Graco Inc. — Q2 2015 Form 10-Q
Reporting period: Thirteen weeks ended June 26, 2015; year-to-date figures cover the twenty-six weeks ended June 26, 2015. Comparisons are with the corresponding 2014 periods. Graco designs, manufactures and markets equipment and systems for moving, measuring, controlling, dispensing and spraying fluids and coatings.
Financial performance
| Metric | Q2 2015 | Q2 2014 | First half 2015 | First half 2014 |
|---|---|---|---|---|
| Net sales | $335.5 million | $322.5 million | $641.9 million | $612.5 million |
| Gross profit | $180.6 million | $176.9 million | $342.8 million | $336.2 million |
| Operating earnings | $83.9 million | $85.8 million | $149.1 million | $160.6 million |
| Net earnings | $172.6 million | $66.2 million | $241.5 million | $117.0 million |
| Diluted earnings per share | $2.90 | $1.07 | $4.02 | $1.88 |
- Sales rose 4% in Q2 and 5% year to date. Currency translation reduced sales by about $17 million and $30 million, respectively.
- Reported gross margin was approximately 53.8% in Q2 and 53.4% year to date, below the comparable 2014 periods. Management attributed the decline mainly to currency and lower gross margins at acquired businesses, including purchase accounting effects.
- Operating earnings fell 2% in Q2 and 7% year to date, despite higher sales, as operating expenses increased. Operating expenses were up $6 million in Q2 and $18 million year to date, including acquisition costs and spending on expansion initiatives.
- Net earnings and EPS included after-tax Liquid Finishing sale proceeds and dividends of $110 million ($1.85 per diluted share) in Q2 and $139 million ($2.32 per share) year to date. Excluding held-separate investment income and related effects, the company reported adjusted diluted EPS of $1.05 versus $0.89 in Q2, and $1.70 versus $1.65 year to date. These are company-presented non-GAAP measures.
- Operating cash flow was $96.7 million versus $84.0 million in the first half of 2014. Investing cash flow was $381.8 million, including $589.8 million of proceeds from the Liquid Finishing asset sale and $187.9 million spent on acquisitions. Financing cash flow was a $460.0 million use, including $773.1 million of long-term debt repayments, $130.6 million of share repurchases and $35.3 million of dividends.
- Cash was $44.3 million at June 26, 2015. Long-term debt was $300.4 million, down from $615.0 million at year-end 2014; notes payable to banks were $10.4 million. The company reported $549 million of credit lines, of which $539 million was unused.
Material changes and segment results
- Industrial sales declined 2% in Q2 and 4% year to date as reported; at consistent currency translation rates, they increased 4% and 2%, respectively. Segment operating margin was approximately 33% in Q2 and 32% year to date, broadly in line with 2014.
- Process sales increased 31% in Q2 and 29% year to date, largely from acquisitions; organic growth at consistent currency rates was 4% in both periods. Operating margin declined to approximately 19% in Q2 and 18% year to date, versus 25% and 24%, reflecting acquired-business margins, currency and investment in oil and natural gas products.
- Contractor sales declined 1% in Q2 and increased 5% year to date as reported; at consistent currency rates they rose 3% and 9%. Segment margin was approximately 25% in Q2 and 23% year to date, with the first-half decline linked partly to currency and marketing and product-launch spending.
- Graco sold its Liquid Finishing assets in April for $590 million cash, subject to customary post-closing adjustments, recognizing a $147 million pretax gain. It said no further dividends from Liquid Finishing would be received.
- The company acquired High Pressure Equipment for $160 million in January and White Knight Fluid Handling for $16 million cash plus contingent consideration valued at $8 million. Acquisitions contributed substantially to Process growth; acquired operations contributed 6 percentage points to consolidated sales growth in both Q2 and the first half.
- Beginning in 2015, Graco revised its reportable segments by combining Process, Oil and Natural Gas, and Lubrication in the Process segment; prior-period segment information was restated.
Outlook, risks and other matters
- Management continued to target mid-single-digit organic sales growth on a constant-currency basis for full-year 2015, with growth in all reportable segments and regions. It identified the Americas as its strongest region and expressed optimism about Contractor performance there in the second half.
- Management cited currency uncertainty and geopolitical instability as challenges, particularly for EMEA and Asia Pacific. At then-current exchange rates, it estimated a full-year currency headwind of about 5% on sales and 11% on earnings.
- Other disclosed risks include economic conditions, foreign exchange, international operations, acquisitions and growth initiatives, customer demand and supply interruptions, litigation and indemnification claims related to the Liquid Finishing divestiture, and potential declines in purchases by large Contractor customers.
- The year-to-date effective tax rate was 26%, down 3 percentage points from 2014. The company’s assertion that certain foreign earnings would be indefinitely reinvested reduced related deferred taxes by $7 million; a separate $2 million non-recurring tax benefit also lowered the year-to-date rate.
- In May, Graco entered an accelerated share repurchase for an upfront $60 million. It received 742,880 shares during the quarter and another 94,515 shares after quarter-end to complete the arrangement.
- Management stated disclosure controls were effective and that there had been no material change in internal control over financial reporting during the quarter. The filing reported no material change in market-risk disclosures from the 2014 Form 10-K.
Key facts for investors to verify
- Reconcile reported earnings growth to the $147 million pretax divestiture gain and Liquid Finishing dividends; assess recurring earnings using the company’s non-GAAP reconciliation.
- Track organic sales and margins separately from acquisition contributions, especially in Process, and evaluate whether acquired businesses improve profitability over time.
- Review the effects of currency movements against management’s estimated 2015 sales and earnings headwinds and its mid-single-digit organic-growth target.
- Monitor working-capital requirements, debt and liquidity after the asset-sale proceeds, acquisitions, debt repayments and share repurchases.
- Assess the contingent consideration for White Knight, the final Liquid Finishing sale adjustments, and any litigation or indemnification exposure connected with the divestiture.