Graco Inc. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 30, 2018; comparative period ended March 31, 2017. The unaudited financial statements are prepared on a consolidated basis. 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 performance
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Net sales | $406.3 million | $340.6 million | +19% |
| Gross profit | $222.4 million | $185.8 million | +20% |
| Operating earnings | $111.7 million | $87.4 million | +28% |
| Net earnings | $85.5 million | $60.7 million | +41% |
| Diluted EPS | $0.49 | $0.35 | +40% |
| Operating cash flow | $58.8 million | $50.2 million | +$8.5 million |
Gross margin was 54.7%, versus 54.6%; operating margin was 27.5%, versus 25.7%; and net margin was 21.0%, versus 17.8%. Interest expense declined to $3.2 million from $4.1 million. The reported effective tax rate was 20.4%, versus 25.6%. Management reported adjusted net earnings of $84.1 million and adjusted diluted EPS of $0.48, excluding excess tax benefits from stock-option exercises; these non-GAAP figures compare with $57.0 million and $0.33, respectively.
Growth, segments and material changes
- Sales grew 11% from volume and price, 3% from acquisitions and 5% from currency translation. Growth was double-digit across all segments and regions.
- Industrial sales were $195.2 million (+25%); operating earnings were $69.1 million, with a 35% segment margin versus 34%. Growth included $9 million from acquired operations.
- Process sales were $80.0 million (+14%); operating earnings were $17.7 million, with a 22% margin versus 19%. Management cited broad application growth, particularly in Lubrication.
- Contractor sales were $131.1 million (+15%); operating earnings were $31.4 million, with a 24% margin versus 23%. Sales increased across channels.
- By region, sales increased 11% in the Americas, 28% in EMEA and 36% in Asia Pacific. Currency translation added approximately $14 million, or five percentage points, to consolidated growth.
- Operating expenses increased 13% to approximately $110.7 million, but grew more slowly than sales. Management cited currency, acquired operations and higher incentive and share-based compensation costs.
Cash, debt and liquidity
Cash and cash equivalents were $113.8 million at March 30, 2018, up from $103.7 million at year-end; $9.2 million was restricted for self-insurance reserves. Current assets were $716.2 million and current liabilities were $280.6 million. Total debt, comprising bank notes payable and long-term debt, was $297.1 million, compared with $232.6 million at year-end. The company had $546 million of credit lines, of which $475 million was unused.
Operating cash flow of $58.8 million was partly offset by $19.8 million of investing outflows and $28.2 million of financing outflows. Investing included $9.0 million of capital expenditures and $10.9 million for acquisitions. Financing included $84.7 million of share repurchases and $22.4 million of dividends, partly offset by borrowings and share issuance.
Outlook, risks and notable items
- Graco raised its full-year 2018 outlook to mid-to-high single-digit worldwide organic sales growth on a constant-currency basis, from prior guidance for mid-single-digit growth. It expected mid-to-high single-digit full-year growth regionally.
- Management expected Industrial second-quarter growth to moderate; first-half Industrial sales growth was expected to be consistent with the company’s full-year outlook. In Q1, Industrial sales growth exceeded bookings.
- Acquired operations and purchase accounting weighed on gross margins, including a $1 million charge for acquired inventory valuation. Acquisitions were described as not material to the consolidated financial statements.
- Federal tax reform reduced the reported effective tax rate by eight percentage points versus the prior-year quarter. The company said its accounting for certain transition-tax effects remained incomplete and provisional estimates were recorded.
- The company adopted ASC 606 using the modified retrospective approach; adoption had no material impact on operations or opening retained earnings. It also early-adopted guidance on stranded tax effects, reclassifying $15.5 million from accumulated other comprehensive income to retained earnings.
- Management identified risks including economic and industry conditions, currency movements, acquisition execution and impairment, customer demand and concentration, supply interruptions, international operations, regulation, litigation, cybersecurity and personnel. No material changes to previously disclosed risk factors or market-risk disclosures were reported.
- The company expected adoption of the new lease standard in 2019 to materially increase balance-sheet assets and liabilities, but could not yet estimate the amount; it did not expect a material impact on earnings or shareholders’ equity.
Important facts for investors to verify
- Whether organic sales growth and the raised full-year outlook are achieved, including the expected moderation in Industrial growth.
- How acquired businesses affect margins and whether acquisition-related purchase-accounting effects persist.
- Whether receivables, inventory and incentive-related cash outflows normalize as growth continues, and how debt and share repurchases affect liquidity.
- Final tax-accounting estimates and the balance-sheet impact of implementing lease accounting in 2019.
- Potential exposure to Contractor customer concentration and fluctuations in construction, automotive, mining, and oil and natural gas markets.