Q4 2020 Graco Inc Earnings Call
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Good morning are local to the fourth quarter conference call for Graco, Inc. If you wish to access the replay for this call you may do so by dialing 8558592 056 within the United States or Canada.
Dial in number for international callers is for O for 5373 for zero six the.
The conference I'd number is 516 to 659 day replay will be available at their two P. M. Eastern time Tuesday February <unk>.
2021.
Great Girl has additional information available in the Powerpoint.
My presentation, which is available as part of the webcast player at the request on the company. We will open the conference up for questions and answers after the opening remarks from management there on this call.
Various remarks may be made by management about the expectations plans and prospects for the future.
His remarks constitute forward looking statements for the purposes of the Safe Harbor provisions of the private Securities Litigation Reform Act actual results may differ materially from those indicated as a result of various risk factors, including those identified in item one a other companies 2019 annual report.
On form 10-K and in item one a of the.
The company's most recent quarterly report on form 10-Q.
These reports are available on the company's website at Www Graco Dot com and the SEC's website at Www Dot S E C Dot Gov.
Looking forward statements reflect management's current views and speak only as of the time. They are made the company undertakes no obligation to update these statements in light of new information or future events I will now turn the conference over to Kathy Sean Rock Executive Vice President corporate controller.
Good morning, I'm here today, with Pat Mchale, and Mark Sheahan our.
Our conference call slides for them put debt on our website and provide additional information that may be helpful.
Sales totaled $470 million this quarter, an increase of 14% from the fourth quarter last year, and an increase of 12% at consistent translation rates.
Net earnings totaled $115 million for the quarter or 66 cents per diluted share.
After adjusting for the impact of excess tax benefits from stock option exercises net earnings totaled $106 million or 61 cents per diluted share.
Gross margin rates increased 130 basis points from last year's fourth quarter.
Realized pricing and foreign currency were favorable in the quarter.
Mix was also favorable as we saw the margin impact of sales growth in our higher margin industrial segment.
More than offset the continued strength in our lower margin contractor segment.
Operating expenses increased $7 million in the fourth quarter as compared to a year ago due to increases in sales and earnings based expenses and higher product development costs.
The reported income tax rate was 11% for the quarter down five percentage points from last year, primarily due to an increase in tax benefits related to stock option exercises.
After adjusting for the effect of stock option exercises our tax rate for the quarter was 18% slightly lower than the fourth quarter last year due to additional foreign income taxed at lower rates.
Cash flow from operations totaled $131 million in the fourth quarter and $394 million for the full year.
Discretionary cash outflows on the quarter included the final repayment of $125 million of the 250 million borrowed on our revolving credit facility on the first quarter.
We also made a voluntary contribution of $20 million to our U S pension plan.
For the full year 2020 dividends paid totaled $117 million and capital expenditures were $71 million.
A few comments as we look forward to 2021.
Based on current exchange rates and the same volume and mix of products and sales by currency. The effect of exchange is currently expected to benefit sales by 2% and earnings by 6% for the full year with the most significant impact coming in the first half.
Unallocated corporate expenses are projected to be $30 million and can vary by quarter.
The effective tax rate for the year is expected to be 18% to 19%.
Capital expenditures expenditures are expected to be 115 million, including 80 million for facility expansion projects.
We may make share repurchases in 2021 via opportunistic open market transactions or short dated accelerated share repurchase programs.
Finally, 2021 will be a 53 week year with the extra week occurring in the fourth quarter.
I'll turn the call over to Pat now for further comments.
Thank you Cathy good morning, everyone.
All of my comments this morning will be on an organic constant currency basis.
The second quarter on a roll of the contractor segment exceeded 30% growth and ended the year with record sales and earnings.
Contract or grew in all regions during the quarter and for the year.
Residential construction activity remained solid in the home improvement market robust cash.
Contract for North America saw strong out the door sales in both propane and home center and we continue to work hard to maintain adequate channel inventory.
The industrial segment grew mid single digits for the quarter.
Still ended the year down 10%.
Paired to the previous three quarters activity improved in some key end markets like spray for electronics and battery.
Access to industrial facilities remains limited with quoting activity has improved.
The Asia Pacific region was up versus last year's Q4, which was particularly weak.
Price realization solid factory performance and good expense management combined with improved sales resulted in strong industrial operating earnings for the quarter.
Process segment sales declined 10% for both the quarter and the year.
For a markets on our process segment remains challenged particularly those related to the vehicle lubrication or oil and gas sectors.
Heading into 2021, we expect challenging end market conditions to remain in place in our industrial and process segments for at least the first half of the year as Lockdowns persist and access to customers remains limited.
Our outlook for the contractor segment remains positive as favorable conditions continue and demand has been solid to start the year.
Thanks to our outstanding employees suppliers and distributor partners, we were able to keep our factories and distribution centers fully operational avoid layoffs and wage reductions and fully invest in our core long term growth strategies of new product development channel expansion and new markets.
A special thanks, as an order to our contractor employees and the employees from other factories, who relocated to the contractor factory to assist with the large demand spike in the second half.
From the sales team to the shop floor. The contractor team worked incredibly long hours maintained a positive attitude and we're committed to doing whatever it took to get the job done.
At your matters and they are winners.
We exited the year with momentum and look forward to the fight again this year.
Operator, we're ready for questions.
Thank you.
The question and answer session will begin at this time for your question will be taken in the order that is received please standby for your for for your first question.
Our first question on comes from the line of Deane Dray from RBC capital markets you may begin.
Thank you good morning, everyone, Hey, good morning Deane.
Can we start in contractor.
Just a couple things one is what's the visibility beyond the six weeks' average orders that you are giving which we appreciate but just what are kind of the data points are you using you say you expected to stay robust.
Your line of sight into that and then also you called out some mix issues and for segment, maybe you can clarify that too please.
The book and Bill business. So we're always interested every weekend, what's happening with incoming order rates. However, when you take a look at the macro residential construction it looks like it's going to remain in pretty good shape through 2021. So we expect to capitalize on that and at least currently what we're hearing and what we're seeing there doesn't appear.
To be a big pullback in what's happening with the home centers work from home business. So we feel like based upon the orders to start the year and what we're hearing in the marketplace that we've got a good shot of having a successful year on contractor. Despite the fact that we do have some very tough comps that we're gonna be up against as.
