective.
Most important facts for investors to verify
- Reconcile reported net earnings and EPS with the $30 million Liquid Finishing dividend and the filing’s adjusted, non-GAAP results excluding held-separate investment income.
- Confirm completion and final proceeds of the April 1 sale, the amount and timing of debt repayment, and remaining debt and liquidity after the transaction.
- Assess whether sales growth can meet management’s outlook after separating organic performance, acquisition contributions and foreign-exchange effects.
- Monitor margin recovery, especially in Industrial and Process, given elevated expenses, acquisition accounting, and planned growth investments.