GRACO INC. Overview
The Company supplies technology and expertise for the management of fluids and coatings in both industrial and commercial applications. It designs, manufactures and markets systems and equipment to move, measure, control, dispense and spray fluid and coating materials. Management classifies the Company's business into three reportable segments: Industrial, Process and Contractor. Key strategies include developing and marketing new products, leveraging products and technologies into additional, growing end-user markets, expanding distribution globally and completing strategic acquisitions that provide additional channel and technologies. The following Management's Discussion and Analysis reviews significant factors affecting the Company's results of operations and financial condition. This discussion should be read in conjunction with the financial statements and the accompanying notes to the financial statements.
Consolidated Results
A summary of financial results follows (in millions except per share amounts):
Three Months Ended Six Months Ended
June 26, June 28, % June 26, June 28, %
2020 2019 Change 2020 2019 Change
Net Sales $ 366.9 $ 428.3 (14) % $ 740.5 $ 833.2 (11) %
Operating Earnings 44.8 112.4 (60) % 134.6 216.9 (38) %
Net Earnings 28.8 88.1 (67) % 101.7 174.9 (42) %
Net Earnings, adjusted (1) 62.3 85.9 (27) % 127.5 166.0 (23) %
Diluted Net Earnings per Common Share
(67) %$ 0.59 $ 1.02 (42) % Diluted Net Earnings per Common Share, adjusted (1)$ 0.37 $ 0.50 (26) %$ 0.74 $ 0.97 (24) %
(1) See below for a reconciliation of adjusted non-GAAP financial measures to GAAP.
Increases in Contractor sales for the quarter and year to date partially offset the impact of double digit organic percentage declines in other segments. Changes in currency translation rates decreased worldwide sales by approximately$5 million for the quarter and$9 million for the year to date. Sales from acquired operations contributed approximately$7 million (2 percentage points) to the second quarter and$12 million (2 percentage points) to the year to date. Changes in product and channel mix, lower factory volume and changes in currency translation rates drove decreases in gross margin rates for the quarter and the year to date. Earnings for the quarter and year to date included non-cash impairment charges of$35 million ($34 million ,$0.20 per diluted share, after tax effects) related to aU.K. -based valve business that was sold in the third quarter. Total operating expenses before impairment charges decreased 10 percent for the quarter and 6 percent for the year to date. Reductions in volume and earnings-based expenses more than offset increases in product development expenses. 15
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Excluding the impact of impairment charges, excess tax benefits related to stock
option exercises and certain tax provision adjustments presents a more
consistent basis for comparison of financial results. A calculation of the
non-GAAP measurements of adjusted operating earnings, earnings before income
taxes, income taxes, effective income tax rates, net earnings and diluted
earnings per share follows (in millions except per share amounts):
Three Months Ended Six Months Ended
June 26, June 28, June 26, June 28,
2020 2019 2020 2019
Operating earnings, as reported $ 44.8 $ 112.4 $ 134.6 $ 216.9
Impairment 35.0 - 35.0 -
Operating earnings, adjusted $ 79.8 $ 112.4 Earnings before income taxes, as reported$ 42.0 $ 107.8 $ 124.1 $ 208.5 Impairment 35.0 - 35.0 - Earnings before income taxes, adjusted$ 77.0 $ 107.8