As we get into the peak that we hit this year in terms of the mix issue on contractor typically that's just a mix issue between selling more of the smaller units other than the larger units or home center business versus propane.
Alright, that's helpful. And then just as a follow up can you clarify for us on what the opportunity is in batteries I mean, when we talk to our auto analyst he keeps emphasizing all of the for growth in batteries and.
And capacity, that's coming on new technologies, and just remind us where and how it has great go play on that market.
Yeah, Deane, it's mark and we play in our industrial segment and areas, where customers are putting in new battery facilities and they're looking to use.
Fluid compounds to either do bonding of various components of the batteries themselves or we also get involved in what's called thermal interface materials, which are highly reactive abrasive materials that are put down to dissipate heat on batteries are actually being used and.
We have the equipment and the expertise to get involved in those applications along with our distributor partners to put together a nice packages.
For the end users so as long as there is demand for batteries, we expect that we're going to get a fair shot at being able to be involved in those opportunities.
Got it and if I could just squeeze one more question and can you talk about pricing expectations I know, it's at the beginning of the year is when you put through pricing.
What are the dynamics this year and anything on contribution from new products do you expect to launch pricing ought to be like it is typically a weak.
Generally put through a modest price increase each year and expect to realize somewhere in that one and a half maybe.
Maybe up to 2% realized pricing and I don't think this year is going to be really anything different on that we did not cut any of our new product investments for our new product programs. So we feel like our new product pipeline for 'twenty, one and even going into 'twenty two looks pretty good.
Thank you.
Okay.
Thank you. Our next question comes from Brian <unk> from Jefferies May begin.
Good morning, good morning.
Hearing that Theres, a lot of capital being spent on automation in China right now could you comment on what you're seeing there that drove the pick up in industrial and then do you think that Covid will increase the demand for more automation in factories globally.
So theres a lot of talk about COVID-19, increasing the demand for automation I think we saw the demand for automation trend that's been a multiyear trend that's really nothing new well will it add a little bit of <unk>.
<unk> for the fire for some folks I suppose that it probably will in terms of our Asia Pacific performance was good vis vis 2019, but I would remind you that we did have a pretty weak fourth quarter that we were comparing to so well business is improving there we definitely need to see strength globally to get maximum performance.
Out of China, because a lot of their work of course it gets exported.
Yeah.
Then last quarter I believe you talked about being surprised as industrial and process demand for that kind of moved together with process does seem to be lagging here. So do you expect sales to bounce back as we've seen in industrial.
Yeah, you know I would say that I was a little bit surprised but not terribly because within process.
Got some segments that have felt more pain than others, and particularly I referenced the vehicle services in the oil and gas industries and so they're actually taken the average in that price.
The segment down and so we need to see some recovery there.
And then if I could just one last question similar to the question on batteries, there's been a lot of talk on the auto industry about the amount of capital needed to support electric vehicles production have you looked into what that opportunity means for graco. Thank you.
Yeah, you know a lot of our applications in automotive are going to be the same whether the car is got.
Gas engine in a diesel engine in it or an electric motor in it.
We do a lot of seam sealing we do bonding we do sound deadening, we do anti flutter, we do light weighting activities I'm, obviously, we do finishing systems. So those aren't necessarily aren't driven by just what's happening with the drivetrain were trying to capitalize where we can in markets like battery that mark.
Gave you a nice summary on them and.
And we don't today and get a lot of work on the actual drivetrain itself, we don't sell a lot into direct drivetrain manufacturing. So I don't view the switch to electric vehicles is to being a major change in the business for graco.
Great. Thank you so much.
Thank you. Our next question will come for like a line of Mike Halloran from Baird you may begin.
Hey, good morning, everyone.
Mike.
Just a quick clarification on anything deemed last question two pet you're seeing price cost positive. It's still it still what you guys are angling despite the inflation.
And still thinking about on more normal price increase.
I talked about what I thought a realized price increase would be we are definitely seeing some commodity inflation.
And how that's all going to play out I'm not sure on with some volume I think our factories are going to perform so I feel pretty good on the overall cost side. Despite the fact that we will probably get some commodity pressure.
The other thing that I would point out is is that historically when we see commodity pressure we have good.
Years of good top line performance.
That tends to get a lot of things go on that are in our wheelhouse. So.
Well I'd love to have strong topline and commodity is getting weak typically we don't see that and I think it's actually a positive sign.
No. That's helpful and then maybe some context on the industrial segment.
Two things here, one sustainability of the momentum that you saw kind of sequentially through the quarter.
Obviously, a little different sequentially on the revenue line. This is what the order trend seems to be but maybe some thoughts there on any specifics on end markets auto anything else of size that you think is moving the needle one way or another.
Yeah, Mike.
This is temporal and industrial obviously did get better in Q4, but we.
We hope.
It continues here.
We get into the first half for the year profitability was way up as you saw in Q for some of that was due to just the fact that we had some lower spending as a result of Covid I would expect that as our teams get back out on the road and we start.
Re engaging with customers and moving around that we will be spending more and also.
The incentives for that particular segment haven't been great. This year with business being down so there's going to be a normal uptick in spending hopefully the volume tracks with that it should.
And that we're able to put up decent operating margin performance here in 'twenty one.
Helpful and then last one.
I'm sure the answer probably doesn't change a heck of a lot here, but just thoughts on the M&A environment from your perspective and action ability as you see it today.
Still expensive and while we'd like to do something bigger my guess is is what youll see is.
Niche type things that we can leverage into either existing businesses or that we think we can build on and I wouldnt anticipate in this environment that you should bank too much on anything big happening.
Makes sense. Thanks, guys appreciate it.
Thank you. Our next question on comes from the line of Bryan Blair from Oppenheimer you may begin.
Thanks, Good morning, everyone for you Brian morning.
A couple of follow up questions I apologize if I missed some of the detailing for.
Prior responses.
Starting with the industrial rebound in Asia Pacific Admittedly versus a <unk>.
Weak comp last year.
How much of that was driven by automotive left and how does that.
Second our momentum.
If we're correct and then read factor into the six week booking rates to kick off 2021.
Yeah, Brian we don't break out the automotive portion of the business. It's number one it's really hard to quantify it we sell through distribution that we don't exactly know where stuff goes.
And number two just for competitive reasons, we don't think it's a good thing to do if we had the data available. So I would characterize it as more of a broad based recovery across the industrial product categories.
As you mentioned.
