Graco Inc. — Q3 2017 Form 10-Q
Business context and period. Graco designs, manufactures and markets fluid and coating management equipment. This unaudited report covers the three and nine months ended September 29, 2017; comparisons are with the periods ended September 23, 2016. The company reports Industrial, Process and Contractor segments.
Financial performance
| Metric | Q3 2017 | Q3 2016 | 9M 2017 | 9M 2016 |
|---|---|---|---|---|
| Net sales | $379.8m | $327.2m | $1,099.9m | $980.2m |
| Operating earnings | $99.6m | $81.5m | $284.2m | $220.8m |
| Net earnings | $75.5m | $54.4m | $216.0m | $144.9m |
| Diluted EPS | $1.30 | $0.95 | $3.73 | $2.55 |
| Gross margin | 53.6% | 54.0% | 53.9% | 53.4% |
| Operating margin | 26.2% | 24.9% | 25.8% | 22.5% |
| Net margin | 19.9% | 16.6% | 19.6% | 14.8% |
Sales rose 16% in Q3 and 12% year to date; operating earnings increased 22% and 29%, respectively. Management attributed earnings growth principally to sales growth and operating expense leverage. Sales growth was broad-based across regions and segments. Nine-month sales increased 11% in the Americas, 10% in EMEA and 18% in Asia Pacific.
Segment highlights: Q3 sales were Industrial $178.5m, Process $73.7m and Contractor $127.7m. Nine-month operating margins were 35% for Industrial, 18% for Process and 25% for Contractor, up 3, 5 and 3 percentage points, respectively, from the prior year. Process continued to face weakness in Oil and Natural Gas.
Cash flow, balance sheet and capital allocation
- Nine-month operating cash flow was $246.1m, versus $207.7m. Investing cash outflow was $40.6m, including $28.9m of capital expenditures and $12.9m for acquisitions. Financing cash outflow was $116.8m.
- Cash and equivalents were $140.0m at September 29, 2017, up from $52.4m at December 30, 2016. Current assets were $642.4m and current liabilities $288.3m.
- Debt comprised $225.0m long term, $75.0m current maturities and $6.2m of bank notes payable at quarter-end. The company had $545m in credit lines, of which $540m was unused.
- Share repurchases were $90.2m, dividends paid were $60.3m, and the company contributed $20m to its funded U.S. defined benefit pension plan. Dividends declared were $0.36 per share for Q3 and $1.08 per share year to date.
Material changes, outlook and notable items
- Reported net earnings benefited from tax items. The new share-based compensation accounting standard reduced income tax expense by $3.2m in Q3 and $20.5m year to date; a further $5.5m tax-planning benefit was recognized year to date. Reported effective tax rates were 22% for Q3 and 21% year to date; adjusted for these items, management reported rates of 31% for both periods. Adjusted diluted EPS was $1.15 for Q3 and $3.28 year to date, compared with reported EPS of $1.30 and $3.73.
- Gross margin declined 0.5 percentage point in Q3 but increased 0.5 point year to date. Higher production volume and pricing helped, while product mix was unfavorable.
- Management said demand remained robust and broad-based and expected the positive business environment to continue into 2018. For Q4, it anticipated low-single-digit organic, constant-currency growth, citing a difficult comparison against a strong prior-year quarter and one fewer week (13 versus 14). Management said full-year 2017 sales growth could reach double digits.
- A pension-plan restructuring effective October 30, 2017 is expected to produce a Q4 settlement loss estimated at $11m–$13m; the actual amount depends on plan assets, the amount transferred to an insurer and the measurement-date discount rate.
- The company said its preliminary assessment of the revenue-recognition standard, effective in 2018, indicated no expected material financial-statement impact, though project-based revenue timing and balance-sheet presentation may change; assessment remained ongoing.
- Management cited risks including economic conditions, currency movements, international operations and regulation, demand and supply disruptions, cybersecurity, acquisitions and impairment, litigation and indemnification claims, and industry cyclicality. It reported no material changes to previously disclosed risk factors or market-risk disclosures.
Important facts for investors to verify
- Whether Q4 and full-year sales performance meet management’s stated outlook, accounting for the shorter quarter and comparison base.
- The sustainability of sales growth and segment margin gains, particularly given product-mix pressure and continued Oil and Natural Gas weakness.
- How much reported earnings growth reflects operating performance versus nonrecurring tax benefits; review the company’s adjusted, non-GAAP measures alongside GAAP results.
- The final pension settlement loss and effects of the plan restructuring, and any actual revenue-recognition transition adjustments.
- Cash generation, debt maturities and use of capital for repurchases, dividends, acquisitions and pension funding.