Graco Inc. — Q3 2016 Form 10-Q
Business and period: Graco designs, manufactures and markets equipment and systems for moving, measuring, controlling, dispensing and spraying fluids and coatings. The unaudited quarter ended September 23, 2016; year-to-date figures cover the nine months ended that date. Its reportable segments are Industrial, Process and Contractor.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net sales | $327.2m | $319.0m | $980.2m | $960.9m |
| Gross profit / margin | $176.6m / 54.0% | $170.2m / 53.4% | $523.5m / 53.4% | $512.9m / 53.4% |
| Operating earnings / margin | $81.5m / 24.9% | $76.9m / 24.1% | $220.8m / 22.5% | $226.0m / 23.5% |
| Net earnings | $54.4m | $50.7m | $144.9m | $292.2m |
| Diluted EPS | $0.95 | $0.86 | $2.55 | $4.90 |
| Operating cash flow | Not separately provided for quarter | $201.9m | $135.2m |
Q3 sales rose 3%, operating earnings 6% and net earnings 7% year over year. Nine-month sales grew 2%, while operating earnings declined 2%. The large year-over-year decline in reported nine-month net earnings and EPS reflects 2015 investment income from the Liquid Finishing business sold that year. Excluding investment income and expense, nine-month net earnings were $144.9m versus $151.2m and diluted EPS was $2.55 versus $2.54. On the same adjusted basis, Q3 diluted EPS was $0.95 versus $0.84.
Q3 sales growth included 2% organic growth at consistent exchange rates and a 1 percentage-point contribution from recent acquisitions. Year-to-date sales growth included 1% organic growth and a 2 percentage-point acquisition contribution. Currency translation reduced year-to-date sales by about $9m and net earnings by about $2m.
Liquidity, debt and capital
- At September 23, cash and equivalents were $53.3m; current assets were $498.2m and current liabilities $177.2m. Restricted cash of $9m was included in other current assets.
- Short- and long-term debt totaled approximately $364.2m, down from $408.6m at December 25, 2015. The company reported $547m of credit lines, of which $484m was unused.
- Nine-month operating cash flow was $201.9m. Investing cash use was $83.0m, including $48.6m for acquisitions and $34.3m for capital expenditures. Financing cash use was $116.0m, including $48.1m of share repurchases and $55.1m of dividends paid.
- Cash increased $1.0m from year-end to $53.3m. Dividends declared were $0.33 per share in Q3 and $0.99 year to date.
Segments and material changes
- Industrial: Q3 sales decreased 1% to $150.9m; nine-month sales increased 1% to $455.0m. Year-to-date operating earnings rose to $147.4m from $144.5m.
- Process: Q3 sales increased 4% to $67.1m, but nine-month sales fell 4% to $196.1m. Year-to-date operating earnings decreased to $25.3m from $34.9m, with lower volume and unfavorable expense leverage cited.
- Contractor: Q3 sales increased 7% to $109.2m; nine-month sales increased 7% to $329.2m. Year-to-date operating earnings rose modestly to $71.7m from $70.6m, while margin rates declined slightly.
Management said Q3 gross margin improved slightly, as pricing and product/channel mix offset lower factory volume. Year-to-date gross margin was flat. Q3 operating expenses increased $2m year over year; year-to-date expenses increased $16m, including acquired-business expenses.
Outlook, risks and unusual items
- Management maintained its outlook for low-single-digit worldwide sales growth in full-year 2016. It expected the Americas to be flat, revising down from prior low-single-digit growth; EMEA expectations remained low-to-mid-single-digit growth and Asia Pacific low-single-digit growth.
- Management described worldwide industrial capital-equipment spending as uneven, with weakness particularly evident in the Americas, and remained cautious about Process segment headwinds. A strong organic, constant-currency comparison in Q4 2015 was expected to make the final quarter’s comparison difficult.
- Weak oil and natural gas markets and ONG results below expectations prompted a goodwill impairment review. Preliminary analysis indicated potential impairment. ONG goodwill was $147m and related identifiable intangible assets were $73m; the company could not yet estimate the potential non-cash charge and expected to complete the valuation in Q4.
- Other disclosed risks include economic and currency changes, acquisition performance and impairments, international operations, supply interruptions, product demand, large Contractor customers, and activity in construction, automotive, mining, and oil and gas markets. The filing reported no material change in market-risk disclosures and no material change to internal controls during the quarter.
Important facts for investors to verify
- Q4 outcome of the ONG impairment analysis, including any charge and its effect on earnings and asset values.
- Whether full-year low-single-digit sales growth guidance was achieved, particularly given the revised flat outlook for the Americas and the difficult Q4 comparison.
- Whether Process segment sales and margins improved after the year-to-date declines, and whether Industrial and Contractor trends continued.
- How acquisition-related costs, capital spending, dividends, and repurchases affected cash generation and debt levels.
- Comparability of reported earnings: 2015 results included Liquid Finishing investment income, including a $149m pretax sale gain and year-to-date dividend income.