The comparison was really pretty.
On a pretty low for them in Q4, I think last year industrial was down somewhere around 26 or 28% in Q4. So they made it come back and on a per.
Full year basis, Asia is down 1%, but for the full year last year for East Asia was down about 19% last year on a full year basis. So.
We're encouraged by the momentum that we're seeing.
But hopefully.
The business continues the temple stays and we should see decent year here in 2021.
Got it.
And then on process trends and then the areas of sustained pressure there.
And then you deliver occasion business in oil and gas.
On a.
I guess to address.
The second first.
Believe the oil and gas exposure is very modest so on your Alco divestiture is that.
Correct, and then with lubrication on I would assume that you have some sequential momentum there.
But perhaps on I'm overlooking the timing of spending and any color would be helpful. Yes. So we don't want to break out.
Sequential momentum by individual product line within a segment that just takes us in the no man's land. So I'm not going to go there on the oil and gas side, you're correct, our direct oil and gas exposure is not large.
However, indirect oil and gas exposure can be meaningful meaning that we sell on to industries that are also do well when oil and gas does well. So we would like to see some sustainability of that kind of the recent uptick in oil prices and I think if that can happen over a period of time, we will see some.
But then that should help us across a number of our business lines.
Okay I appreciate the color. Thanks again.
Okay.
And our next question comes from the line of Jeff Hammond from Keybanc you may begin.
Hey, good morning, good morning, good morning.
Just on contract or if you look at.
That's kind of the bookings.
Mix and what you're hearing from customers do you expect kind of the smaller on the home center to continue to be strong and weigh on mix or what are you thinking there.
Yeah, it's kind of hard to predict but I mean, that's what we've experienced recently.
I think debt.
In my time here at Graco I have never seen anything like we've seen here in the last six or eight months on many fronts.
And so we're not trying to predict the future and we withdrawn sort of our forward looking guidance, but.
What I'm hearing and what I'm seeing I believe that both.
The paint channel and the home Center channel.
Are likely to remain a favorable markets for us as we move through 'twenty one here.
Okay, Great and then.
Just on the six week booking back on industrial is that is that growth pretty broad based geographically or is that still being driven heavily by the Asia Pac.
Yes, I think it's I think it's more or less a broad base, Jeff I don't think I don't think there's any one particular region, that's standing out more than the others.
Okay. Thanks, a lot.
Okay.
And our next question comes from the line of Joe Ritchie from Goldman Sachs May begin.
Hi, Good morning, everyone. Good morning, Joe.
Hey, Pat maybe maybe just starting off can you just tell us a little bit about how your parts and accessories business trended throughout the quarter versus maybe like new equipment sales.
<unk> not looked right in line with how it always looks which is not surprising because that's how it always looks but.
I think we're fine there.
Okay. So I guess the question is really kind of trying to get a sense for whether maybe.
Maybe like break in Texas is.
Is is trending better than new but.
What I'm sensing is basically trending kind of in line with each other that is that the right way to think about it yeah and you can go back it's pretty amazing that you can go back in time on quarter by quarter and year by year end it doesn't vary for that point or two.
It's really pretty steady and I think there's there's more of that more reasons for that than just what's happening at the end market level you have to keep in mind that.
We ship our products pretty much same day, we have some products, we don't but the vast majority of our products in order comes in and then it gets shipped out so what the local distributors need to carry as they need to carry the service and repair parts that are needed to be able to take care of their customer and so they'll typically carry inventory on service parts and then they'll typically.
Or are the larger more expensive items on an as needed basis, So I think that kind of.
Kind of as an accumulator effect, a dampening effect on what we see in our parts and accessories business.
Because distributors carry stock.
Got it Okay, and then maybe just kind of following on that maybe just the margin question for for industrial like obviously, the incremental margin this quarter were extremely strong.
And you guys didn't take a lot of discretionary reactions in.
In 2020, you feel like I should be thinking about the incremental margin in industrial in 2021, Yeah, I'd say like what we've always said.
Joe if we can get that you know mid single digit or higher topline growth rate, we should be in the above 40% incremental margins for that business that segment.
Okay was there any was there anything unusual that impacted.
The fourth quarter, because you were in that mid single digit range, but that the incrementals, but were much stronger than that yeah. I think the biggest the biggest couple of things I had mentioned one currency definitely help on the gross margin line, but also just the absolute level of spending that we had and the fact that we didn't have as much volume in.
Earnings based expenses in the P&L in Q4 versus what we would have had a year ago I think those are the major factors.
Got it great and if I could maybe sneak one more.
A weak year.
Just sales and margin impact.
Impact I mean is it just.
Simple as thinking like a two point impact on sales and you know.
Is it any impact on margins from on the extra week I'm going to jump back for a second to your prior question on just in general when you're looking at our different segments.
Looking at the.
Incremental margins quarter to quarter, I think is less instructive and looking at them on an annual basis, because lots of things can make them jump around so I think if you're really trying to figure out what's going out the incremental margins you will serve yourself well by looking at the kind of the annual numbers on your second question. The 50 <unk> week, that's always a big debate internally here to what is that.
At 50, <unk> week worth is it worth two days were five days, which which days are they and are they busy business days are there between Christmas and new year's so you know.
I can't give you an actual answer on that and if you ask five business leaders at graco, you'd probably get five little bit different answer so it's probably somewhere between one for 1% to 2% on the top line.
Okay. Thanks, Thanks, guys.
And our next question on the top line of Matt Summerville from D. A Davidson you may begin.
Thanks. Good morning, just one question here most of mine have been answered as we think about.
Is there a way to think about how much lack of accessibility to facilities is hindered Greg those top line and the reason I ask is in the context of theoretically this vaccine sort of ramps up maybe that tempers.
The the <unk>.
Accessibility issue for you guys and you see some release in pent up demand is there a way you guys are thinking about that.
I don't think it's measurable.
Meaning I don't think there's any way we can measure it.
Certainly, we believe that not getting our salespeople in front of customers.
It's hurting our top line, we don't get a chance to push the new products, we don't get to be proactive walking through factories looking for opportunities to.
Sell something that maybe the customer didn't even know that they wanted.
No you've got a lot of the engineering folks would be working from home, which I think is less effective so theres an impact there, but how to measure that I really have no idea I think debt.