Income taxes, as reported$ 13.2 $ 19.7 $ 22.5 $ 33.6 Excess tax benefit from option exercises 0.3 2.2 8.0 7.4 Impairment tax benefit 1.2 - 1.2 - Other non-recurring tax benefit - - - 1.5 Income taxes, adjusted$ 14.7 $ 21.9 $ 31.7 $ 42.5 Effective income tax rate As reported 31.4 % 18.2 % 18.1 % 16.1 % Adjusted 19.1 % 20.3 % 19.9 % 20.4 % Net Earnings, as reported$ 28.8 $ 88.1 $ 101.7 $ 174.9 Impairment, net 33.8 - 33.8 - Excess tax benefit from option exercises (0.3) (2.2) (8.0) (7.4) Other non-recurring tax benefit - - - (1.5) Net Earnings, adjusted$ 62.3 $ 85.9
Weighted Average Diluted Shares 170.5 172.0 171.6 171.5 Diluted Earnings per Share As reported$ 0.17 $ 0.51 $ 0.59 $ 1.02 Adjusted$ 0.37 $ 0.50 $ 0.74 $ 0.97 16
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Table of Contents The following table presents an overview of components of net earnings as a percentage of net sales:
Three Months Ended Six Months Ended
June 26, June 28, June 26, June 28,
2020 2019 2020 2019
Net Sales 100.0 % 100.0 % 100.0 % 100.0 %
Cost of products sold 50.2 47.0 48.5 46.8
Gross Profit 49.8 53.0 51.5 53.2
Product development 4.9 4.1 4.7 4.1
Selling, marketing and distribution 13.3 14.1 14.4 14.6
General and administrative 9.8 8.6 9.5 8.5
Impairment 9.6 - 4.7 -
Operating Earnings 12.2 26.2 18.2 26.0
Interest expense 0.9 0.8 0.8 0.8
Other expense (income), net (0.2) 0.2 0.6 0.2
Earnings Before Income Taxes 11.5 25.2 16.8 25.0
Income taxes 3.6 4.6 3.1 4.0
Net Earnings 7.9 % 20.6 % 13.7 % 21.0 %
Net Sales
The following table presents net sales by geographic region (in millions):
Three Months Ended Six Months Ended
June 26, June 28, June 26, June 28,
2020 2019 2020 2019
Americas(1) $ 227.7 $ 253.7 $ 452.5 $ 485.7
EMEA(2) 71.1 101.1 158.9 200.6
Asia Pacific 68.1 73.5 129.1 146.9
Consolidated $ 366.9 $ 428.3 $ 740.5 $ 833.2 (1) North, South and
The following table presents the components of net sales change by geographic
region:
Three Months Six Months
Volume and Price Acquisitions Currency Total Volume and Price Acquisitions Currency Total
Americas (11)% 1% 0% (10)% (7)% 0% 0% (7)%
EMEA (30)% 2% (2)% (30)% (21)% 2% (2)% (21)%
Asia Pacific (9)% 4% (2)% (7)% (13)% 3% (2)% (12)%
Consolidated (15)% 2% (1)% (14)% (12)% 2% (1)% (11)%
Gross Profit
Gross profit margin rates for the quarter and year to date decreased from the
comparable periods last year. Strong price realization was not enough to offset
the adverse impacts of unfavorable product and channel mix (lower high-margin
Industrial sales combined with growth in lower-margin Contractor segment sales),
lower factory volume and changes in currency translation rates.
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Operating Expenses
In the second quarter, the Company entered into negotiations to sell its
U.K. -based valve business ("Alco"), which has significant exposure to oil and
natural gas markets, and has accumulated operating losses since acquired in
2014. Alco operations contributed $7 million of sales for the year to date and
are included within the Company's Process segment. Based on the negotiations to
sell, the Company revalued its investment in Alco, recording non-cash impairment
charges of $35 million , including $24 million of previously unrealized foreign
currency translation losses recorded in accumulated other comprehensive income.
The impact on net earnings was $34 million or $0.20 per diluted share. The sale
of Alco was completed in the third quarter.
Total operating expenses before impairment charges decreased $12 million (10
percent) for the quarter and $14 million (6 percent) for the year to date
compared to last year. Reductions in volume and earnings-based expenses more
than offset increases in product development, which increased 4 percent for the
quarter and 3 percent for the year to date, as the Company continued its
development initiatives.
