Graco Inc. — Q2 2014 Form 10-Q
Business context and period. Graco designs, manufactures and markets fluid-handling and coating systems and equipment. The unaudited quarter ended June 27, 2014 covered 13 weeks; year-to-date results cover 26 weeks. Reportable segments are Industrial, Contractor and Lubrication. Financial amounts below are in millions except per-share data.
Financial performance
| Metric | Q2 2014 | Q2 2013 | First half 2014 | First half 2013 |
|---|---|---|---|---|
| Net sales | $322.5 | $286.0 | $612.5 | $555.1 |
| Gross profit | $176.9 | $158.7 | $336.2 | $309.4 |
| Operating earnings | $85.8 | $75.2 | $160.6 | $146.7 |
| Net earnings | $66.2 | $57.8 | $117.0 | $110.0 |
| Diluted earnings per share | $1.07 | $0.92 | $1.88 | $1.76 |
| Gross margin | About 55% | About 56% | About 55% | About 56% |
| Operating margin | 26.6% | 26.3% | 26.2% | 26.4% |
- Q2 sales, operating earnings, net earnings and diluted EPS rose 13%, 14%, 15% and 16%, respectively. First-half growth was 10%, 9%, 6% and 7%.
- First-half operating cash flow was $84.0, down from $100.2. Capital expenditures were $17.1; cash used for acquisitions was $65.2. Cash and equivalents ended the period at $29.6.
- At June 27, current assets were $859.5 and current liabilities $165.2. Current assets include a $421.8 investment in businesses held separate, not ordinary cash. Short-term bank notes were $12.6 and long-term debt $522.8, for total reported debt of $535.4, compared with $418.0 at year-end 2013.
- Graco had $552 of credit lines, of which $317 was unused. Its amended revolving facility provides up to $500, matures June 26, 2019 and has improved borrowing spreads and commitment fees.
- Cash dividends declared were $0.28 per share in Q2 and $0.55 year-to-date, compared with $0.25 and $0.50, respectively, in 2013. First-half share repurchases totaled $93.8.
Material changes and drivers
- All segments grew in Q2: Industrial sales increased 14%, Contractor 13% and Lubrication 7%. First-half growth was 11%, 11% and 6%, respectively. Q2 sales increased across all regions; first-half Asia Pacific sales were flat overall and down 1% on the company’s reported growth bridge.
- Acquisitions contributed approximately 4 percentage points to Q2 sales growth and 3 points year-to-date. The QED Environmental Systems acquisition, completed in Q1 for approximately $65 cash, expanded Industrial into environmental monitoring and remediation. The acquisition added $37.3 of goodwill and $22 of identifiable intangible assets.
- Gross margin declined by less than one percentage point, reflecting product mix and lower margins at acquired operations; year-to-date results also included approximately $1 of non-recurring purchase-accounting inventory effects. Expense leverage helped operating earnings; operating expenses rose 9% in Q2 and 8% year-to-date.
- Contractor and Lubrication segment operating margins improved year-to-date; Industrial’s declined, in part because of acquired-business margins and investments in growth initiatives. The first-half effective tax rate was 29%, versus a lower prior-year rate that benefited from the renewed federal R&D credit.
Outlook, risks and unusual items
- Management said it was well positioned for full-year growth in all segments and geographies. It expected low-double-digit growth in Contractor’s Americas business and cited mid-single-digit organic growth as the second-half outlook, with potential upside from stable developed-market conditions and firmer demand in emerging EMEA markets and China. This is commentary, not a specific full-year earnings or sales forecast.
- The FTC’s proposed order requires divestiture of the Liquid Finishing businesses, subject to a final order. Graco was marketing the business and must keep it separate and viable in the interim. The $421.8 investment was not considered impaired at quarter-end. Dividends from Liquid Finishing were $11 in Q2 and $15 year-to-date; management said dividends would cease after the sale. Graco may also need to provide resources to maintain the separate businesses.
- Management cited risks including economic and demand changes, construction and automotive activity, international and political risks, supply interruptions, competition and intellectual-property issues, regulation and litigation, cybersecurity and natural disasters, and the ability to complete the FTC-required divestiture. The filing reported no material change to previously disclosed risk factors and no material change in market-risk disclosures.
- A new revenue-recognition standard was issued in May 2014, effective for Graco in fiscal 2017; the company was evaluating its effect and had not selected a transition method. Disclosure controls were judged effective, with no material change in internal control over financial reporting reported.
Key facts for investors to verify
- Progress, timing, proceeds and any obligations associated with the FTC-required Liquid Finishing divestiture, including the effect of ending related dividends.
- Whether organic sales growth and acquired-business margins meet management’s outlook, particularly in Industrial and Asia Pacific.
- Whether receivables and inventory growth convert to cash; operating cash flow fell despite higher earnings.
- Debt levels, financing capacity and capital allocation, including the pace of share repurchases and dividends.
- The effect of the expired federal R&D credit and other tax-rate factors on subsequent results.