To the extent debt, we start to see the world loosen up we're going to feel better about our opportunities and we should see debt in the topline, particularly in the industrial and that potentially the process segments and we're kind of looking towards maybe the back half of 'twenty one to see some more normalization as you've been watching on the news right now depending.
Upon where youre looking in the world there are different levels of loosening and tightening and it's really hard to predict really one month for the next so we're going to keep doing our job in a day.
The best we can but we would really like to have access to customers back to a more normal process.
At some point Pat.
I guess, what would you need to see in your business and it's great by the way did you give the sales cadence in the six week order data.
I really liked that granularity at some point do you think Greg Hill will get back to providing at least at a high level some sort of guidance framework and if so what do you need to see to be able to do that yes, I think it's likely that we will I'm not going to promise that we will but I think it's likely that we will but we just need to have confidence that.
What we're telling you is got something behind it and right now anybody who thinks that they can predict what the world is going to look like in three or four months is probably it's probably a coin flip for a swag or whatever and we tried to be a little bit more.
Finite with our guidance then just taking a guess so we're just going to hold off here and I think you have to make some macro calls when you take a look at the world and you take a look at what's happening with other industrial companies and what's happened with macro data on what's happening with Covid.
Try to make some some color on your own because from our standpoint, it's pretty much of a wildcard.
Got it thanks Pat.
Okay.
And our next call will come from the line of drew Borst from Banbury may begin.
Good morning, guys good morning.
I was hoping you could you can you can you give some indication.
Around margin expansion potential in 2021, because there's a lot of puts and takes on that costs are going up it seems like youre going to have.
Pricing offsetting some of that and then you're going to face really tough comps and contract or even on the margin side, So where I guess where is the juice.
For margin expansion next year for this year rather.
I think the positive view is with commodity prices going up typically that would indicate that things are going to be good on the industrial side of our business and obviously, we've got great incremental margins on the industrial side. What we saw in 2020 was the contractor growth really curate the organization lower overall margins.
And I really pressure on process industrial on the topline created some challenges for us on the operating margin. So I think as you see <unk>.
Australia process pop back Youre going to see those 40% plus kind of incremental operating margins that are going to drive nice profitability for graco I'd really like to see those in the.
High single digits, which would not be unusual at all for recovery.
Recovery in the past getting high single digit growth out of our industrial businesses. It's been something that we've seen I think it's more.
I have a question about when and if I expect it to come back, but I just don't know exactly when I'm. Obviously find short term are looking positive and we like that but I think theres still some uncertainty in the next half year or so here.
Yeah Okay.
Okay.
And you're on pad youre kind of in a pickle with.
Use of cash here because it sounds like M&A is tough valuation wise your stock's not exactly cheap. So you can't really a big buyback is probably unlikely I don't know where do you. How are you thinking about use of cash and.
You know with these with M&A would not would you guys be able to find some accretion just given kind of where you're at.
Where your evaluation is relative to other companies you're buying.
So I think one on the keys during times like this is to be patient, but we don't have you know.
I don't know how many here, but if I did it wouldn't be on fire right now because of the amount of cash that we have in the bank that provides us some nice opportunity to do something we continue to be active in looking for M&A opportunities I was just suggesting really that if you're building a model I wouldn't put it in there we're not going to go out and do something just because we have a pilot.
Cash our shareholders expect us to invest.
Invest that and get a good return and they don't expect us to go and just blow it off the balance sheet immediately on a poor return on investment went a little bit of patients could be an order. So we're gonna do like we've always done and we're gonna be opportunistic if we see opportunities to buy our stock back at what we think are.
Good good prices and we're going to look for M&A opportunities, we're going to invest back in the business and new product development and.
Automation and other cost reduction projects and the Graco recall program is going to continue and hopefully we'll continue to put up results like we have in the past, but I don't feel any urgency on it.
Alright got it thank you.
Yeah.
Thank you and our next question comes on line of Walter Liptak from Seaport Global maybe.
You may begin.
Hi, Thanks, Good morning, everyone. Good morning.
I wanted to ask you about industrial and I guess.
It's good to see these early signs of recovery, especially in the six week bookings number I wonder if as you looked at the data was there anything that stood out to you like geographically.
For by industrial sector.
Yeah.
Oh might give us some insight into what's going on.
Industrial sectors.
As Mark alluded to on an earlier question it seems to be spread out not just all concentrated in one spot.
And again when you see what's happening with the commodities that would kind of indicate that there is some some reason for optimism here. So we'll have to wait a little bit longer time before we're going to get bullish on it but I would say that we feel positive about where we're at versus where we were at six months ago.
Okay is it.
You know any thoughts about is this new capacity that's coming on line or is it capacity upgrades because of the new products.
Well the world has been producing but you know there's been some interesting dislocations out there in the marketplace and then there are of course have been.
Lots of.
Say unusual situations just in terms of.
Employees at work and what are they doing and you know I feel lucky for Graco as an organization. Our engineering groups have remained very active they've been they've been on site they've been getting the job done and we've been investing in capital equipment buying robots and automation, but certainly that hasn't been the case, they're even.
Lots of factories, where they're hanging in there and they're doing what they need to do to get by but theyre minimizing the number of resources that they have on the ground in depth.
Definitely puts a damper on industrial Capex so.
It's a it's a very unusual situation and it's pretty fluid and I'm not sure exactly what it's going to take to get it back, but I would say that debt.
The likelihood that a six months worth of vaccines changes things at least in key markets in Western Europe, and the U S. It seems to be favorable.
Okay.
Okay.
Just thinking about those six week orders again, you know as you look through those.
Is the timing of shipments stretched out.
Where is this stuff that it'll go in early in the year for.
Installation, so we have some businesses within industrial that have.
Brian on backlog and longer lead time, but.
I Havent parsed, the six week numbers. So I can't give you an exact thing but my sense is is that it looks pretty much like it typically does yeah and I would just add debt you know the.
Six weeks is a is a pretty short time period. So you know there is some danger involved and trying to extrapolate those numbers there's systems jobs in there there is some lumpiness both positive and negative so take it with a grain of salt.
Okay, well, it's good to see it so okay. Thanks guys. Okay.
Thank you.
Okay.
And if there are no further questions I will now turn the conference over to Pat Mchale.
Alright, well thanks, everybody for your participation.
Participation here today.
Thanks to all the employees for the great job that you did in the quarter and we're going to start 2021 out with a little bit of momentum and we're going to do our best to have a decent year. So on with that we'll sign off.