Other Expense
Other non-operating expenses decreased$2 million for the quarter and increased$3 million for the year to date mostly due to market valuation fluctuations on investments held to fund certain retirement benefits liabilities. Income Taxes The effective income tax rate for the quarter was 31 percent, up 13 percentage points from the comparable period last year, primarily due to non-deductible impairment charges. The effective income tax rate for the year to date was 18 percent, up 2 percentage points from the comparable period last year. The year-to-date increase from the non-deductible impairment charges was partially offset by the favorable impact of an increase in excess tax benefits related to stock option exercises. Economic Uncertainty The ongoing COVID-19 pandemic and related governmental and business responses had an adverse effect on our operations, supply chains, distribution channels, and end-user customers. Incoming order rates, on an organic, constant currency basis, declined by approximately 24 percent in April and improved sequentially in May and June, as government restrictions loosened in certain areas, and as our customers responded favorably to new product offerings. Current order rates for our Industrial and Process segments have not recovered to pre-pandemic levels. While our Contractor segment has seen growth in order rates, there is uncertainty with respect to the duration and level at which the activity will continue. We manufacture and provide essential products and services to a variety of critical infrastructure customers. We have remained operational during the pandemic and we intend to continue providing our products and services to our customers. Our commercial teams are focused on customer service, maintaining end-user customer contact and providing support to our distributors. Our engineering teams continue to develop and launch new products. As a result of the pandemic and various governmental orders, a significant number of our employees are working from home, and we altered our manufacturing operations to allow for appropriate social distancing, hygiene, cleaning and disinfecting. In our supply chain, we have experienced isolated instances of suppliers temporarily closing their operations, delaying order fulfillment or limiting their production, and we are utilizing alternative supply arrangements as needed. We have also experienced isolated instances of distributors reducing or closing their operations, impacting the ability of some of our end-user customers to procure our products through our traditional distribution channels. Some of our end-user customers are deferring capital equipment purchases, and have eliminated in-person sales meetings. In addition, trade shows, industry events and product demonstrations have been cancelled or postponed. As a result, our selling activities and our ability to convert those activities into sales have been and we expect will continue to be adversely impacted. We will continue to manage our working capital, such as receivables and inventory, to align with customer needs and changes in demand for our products and services. The timing and extent of the economic recovery from the pandemic in our major geographies is still uncertain and we cannot predict the magnitude of the impact to the results of our operations or financial position. We do not expect the pandemic to have a significant effect on our liquidity as operating cash flows and available liquidity are sufficient to support operations at current order rates (see Liquidity and Capital Resources below). 18 -------------------------------------------------------------------------------- Table of Contents Segment Results
Certain measurements of segment operations compared to last year are summarized below:
Industrial Segment
The following table presents net sales and operating earnings as a percentage of
sales for the Industrial segment
(dollars in millions):
Three Months Ended Six Months Ended
June 26, June 28, June 26, June 28,
2020 2019 2020 2019
Net Sales
Americas $ 58.4 $ 80.7 $ 132.8 $ 161.6
EMEA 34.8 59.1 81.0 117.2
Asia Pacific 40.0 48.7 78.1 98.8
Total $ 133.2 $ 188.5 $ 291.9 $ 377.6
Operating earnings as a percentage of net sales 28 % 34 % 30 % 34 %
The following table presents the components of net sales change by geographic region for the Industrial segment:
Three Months Six Months
Volume and Price Acquisitions Currency Total Volume and Price Acquisitions Currency Total
Americas (27)% 0% (1)% (28)% (17)% 0% (1)% (18)%
EMEA (40)% 0% (1)% (41)% (29)% 0% (2)% (31)%
Asia Pacific (16)% 0% (2)% (18)% (19)% 0% (2)% (21)%
Segment Total (28)% 0% (1)% (29)% (22)% 0% (1)% (23)%
Industrial segment sales for the quarter and year to date declined in all
regions with worldwide government actions that severely reduced economic
activity in major geographies. While gross margin rates in this segment remained
relatively strong, decreases in operating expenses did not keep pace with the
drop in sales volume, driving operating earnings as a percentage of sales down
compared to last year.
