Graco Inc. — First-Quarter 2011 Form 10-Q
Business context and reporting period
Graco designs, manufactures and markets equipment and systems for moving, measuring, controlling, dispensing and spraying fluid materials. This unaudited report covers the 13 weeks ended April 1, 2011, compared with the 13 weeks ended March 26, 2010. Its reportable segments are Industrial, Contractor and Lubrication.
Financial results and liquidity
| Metric | Q1 2011 | Q1 2010 | Change |
|---|---|---|---|
| Net sales | $217.7 million | $164.7 million | +32% |
| Gross profit / margin | $124.4 million / 57% | $89.3 million / 54% | Margin +3 points |
| Operating earnings | $57.1 million | $32.7 million | +75% |
| Net earnings | $37.3 million | $20.6 million | +81% |
| Diluted EPS | $0.61 | $0.34 | +79% |
| Operating cash flow | $14.2 million | $16.0 million | Down $1.9 million |
All three segments and geographic regions recorded double-digit sales growth. Segment sales and operating earnings were: Industrial, $122.8 million and $45.0 million; Contractor, $70.2 million and $11.1 million; Lubrication, $24.6 million and $5.2 million. Management attributed improved margins and earnings mainly to higher volume and expense leverage. Selling price increases also contributed to gross-margin improvement.
Operating expenses rose 19% to approximately $76.3 million, including higher selling and marketing costs, payroll and product promotion. Expenses declined as a share of sales to 31% from 34%. The effective tax rate was 34%, versus 34.5%, with the 2011 rate benefiting from the federal research and development credit.
At April 1, cash and cash equivalents were $102.5 million, versus $9.6 million at year-end 2010. Current assets were $380.5 million and current liabilities $121.8 million. Notes payable to banks were $11.2 million and long-term debt was $150.0 million. The company reported $262 million unused of $271 million in credit lines and compliance with debt covenants. The March private placement of $150 million in unsecured notes funded repayment of revolving borrowings and investment in cash equivalents. Cash dividends declared were $0.21 per share, compared with $0.20.
Material changes and management commentary
Sales increased 33% in the Americas, 27% in Europe, and 35% in Asia Pacific (31% at consistent translation rates). Management said currency translation had no significant effect on consolidated results. Operating cash flow declined despite higher earnings, mainly because of increased receivables and inventory and incentive and bonus payments made in Q1 2011. Since year-end, receivables increased $29 million and inventories increased $11 million.
Management was optimistic that sales momentum would continue through 2011, while warning that percentage gains could moderate against tougher comparisons, particularly in Contractor following initial stocking of new handheld products in Q2 2010. The filing gives no numerical full-year sales or earnings guidance.
Acquisition, risks and contingencies
In April 2011, after the quarter-end, Graco agreed to acquire Illinois Tool Works’ finishing businesses for $650 million in cash, with closing expected in Q3 2011 subject to regulatory approval and other conditions. Graco planned to fund the purchase using a new committed $450 million revolving credit facility and funds available under the note agreement; the new facility had not yet been executed. The note agreement provides for a further $150 million note issuance on or before July 26, 2011.
If Graco terminates the acquisition agreement before April 1, 2012 because regulatory approval is not obtained, it may owe a $20 million termination fee. Risks include obtaining approvals and financing, satisfying closing conditions, incurring acquisition-related debt, integration, and whether anticipated benefits are realized. The filing reports no material change in market risks and no material change in internal controls; management concluded disclosure controls were effective.
Important facts for investors to verify
- Whether regulatory approvals and closing conditions are satisfied and the acquisition closes on the expected timetable.
- Whether the planned $450 million revolving facility is executed on acceptable terms and how the acquisition affects leverage and covenant headroom.
- Whether strong sales growth and margin gains persist as comparisons become more difficult, especially in Contractor.
- How working-capital demands, particularly receivables and inventory, affect operating cash generation.
- Whether the acquisition delivers expected financial results and benefits without material integration or customer, supplier, competitor or employee disruption.