This concludes our conference for today. Thank you all for participating and have a.
A nice day all parties may now disconnect.
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Okay.
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[music].
Good morning, and welcome to the fourth quarter Conference call for Graco, Inc. If.
You wish to access the replay for this call you may do so by dialing 855859.
056, within the United States or Canada.
For a number for international callers is for O for 5373 for zero six the.
The conference I D number is 516 to 659.
A replay will be available at two P. M Eastern time Tuesday February <unk>.
2021.
Great go has additional information available in the Powerpoint.
My presentation, which is available as part of the webcast player at the request of the company. We will open the conference up for questions and answers after for opening remarks for management there on this call.
Remarks may be made by management about their expectations plans and prospects for the future.
These remarks constitute forward looking statements for the purposes of the Safe Harbor provisions of the private Securities Litigation Reform Act actual results may differ materially from those indicated as a result of various risk factors, including those identified in item one a other companies 2019 annually.
On form 10-K, and then item on a or the.
The company's most recent quarterly report on form 10-Q.
These reports are available on the company's website at Www Graco Dot com and the SEC's website at Www Dot E C Dot Gov.
Looking forward statements reflect management's current views and speak only as of the time. They are made the company undertakes no obligation to update these statements in light of the new information or future events I will now turn the conference over to Kathy <unk> Executive Vice President corporate controller.
Good morning, I'm here today, with Pat Mchale, and Mark Sheahan, Our conference call slides have been posted on our website and provide additional information that may be helpful.
Sales totaled $470 million this quarter, an increase of 14 per cent from the fourth quarter of last year, and an increase of 12% at consistent translation rates.
Net earnings totaled $115 million for the quarter or 66 cents per diluted share.
After adjusting for the impact of excess tax benefits from stock option exercises net earnings totaled 106 million or 61 cents per diluted share.
Gross margin rates increased 130 basis points from last year's fourth quarter.
Realized pricing and foreign currency were favorable in the quarter.
Mix was also favorable as we saw the margin impact on sales growth in our higher margin industrial segment.
More than offset the continued strength in our lower margin contractor segment.
Operating expenses increased $7 million in the fourth quarter as compared to a year ago due to increases in sales and earnings based expenses and higher product development costs.
The reported income tax rate was 11% for the quarter down five percentage points from last year, primarily due to an increase in tax benefits related to stock option exercises.
After adjusting for the effect of stock option exercises our tax rate for the quarter was 18% slightly lower than the fourth quarter last year due to additional foreign income taxed at lower rates.
Cash flow from operations total of $131 million in the fourth quarter and $394 million for the full year.
Discretionary cash outflows on the quarter included the final repayment of $125 million of the 250 million borrowed on our revolving credit facility on the first quarter.
We also made a voluntary contribution of $20 million to our U S pension plan.
For the full year of 2020 dividends paid totaled $117 million and capital expenditures were $71 million.
A few comments as we look forward to 2021.
Based on current exchange rates and the same volume and mix of products and sales by currency. The effect of exchange is currently expected to benefit sales by 2% and earnings by 6% for the full year with the most significant impact coming in the first half.
Unallocated corporate expenses are projected to be $30 million and can vary by quarter.
The effective tax rate for the year is expected to be 18% to 19%.
Capital expenditures expenditures are expected to be 115 million, including $80 million for facility expansion projects.
We may make share repurchases in 2021 via opportunistic open market transactions or short dated accelerated share repurchase programs.
Finally, 2021 will be a 53 week year with the extra week occurring in the fourth quarter.
I'll turn the call over to Pat now for further comments.
Thank you Cathy good morning, everyone.
All of my comments this morning will be on an organic constant currency basis.
The second quarter on a roll of the contractor segment exceeded 30% growth and ended the year with record sales and earnings contractor.
Contractor grew in all regions during the quarter and for the year.
Residential construction activity remains solid and the home improvement market robust.
Contract for North America saw strong out the door sales in both propane and home center and we continue to work hard to maintain adequate channel inventory.
The industrial segment grew mid single digits for the quarter, but still ended the year down 10%.
Compared to the previous three quarters activity improved in some key end markets like spray foam electronics and battery.
Access to industrial facilities remains limited for quoting activity has improved.
The Asia Pacific region was up versus last year's Q4, which was particularly weak.
Price realization solid factory performance and good expense management combined with improved sales resulted in strong industrial operating earnings for the quarter.
Process segment sales declined 10% for both the quarter and the year.
Number of markets on our process segment remained challenged particularly those related to the vehicle lubrication or oil and gas sectors.
Heading into 2021, we expect challenging end market conditions to remain in place and our industrial and process segments for at least the first half for the year as Lockdowns persist and access to customers remains limited.
Our outlook for the contractor segment remains positive as favorable conditions continue and demand has been solid to start for year.
Thanks to our outstanding employees suppliers and distributor partners, we were able to keep our factories and distribution centers fully operational avoid layoffs and wage reductions and fully invest in our core long term growth strategies of new product development channel expansion and new markets are.
A special thanks, as an order to our contractor employees and the employees from other factories, who relocated to the contractor factory to assist with the large demand spike in the second half.
From the sales team to the shop floor. The contractor team worked incredibly long hours.
On a positive attitude and we're committed to doing whatever it took to get the job done.
Culture matters and they are winners.
We exited the year with momentum and look forward to the fight again this year.
Operator, we're ready for questions.
Thank you.
Okay.
The question and answer session will begin at this time for your question will be taken in the order that is received please standby for your for for your first question.
Our first question on comes from the line of Deane Dray from RBC capital markets you may begin.
Thank you good morning, everyone, Hey, good morning Deane.
Can we start in contractor just a couple of things one is what's the visibility beyond the six weeks' average orders that you are giving which we appreciate but just what are your kind of the data points are you using you say you expected to stay robust.
Your line of sight into that and then also you called out some mix issues and per segment, maybe you can clarify that too. Please.
The book and Bill business. So we're always interested every weekend and what's happening with incoming order rates. However, when you take a look at the macro residential construction it looks like it's going to remain in pretty good shape through 2021. So we expect to capitalize on that and at least currently what we're hearing and what we're seeing there doesn't appear.
<unk> to be a big pullback in what's happening with the home centers work from home business. So we feel like based upon the orders to start the year and what we're hearing in the marketplace that we've got a good shot of having a successful year on contractor. Despite the fact that we do have some very tough comps that we're going to be up against as.