Process Segment
The following table presents net sales and operating earnings as a percentage of
sales for the Process segment
(dollars in millions):
Three Months Ended Six Months Ended
June 26, June 28, June 26, June 28,
2020 2019 2020 2019
Net Sales
Americas $ 45.9 $ 55.1 $ 101.0 $ 112.2
EMEA 13.2 14.3 29.0 30.1
Asia Pacific 18.6 15.7 33.8 29.7
Total $ 77.7 $ 85.1 $ 163.8 $ 172.0
Operating earnings as a percentage of net
sales 15 % 22 % 18 % 22 %
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The following table presents the components of net sales change by geographic
region for the Process segment:
Three Months Six Months
Volume and Price Acquisitions Currency Total Volume and Price Acquisitions Currency Total
Americas (20)% 4% 0% (16)% (13)% 3% 0% (10)%
EMEA (17)% 11% (2)% (8)% (11)% 9% (2)% (4)%
Asia Pacific 1% 20% (3)% 18% (1)% 18% (3)% 14%
Segment Total (16)% 8% (1)% (9)% (11)% 7% (1)% (5)%
Acquired operations in the Process segment contributed sales of $7 million for
the quarter and $12 million for the year to date. Lower volume, higher product
costs, unfavorable channel and product mix, and lower operating margins of
acquired operations combined to decrease operating earnings as a percentage of
sales for both the quarter and the year to date.
Contractor Segment
The following table presents net sales and operating earnings as a percentage of
sales for the Contractor segment
(dollars in millions):
Three Months Ended Six Months Ended
June 26, June 28, June 26, June 28,
2020 2019 2020 2019
Net Sales
Americas $ 123.3 $ 118.0 $ 218.6 $ 211.9
EMEA 23.0 27.7 48.8 53.3
Asia Pacific 9.5 9.1 17.2 18.4
Total $ 155.8 $ 154.8 $ 284.6 $ 283.6
Operating earnings as a percentage of net
sales 26 % 26 % 24 % 23 %
The following table presents the components of net sales change by geographic region for the Contractor segment:
Three Months Six Months
Volume and Price Acquisitions Currency Total Volume and Price Acquisitions Currency Total
Americas 5% 0% (1)% 4% 3% 0% 0% 3%
EMEA (15)% 0% (2)% (17)% (6)% 0% (2)% (8)%
Asia Pacific 9% 0% (4)% 5% (3)% 0% (4)% (7)%
Segment Total 1% 0% 0% 1% 1% 0% (1)% 0%
Contractor segment sales increased by 1 percent at consistent currency
translation rates for both the quarter and the year to date. Favorable response
to new product offerings and continued stability in construction markets in the
Americas drove the increase. Operating margin rate was steady for the quarter
and increased by 1 percentage point for the year to date, as the favorable
effects of strong realized pricing and expense leverage offset unfavorable
effects of product and channel mix and higher factory spending.
Liquidity and Capital Resources
Net cash provided by operating activities totaled$143 million in the first half of 2020, down$21 million from the comparable period of 2019. The decrease was driven by lower sales and net earnings. Purchases of Company common stock totaling$102 million in 2020 were partially offset by net proceeds from shares issued totaling$40 million . Other significant uses of cash included dividend payments of$58 million , property, plant and equipment additions of$33 million and business acquisitions of$27 million . The Company may make additional opportunistic share purchases going forward. 20 -------------------------------------------------------------------------------- Table of Contents InMarch 2020 , the Company borrowed$250 million under its$500 million revolving credit facility in order to increase its cash position and preserve financial flexibility. The proceeds from the advance are available to be used for working capital, general corporate or other purposes. Significant uses of cash in 2019 included cash dividends of$53 million , property, plant and equipment additions of$70 million and business acquisitions of$6 million . Proceeds from shares issued in the first half of 2019 totaled$33 million , partially offset by$2 million of payments for shares repurchased in 2018 and settled in 2019. AtJune 26, 2020 , the Company had various lines of credit totaling$595 million , of which$326 million was unused. In addition to its lines of credit, under the terms of a master note agreement with a sole lender expiring inJanuary 2023 , the Company may issue up to$200 million of senior notes. Interest on the notes will be determined at the time of issuance, at a fixed or LIBOR-based floating rate at the option of the Company, provided that the maximum aggregate principal amount of notes bearing interest at a floating rate may not exceed$100 million . Fixed rate notes issued under the agreement will mature no longer than 12 years from date of issuance and variable rate notes will mature no longer than 10 years from date of issuance. Cash balances and unused financing sources are expected to provide the Company with the flexibility to meet its liquidity needs in 2020, including its capital expenditure plan, planned dividends, share repurchases, acquisitions and operating requirements.