As we get into the peak that we hit this year in terms of the mix issue on contractor typically that's just a mix issue between selling more of the smaller units other than the larger units or home center business versus propane.
Alright, that's helpful. And then just as a follow up can you clarify for us on.
On what the opportunity is in batteries I mean, when we talk to our auto analyst he keeps emphasizing all the the growth in batteries Ah.
And capacity, that's coming on new technologies, and just remind us where and how it is Greg I'll play on that market.
Yes, Deane, it's mark and we play in our industrial segment and areas, where customers are putting in new battery facilities and they are looking to use.
Fluid compounds to either do bonding of various components of the batteries themselves or we also get involved in what's called thermal interface materials, which are highly reactive abrasive materials that are put down to dissipate heat on.
Batteries are actually being used and we have the equipment and the expertise to get involved in those applications along with our distributor partners to put together a nice packages.
For the end users so as long as there is demand for batteries, we expect that we're going to get a fair shot at being able to be involved in those opportunities.
Got it and if I could just squeeze one more question and can you talk about pricing expectations I know, it's at the beginning of the year is when you put through pricing.
What are the dynamics this year and anything on contribution from new products, you expect to launch pricing ought to be like it is typically we generally put through a modest price increase each year and expect to realize somewhere in that one and a half maybe.
Maybe up to 2% realized pricing and I don't think this year is going to be really anything different on that we did not cut any of our new product investments for our new product programs. So we feel like our new product pipeline for 'twenty, one and even going into 'twenty two looks pretty good.
Thank you.
Okay.
Thank you. Our next question will come from Ryan sorry for Jetski from Jefferies. You may begin.
Good morning, Good morning, where we're hearing that there's a lot of capital being spent on automation in China right now could you comment on what you're seeing there that drove the pick up in industrial and then do you think that Covid will increase the demand for more automation in factories globally.
So theres a lot of talk about COVID-19, increasing the demand for automation I think we saw the demand for automation trend that's been a multiyear trend that's really nothing new will add a little bit of <unk>.
Due to the fire for some folks I suppose that it probably will in terms of our Asia Pacific performance was good vis vis 2019, but I would remind you that we did have a pretty weak fourth quarter that we were comparing to so well business is improving there we definitely need to see strength globally to get the maximum performance.
Out of China, because a lot of their work of course gets exported.
Then last quarter I believe you talked about being surprised with industrial and process demand for that kind of moved together with process does seem to be lagging here. So do you expect sales to bounce back as we've seen in industrial.
Yeah, I would say that I was a little bit surprised but not terribly because within process. We've got some segments that have felt more pain than others, and particularly I referenced that vehicle services and oil and gas industries and so they're actually taken the average in that.
Process segment down and so we need to see some recovery there.
And then if I could just one last question similar to the question on batteries. There has been a lot of talk on the auto industry, but the amount of capital needed to support electric vehicles production have you looked into what that opportunity means for graco. Thank you.
Yeah, you know a lot of our applications in automotive are going to be the same whether the car has got.
Gas engine in a diesel engine in it or an electric motor in it.
We do a lot of seam sealing we do bonding we do sound deadening, we do anti flutter, we do light weighting activities. Obviously, we do finishing systems. So those necessarily aren't driven by just what's happening with the drivetrain were trying to capitalize where we can end markets like battery that mark.
Give you a nice summary on.
And we don't today and get a lot of work on the actual drive train itself, we don't sell a lot into direct drivetrain manufacturing. So I don't view the switch to electric vehicles is to being a major change in the business for graco.
Great. Thank you so much.
Thank you. Our next question will come for like a line of Mike Halloran from Baird you may begin.
Good morning, everyone.
Mike.
Hey, just a quick clarification on other games last question, you're seeing price cost positive. It's still it still what you guys are angling despite the inflation.
And still thinking about it on more normal price increase.
I talked about what I thought a realized price increase would be we are definitely seeing some commodity inflation.
And how that's all going to play out I'm not sure on with some volume I think our factories are going to perform so I feel pretty good on the overall cost side. Despite the fact that we will probably get some commodity pressure.
The other thing that I would point out is is that historically when we see commodity pressure we have good.
Years of good top line performance on.
That tends to get a lot of things go on that are in our wheelhouse. So while I would love to have strong topline and commodity is getting weak typically we don't see that and I think it's actually a positive sign.
No. That's helpful and then maybe some context on the industrial segment.
With two things here one is sustainability of the momentum that you saw kind of sequentially through the quarter.
Little different sequentially on the revenue line. This is what the order trend seems to be but maybe some thoughts there on any specifics on the end markets auto anything else of size that you think is moving the needle one way or another.
Yeah, Mike.
Business tempo in industrial obviously did get better in Q4, but.
We hope.
It continues here as we get into the first half of the year profitability was way up as you saw in Q for some of that was due to just the fact that we had some lower spending as a result of Covid I would expect debt as our teams get back out on the road and we start re engaging.
Aging with customers and moving around that we will be spending more and also.
The incentives for that particular segment haven't been great. This year with business being down so theres going to be a normal uptick in spending hopefully the volume tracks with that it should.
And that we're able to put up decent operating margin performance here in 'twenty one.
Helpful and then last one.
When should you answered probably doesn't change a heck of a lot here, but just thoughts on the M&A environment from your perspective.
Action ability as you see it today.
Still expense sales and while we'd like to do something bigger my guess is is what youll see is a.
Niche type things that we can leverage into either existing businesses or that we think we can build on and I wouldnt anticipate in this environment that you should bank too much on anything big happening.
Makes sense. Thanks, guys appreciate it.
Thank you our next.
Next question on comes from the line of Bryan Blair from Oppenheimer, you may begin.
Thanks, Good morning, everyone.
Good morning.
A couple of follow up questions I apologize if I missed some of the detail on prior responses.
Starting with the industrial rebound in Asia Pacific Admittedly versus a week.
Weak comp last year.
How much of that was driven by automotive left and how does that.
Second our momentum.
If we're correct and then read factor into the six week booking rates to kick off 2021.
Yeah, Brian we don't break out the automotive portion of the business. It's number one it's really hard to quantify it we sell through distribution that we don't exactly know where stuff goes.
For two just for competitive reasons, we don't think it's a good thing to do if we have the data available. So I would characterize it as more of a broad based recovery across the industrial product categories.
As you mentioned.
The comparison was really pretty.
Pretty low for them in Q4, I think last year industrial was down somewhere around 26 or 28% in Q4, so they made it come back.
And on a full year basis Asia is down 1%, but for the full year last year for each.
Asia was down about 19% last year on a full year basis. So.
We're encouraged by the momentum that we're seeing.
But hopefully.
The business continues the temple stays and we should see decent year here in 2021.
Got it.
And then on process trends and then the areas of sustained pressure there.
The lubrication business on an oil and gas.
E.
I guess to address.
The second.
First I'd like to leave the oil and gas exposure is very modest zone.
On your Alco divestiture is that.
Correct, and then with lubrication on I would assume that you have some sequential momentum there, but perhaps on I'm overlooking the timing of spending and any color would be helpful. Yes. So we don't want to break out the sequential momentum by individual product line within a segment that just takes us in the no man's land, so I'm not going to go there on the oil and gas.
Youre correct, our direct oil and gas exposure is not large.
However, indirect oil and gas exposure can be meaningful meaning that we sell on the industries that are also do well when oil and gas does well. So we would like to see some sustainability of that kind of the recent uptick in oil prices and I think if that can happen over a period of time, we'll see some reinvest.
<unk> that should help us across.
A number of our business lines.
Okay I appreciate the color. Thanks again.
Yes.
And our next question will come from the line of Jeff Hammond from Keybanc you may begin.
Hey, good morning, good morning, good morning.
Just on contract or if you look.
That's kind of the bookings.
Mix and what Youre hearing from customers do you expect kind of the smaller on the home center to continue to be strong and weigh on mix or what are you thinking there.
Yes, it's kind of hard to predict but I mean, that's what we've experienced recently.
I think that.
In my time here at Graco I have never seen anything like we've seen here in the last six or eight months on many fronts.
And so we're not trying to predict the future and we withdrawn sort of our forward looking guidance, but.
What I am hearing and what I'm seeing I believe that both.
The paint channel and the home Center channel.
Are likely to remain a favorable markets for us as we move through 'twenty one here.
Okay, Great and then.
Just on the six week booking back on industrial is that is that growth pretty broad based geographically or is that still being driven heavily by the Asia Pac.
Yes, I think it's I think it's more or less broad base, Jeff I don't think I don't think Theres any one particular region, that's standing out more than the others.
Okay. Thanks, a lot.
And our next question comes from the line of Joe Ritchie from Goldman Sachs May begin.
Hi, good morning, everyone.
Hey, Joe.
Hey, Pat maybe maybe just starting off can you just tell us a little bit about how your parts and accessories business trended throughout the quarter versus maybe like new equipment sales.
<unk> not looked right in line with how it always looks which is not surprising because thats, how it always looks but.
I think we're fine there.
Okay. So I guess the question is really trying to trying to get a sense for whether.
Maybe like break in Texas.
Is is trending better than new but.
What I'm sensing is is basically trending kind of in line with each other that is that the right way to think about it yeah and you can go back it's pretty amazing that you can go back in time on quarter by quarter and year by year end it doesn't vary for that point or two.
It's really pretty steady and I think there is there's more of that more reasons for that and just what's happening at the end market level you have to keep in mind that.
We ship our products pretty much same day, we have some products, we don't but the vast majority of our products in order comes in and it gets shipped out so what debt local distributors need to carry as they need to carry the service and repair parts that are needed to be able to take care of their customers and so they'll typically carry inventory on service parts and then they'll typically.
Or are the larger more expensive items on an as needed basis.
So I think that kind of.
Kind of as an accumulator effect, a dampening effect on what we see in our parts and accessories business.
Because distributors carry stock.
Got it Okay, and then maybe just kind of following on that maybe just a margin question for for industrial like obviously, the incremental margins this quarter were extremely strong.
And you guys didn't take a lot of discretionary actions in.
In 2020, you feel like I should be thinking about the incremental margin in industrial in 2021, Yeah, I'd say like what we've always said.
Joe if we can get that.
Mid single digit or higher topline growth rate, we should be in the above 40% incremental margins for that business that segment.
Okay.
There anything unusual that impacted.
The fourth quarter, because you were in that mid single digit range, but that the incrementals, but were much stronger than that yeah. I think the biggest the biggest couple of things I had mentioned one currency definitely help on the gross margin line, but also just the absolute level of spending that we had.
And the fact that we didn't have as much volume in.
Earnings based expenses in the P&L in Q4 versus what we would've had a year ago I think those are the major factors.
Got it great and if I could maybe sneak one more.
Every week year, I guess, just sales and margins.
<unk>.
It just as simple as thinking like a two point impact in sales and.
Is it any impact on margins from the extra week I'm going to jump back for a second to your prior question on just in general when you are looking at our different segments.
Looking at the.
Incremental margins quarter to quarter, I think is less instructive and looking at them on a annual rate basis, because lots of things can make them jump around so I think if you're really trying to figure out what's going on with incremental margins youll serve yourself well by looking at the kind of the annual numbers on your second question. The 50 <unk> week.
Always a big debate internally here to what is that 50 <unk> week worth is it worth two days were five days, which which days are they and are they busy business days or a day between Christmas and new year's so.
I can't give you an actual answer on that and if you ask five business leaders at graco, you'd probably get five little bit different answers, so probably somewhere between one for 1% and 2% on the top line.
Okay. Thanks, Thanks, guys.
And our next question on the top line of Matt Summerville from D. A Davidson you may begin.
Thanks. Good morning, just one question here most of them on been answered as we think about.
Is there a way to think about how much lack of accessibility to facilities is hindered Greg those top line and the reason I ask is in the context of theoretically this vaccine sort of ramps up maybe that tempers.
The <unk>.
Accessibility issue for you guys and you see some release in pent up demand is there a way you guys are thinking about that.
I don't think it's measurable.
Meaning I don't think there's any way we can measure it.
Certainly, we believe that not getting our salespeople in front of customers.
Is hurting our top line, we don't get a chance to push the new products, we don't get to be proactive walking through factories looking for opportunities.
Sell something that maybe the customer didn't even know that they wanted.
<unk> got a lot of the engineering folks would be working from home, which I think is less effective. So there is an impact there, but how to measure that I really have no idea I think debt.