Outlook
While weak economic conditions affected our business in the second quarter, we remain committed to our long-term strategy. Our initiatives for 2021 and beyond have continued as usual. We will use this difficult period to strengthen our competitive position, expand our product offering, build our global channel and enter new market spaces. These initiatives may put pressure on our short-term financial results, but will position us to capitalize when market conditions normalize. We also recognize that the timing and shape of a recovery is highly uncertain. We will remain agile and have contingency plans in place to appropriately respond to conditions as they unfold.
Cautionary Statement Regarding Forward-Looking Statements
The Company desires to take advantage of the "safe harbor" provisions regarding forward-looking statements of the Private Securities Litigation Reform Act of 1995 and is filing this Cautionary Statement in order to do so. From time to time various forms filed by our Company with theSecurities and Exchange Commission , including our Form 10-K, Form 10-Qs and Form 8-Ks, and other disclosures, including our 2019 Overview report, press releases, earnings releases, analyst briefings, conference calls and other written documents or oral statements released by our Company, may contain forward-looking statements. Forward-looking statements generally use words such as "expect," "foresee," "anticipate," "believe," "project," "should," "estimate," "will," and similar expressions, and reflect our Company's expectations concerning the future. All forecasts and projections are forward-looking statements. Forward-looking statements are based upon currently available information, but various risks and uncertainties may cause our Company's actual results to differ materially from those expressed in these statements. The Company undertakes no obligation to update these statements in light of new information or future events. Future results could differ materially from those expressed due to the impact of changes in various factors. These risk factors include, but are not limited to: the impact of the COVID-19 pandemic on our business; economic conditions inthe United States and other major world economies; our Company's growth strategies, which include making acquisitions, investing in new products, expanding geographically and targeting new industries; changes in currency translation rates; the ability to meet our customers' needs and changes in product demand; supply interruptions or delays; security breaches; new entrants who copy our products or infringe on our intellectual property; risks incident to conducting business internationally; catastrophic events; changes in laws and regulations; compliance with anti-corruption and trade laws; changes in tax rates or the adoption of new tax legislation; the possibility of asset impairments if acquired businesses do not meet performance expectations; political instability; results of and costs associated with litigation, administrative proceedings and regulatory reviews incident to our business; our ability to attract, develop and retain qualified personnel; the possibility of decline in purchases from a few large customers of the Contractor segment; and variations in activity in the construction, automotive, mining and oil and natural gas industries. Please refer to Item 1A of our Annual Report on Form 10-K for fiscal year 2019 and Item 1A of this Form 10-Q for a more comprehensive discussion of these and other risk factors. These reports are available on the Company's website at www.graco.com and theSecurities and Exchange Commission's website at www.sec.gov. Shareholders, potential investors and other readers are urged to consider these factors in evaluating forward-looking statements and are cautioned not to place undue reliance on such forward-looking statements. 21
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Investors should realize that factors other than those identified above and in Item 1A might prove important to the Company's future results. It is not possible for management to identify each and every factor that may have an impact on the Company's operations in the future as new factors can develop from time to time.
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