To the extent debt, we start to see the world loosen up we're going to feel better about our opportunities and we should see debt in the top line, particularly in the industrial and that potentially the process segments and we're kind of looking towards maybe the back half of 'twenty one to see some more normalization as you've been watching on the news right now depending on.
On where youre looking in the world there are different levels of loosening and tightening and it's really hard to predict really one month for the next so.
And it keeps doing our job then.
Do the best we can but we would really like to have access to customers back to a more normal process.
At some point Pat.
I guess, what would you need to see in your business and it's great by the way did you give the sales cadence in the six week order data.
I really liked that granularity at some point do you think great. So we'll get back to providing at least at a high level some sort of guidance framework and if so what do you need to see to be able to do that yeah. I think it's likely that we will I'm not going to promise that we will but I think it is likely that we will but.
But we just need to have confidence that what we're telling you as got something behind it and right now anybody who thinks that they can.
Predicting what the world is going to look like in three or four months is probably it's probably a coin flip for a swag or whatever and we tried to be a little bit more.
Finite with our guidance then just taking a guess so we're just going to hold off year and I think you have to make some macro calls when you take a look at the world and you take a look at what is happening with other industrial companies and what's happened with macro data on what's happening with Covid and try to make some some call it on your own because.
From our standpoint, it's pretty much of a wildcard.
Got it thanks Pat.
And on Mexico will come from the line of drove US comment on Banbury may begin.
Good morning, guys good morning.
Hoping you could.
Yes can you can you give some indication.
Around margin expansion potential in 2021, because there's a lot of puts and takes on that costs are going up it seems like youre going to have.
Pricing offsetting some of that and you're going to face really tough comps and contract or even on the margin side for where I guess where is the juice.
For margin expansion next year or this year rather.
I think the positive view is with commodity prices going up typically that would indicate that things are going to be good on the industrial side of our business and obviously, we've got great incremental margins on the industrial side. What we saw in 2020 was the contractor growth really carried the organization lower overall margins.
And I really pressure on process industrial on the topline created some challenges for us on the operating margin. So I think as you see industrial and process pop back youre going to see those 40% plus kind of incremental operating margins that are going to drive nice profitability for graco I'd really like to see those.
On the.
High single digits, which would not be unusual at all for recovery and we see recovery in the past getting high single digit growth out of our industrial businesses. It's been something that we've seen I think it's more of a question about when if I expect it to come back, but I just don't know exactly when obviously.
So on short term are looking positive and we like that but I think theres still some uncertainty in the next half year. So here.
Yes, okay.
Okay.
And on pad, you're kind of in a pickle with.
Use of cash here, because you know it sounds like M&A is tough valuation wise.
Not exactly cheap so you can't really a big buyback is probably unlikely.
Where do you how are you thinking about use of cash and.
With these with M&A would not would you guys be able to find some accretion just given kind of where you're at.
Where your evaluation is relative to the companies are buying.
So I think for one of the keys during times like this is to be patient we don't have.
I don't have any here, but if I did it won't be on fire right now because of the amount of cash that we have in the in the bank that provides us some nice opportunity to do something we continue to be active in looking for M&A opportunities I was just suggesting really debt if youre building a model I wouldn't put it in there.
We're not going to go out and do something just because we have a pile of cash our shareholders expect us to invest.
Invest that and get a good return and.
I don't expect us to go and just blow it off the balance sheet immediately on a poor return on investment went a little bit of patients could be an order. So we're going to do like we've always done and we're going to be opportunistic if we see opportunities to buy our stock back at what we think are.
Good good prices and we're going to look for M&A opportunities, we're going to invest back in the business and new product development and automation and other cost reduction projects and the Graco recall program is going to continue and hopefully we'll continue to put up results like we have in the past, but I don't feel any urgency on it.
Alright got it thank you.
Thank you and our next question comes on line of Walter Liptak from Seaport Global.
You may begin.
Hi, Thanks, Good morning, everyone. Good morning, good morning morning.
Wanted to ask about industrial and I guess the.
Good to see these early signs of recovery, especially in the six week bookings number I wonder as you looked at the data was there anything that stood out to you like geographically.
Or by industrial sector.
Yeah.
No.
It might give us some insight into what's going on.
Just real sectors.
As Mark alluded to on an earlier question it seems to be spread out not just all concentrated in one spot and again when you see what's happening with the commodities that would kind of indicate that there is some some reason for optimism here. So we'll have to we need a little bit longer time, before we're going to get bullish on it but I.
Would say that we feel positive about where we're at versus where we were at six months ago.
Okay.
It.
Any thoughts about is this new capacity, that's coming on line or is it capacity upgrades because of the new products.
For the World has been producing but there's been some interesting dislocations out there in the marketplace and then there are of course have been lots.
Lots of.
I'll say unusual situations just in terms of <unk>.
Employees at work and what are they doing and I feel lucky for Graco as an organization. Our engineering groups have remained very active they've been they've been on site they've been getting the job done we've been investing in capital equipment buying robots and automation, but certainly that hasn't been the case there have been.
Lots of factories, where theyre hanging in there and they're doing what they need to do to get by but theyre minimizing the number of resources that they have on the ground in.
Definitely puts a damper on industrial Capex so.
It's a it's a very unusual situation and it's pretty fluid.
And I'm not sure exactly what it's going to take to get it back, but I would say that.
Likelihood that is six months worth of vaccines changes things at least in key markets in Western Europe, and the U S seems to be favorable.
Okay.
Just thinking about the six week orders again as you look through those.
Is the timing of shipments stretched out.
Where is this stuff that will go in early in the year.
For installation so we have some businesses within industrial that have.
Ron on backlog and longer lead time, but.
I I Havent parsed, the six week numbers. So I can't give you an exact thing but my sense is is that it looks pretty much like it typically does yeah and I would just add debt.
Six weeks is a is a pretty short time period. So you know there.
There is some danger involved and trying to extrapolate those numbers there's systems jobs in there there is some lumpiness both positive and negative so take it with a grain of salt.
Okay, well, it's good to see it so okay. Thanks guys. Okay.
Thank you.
Okay.
And if there are no further questions I will now turn the conference over to Pat Mchale.
Alright, well thanks, everybody for your.
Participation here today.
Thanks for all the employees for the great job that you did in the quarter and we're going to start 2021 out with a little bit on momentum and we're going to do our best to have a decent year zone with that we'll sign off.
This concludes our conference for today. Thank you all for participating and have a.
A nice day all parties may now disconnect.